dna-10q_0307.htm
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
________________________
FORM
10-Q
________________________
|
(Mark
One)
|
|
|
þ
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
For
the quarterly period ended September 30,
2007
|
| |
|
or
|
|
o
|
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
(State
or other jurisdiction of incorporation or organization)
|
94-2347624
(I.R.S.
Employer 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 þ No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
|
Large
accelerated filer þ
|
Accelerated
filer o
|
Non-accelerated
filer o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
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
|
1,053,091,492 Outstanding
at October 26, 2007
|
GENENTECH,
INC.
TABLE
OF CONTENTS
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Page
No.
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Item
1.
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3
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3
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4
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5
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6–15
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16
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Item
2.
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16–41
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Item
3.
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42
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Item
4.
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42
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Item
1.
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43
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Item
1A.
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43–55
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Item
2.
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55
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Item
6.
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56
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57
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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 of which was redeemed by Roche Holdings,
Inc. (RHI) on June 30, 1999.
We
own or have rights to various copyrights, trademarks, and trade names used
in
our business, including the following: Activase® (alteplase, recombinant)
tissue-plasminogen activator; Avastin® (bevacizumab) anti-VEGF antibody;
Cathflo® Activase® (alteplase for catheter clearance); Herceptin® (trastuzumab)
anti-HER2 antibody; Lucentis® (ranibizumab, rhuFab V2) anti-VEGF antibody
fragment; Nutropin® (somatropin [rDNA origin] for injection) growth hormone;
Nutropin AQ® and Nutropin AQ Pen® (somatropin [rDNA origin] for injection)
liquid formulation growth hormone; Pulmozyme® (dornase alfa, recombinant)
inhalation solution; Raptiva® (efalizumab) anti-CD11a antibody; and TNKase®
(tenecteplase) single-bolus thrombolytic agent. Rituxan® (rituximab) anti-CD20
antibody is a registered trademark of Biogen Idec Inc.; Tarceva® (erlotinib) is
a trademark of OSI Pharmaceuticals, Inc.; and Xolair® (omalizumab) anti-IgE
antibody is a trademark of Novartis AG. This report also includes other
trademarks, service marks, and trade names of other companies.
GENENTECH,
INC.
(In
millions, except per share amounts)
(Unaudited)
| |
|
Three
Months
|
|
|
Nine
Months
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales (including amounts from related parties:
three
months—2007–$137;
2006–$87;
nine
months—2007–$659; 2006–$220)
|
|
$ |
2,321
|
|
|
$ |
1,941
|
|
|
$ |
7,094
|
|
|
$ |
5,395
|
|
|
Royalties
(including amounts from related parties:
three
months—2007–$357; 2006–$230;
nine
months—2007–$914; 2006–$603)
|
|
|
524
|
|
|
|
364
|
|
|
|
1,427
|
|
|
|
966
|
|
|
Contract
revenue (including amounts from related parties:
three
months—2007–$30; 2006–$52;
nine
months—2007–$134; 2006–$114)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
operating revenue
|
|
|
2,908
|
|
|
|
2,384
|
|
|
|
8,755
|
|
|
|
6,569
|
|
|
Costs
and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales (including amounts for related parties:
three
months—2007–$100; 2006–$63;
nine
months—2007–$365; 2006–$178)
|
|
|
406
|
|
|
|
297
|
|
|
|
1,227
|
|
|
|
843
|
|
|
Research
and development (associated
with related party collaborations:
three
months—2007–$75; 2006–$62;
nine
months—2007–$222; 2006–$179)
(including
amounts
where reimbursement was recorded as contract revenue:
three
months—2007–$49; 2006–$48;
nine
months—2007–$154; 2006–$135)
|
|
|
615
|
|
|
|
454
|
|
|
|
1,828
|
|
|
|
1,218
|
|
|
Marketing,
general and administrative
|
|
|
541
|
|
|
|
501
|
|
|
|
1,564
|
|
|
|
1,414
|
|
|
Collaboration
profit sharing (including related party amounts:
three
months—2007–$47; 2006–$46;
nine
months—2007–$143; 2006–$137)
|
|
|
276
|
|
|
|
250
|
|
|
|
805
|
|
|
|
735
|
|
|
Write-off
of in-process research and development related to
acquisition
|
|
|
77
|
|
|
|
–
|
|
|
|
77
|
|
|
|
–
|
|
|
Gain
on acquisition
|
|
|
(121 |
) |
|
|
–
|
|
|
|
(121 |
) |
|
|
–
|
|
|
Recurring
charges related to redemption and acquisition
|
|
|
38
|
|
|
|
26
|
|
|
|
90
|
|
|
|
79
|
|
|
Special
items: litigation related
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
costs and expenses
|
|
|
1,846
|
|
|
|
1,541
|
|
|
|
5,511
|
|
|
|
4,329
|
|
|
Operating
income
|
|
|
1,062
|
|
|
|
843
|
|
|
|
3,244
|
|
|
|
2,240
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income, net
|
|
|
84
|
|
|
|
74
|
|
|
|
233
|
|
|
|
249
|
|
|
Interest
expense
|
|
|
(18 |
) |
|
|
(19 |
) |
|
|
(53 |
) |
|
|
(56 |
) |
|
Total
other income, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before taxes
|
|
|
1,128
|
|
|
|
898
|
|
|
|
3,424
|
|
|
|
2,433
|
|
|
Income
tax provision
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Earnings
per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Diluted
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Shares
used to compute basic earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares
used to compute diluted earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(In
millions)
(Unaudited)
| |
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
2,138
|
|
|
$ |
1,519
|
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
345
|
|
|
|
298
|
|
|
Employee
stock-based compensation
|
|
|
300
|
|
|
|
225
|
|
|
In-process
research and development
|
|
|
77
|
|
|
|
–
|
|
|
Gain
on acquisition
|
|
|
(121 |
) |
|
|
–
|
|
|
Deferred
income taxes
|
|
|
(116 |
) |
|
|
(86 |
) |
|
Deferred
revenue
|
|
|
(50 |
) |
|
|
(13 |
) |
|
Litigation-related
liabilities
|
|
|
39
|
|
|
|
39
|
|
|
Excess
tax benefit from stock-based compensation arrangements
|
|
|
(160 |
) |
|
|
(142 |
) |
|
Gain
on sales of securities available-for-sale and other, net
|
|
|
(15 |
) |
|
|
(76 |
) |
|
Write-down
of securities available-for-sale and other
|
|
|
4
|
|
|
|
1
|
|
|
Loss
on property and equipment dispositions
|
|
|
30
|
|
|
|
–
|
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Receivables
and other current assets
|
|
|
(236 |
) |
|
|
(423 |
) |
|
Inventories
|
|
|
(238 |
) |
|
|
(311 |
) |
|
Investments
in trading securities
|
|
|
(140 |
) |
|
|
(26 |
) |
|
Accounts
payable, other accrued liabilities, and other long-term
liabilities
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
|
2,073
|
|
|
|
1,316
|
|
| |
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
Purchases
of securities available-for-sale
|
|
|
(622 |
) |
|
|
(1,078 |
) |
|
Proceeds
from sales of securities available-for-sale
|
|
|
482
|
|
|
|
366
|
|
|
Proceeds
from maturities of securities available-for-sale
|
|
|
358
|
|
|
|
297
|
|
|
Capital
expenditures
|
|
|
(692 |
) |
|
|
(888 |
) |
|
Change
in other intangible and long-term assets
|
|
|
(39 |
) |
|
|
24
|
|
|
Transfer
to restricted cash
|
|
|
–
|
|
|
|
(53 |
) |
|
Acquisition
and related costs, net
|
|
|
(833 |
) |
|
|
|
|
|
Net
cash used in investing activities
|
|
|
(1,346 |
) |
|
|
(1,332 |
) |
| |
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
|
Stock
issuances
|
|
|
381
|
|
|
|
286
|
|
|
Stock
repurchases
|
|
|
(815 |
) |
|
|
(758 |
) |
|
Excess
tax benefit from stock-based compensation arrangements
|
|
|
|
|
|
|
|
|
|
Net
cash used in financing activities
|
|
|
(274 |
) |
|
|
(330 |
) |
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
453
|
|
|
|
(346 |
) |
|
Cash
and cash equivalents at beginning of period
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents at end of period
|
|
$ |
|
|
|
$ |
|
|
| |
|
|
|
|
|
|
|
|
|
Supplemental
cash flow data
|
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
|
Interest
|
|
$ |
71
|
|
|
$ |
77
|
|
|
Income
taxes
|
|
|
1,277
|
|
|
|
851
|
|
|
Non-cash
investing and financing activities
|
|
|
|
|
|
|
|
|
|
Capitalization
of construction in progress related to financing lease
transactions
|
|
|
156
|
|
|
|
84
|
|
|
Deferral
of royalty revenue associated with the acquisition of Tanox,
Inc.
|
|
|
(185 |
) |
|
|
–
|
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(In
millions)
(Unaudited)
| |
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
1,703
|
|
|
$ |
1,250
|
|
|
Short-term
investments
|
|
|
1,217
|
|
|
|
1,243
|
|
|
Accounts
receivable—product sales (net of allowances of:
2007–$109;
2006–$92; including amounts from related parties:
2007–$42;
2006–$57)
|
|
|
1,012
|
|
|
|
965
|
|
|
Accounts
receivable—royalties (including amounts from related
parties:
2007–$581;
2006–$316)
|
|
|
716
|
|
|
|
453
|
|
|
Accounts
receivable—other (including amounts from related parties:
2007–$123;
2006–$150)
|
|
|
185
|
|
|
|
248
|
|
|
Inventories
|
|
|
1,425
|
|
|
|
1,178
|
|
|
Deferred
tax assets
|
|
|
292
|
|
|
|
278
|
|
|
Prepaid
expenses and other current assets
|
|
|
|
|
|
|
|
|
|
Total
current assets
|
|
|
6,671
|
|
|
|
5,704
|
|
|
Long-term
marketable debt and equity securities
|
|
|
1,952
|
|
|
|
1,832
|
|
|
Property,
plant and equipment, net
|
|
|
4,758
|
|
|
|
4,173
|
|
|
Goodwill
|
|
|
1,574
|
|
|
|
1,315
|
|
|
Other
intangible assets
|
|
|
1,208
|
|
|
|
476
|
|
|
Restricted
cash and investments
|
|
|
788
|
|
|
|
788
|
|
|
Other
long-term assets
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$ |
|
|
|
$ |
|
|
| |
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
|
|
Accounts
payable (including amounts to related parties:
2007–$8;
2006–$7)
|
|
$ |
283
|
|
|
$ |
346
|
|
|
Deferred
revenue
|
|
|
44
|
|
|
|
62
|
|
|
Taxes
payable
|
|
|
67
|
|
|
|
111
|
|
|
Other
accrued liabilities (including amounts to related
parties:
2007–$220;
2006–$136)
|
|
|
|
|
|
|
|
|
|
Total
current liabilities
|
|
|
2,056
|
|
|
|
2,010
|
|
|
Long-term
debt
|
|
|
2,346
|
|
|
|
2,204
|
|
|
Deferred
revenue
|
|
|
353
|
|
|
|
199
|
|
|
Litigation-related
and other long-term liabilities
|
|
|
|
|
|
|
|
|
|
Total
liabilities
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
21
|
|
|
|
21
|
|
|
Additional
paid-in capital
|
|
|
10,842
|
|
|
|
10,091
|
|
|
Accumulated
other comprehensive income
|
|
|
212
|
|
|
|
204
|
|
|
Retained
earnings (accumulated deficit) since June 30, 1999
|
|
|
|
|
|
|
(838 |
) |
|
Total
stockholders’ equity
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$ |
|
|
|
$ |
|
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(Unaudited)
|
Note
1.
|
Summary
of Significant Accounting
Policies
|
Basis
of Presentation
We
prepared the Condensed Consolidated Financial Statements following the
requirements of the United States (U.S.) Securities and Exchange Commission
for
interim reporting. As permitted under those rules, certain footnotes or other
financial information that is normally required by U.S. generally accepted
accounting principles (GAAP) can be condensed or omitted. The information
included in this Quarterly Report on Form 10-Q should be read in conjunction
with the Consolidated Financial Statements and accompanying notes included
in
our Annual Report on Form 10-K for the year ended December 31, 2006. In the
opinion of management, the financial statements include all adjustments,
consisting only of normal and recurring adjustments, considered necessary for
the fair presentation of our financial position and operating
results.
Revenue,
expenses, assets, and liabilities can vary during each quarter of the year.
Therefore, the results and trends in these interim financial statements may
not
be the same as those expected for the full year or any future
period.
Principles
of Consolidation
The
consolidated financial statements include the accounts of Genentech and all
wholly owned subsidiaries. Following the completion of our acquisition of Tanox,
Inc. on August 2, 2007, the financial results of Tanox’s operations have been
included in the consolidated financial results of Genentech. Material
intercompany accounts and transactions have been eliminated.
Use
of Estimates and Reclassifications
The
preparation of financial statements in conformity with GAAP requires management
to make judgments, assumptions, and estimates that affect the amounts reported
in our Condensed Consolidated Financial Statements and accompanying notes.
Actual results could differ materially from those estimates.
Certain
reclassifications of prior period amounts have been made to our Condensed
Consolidated Financial Statements to conform to the current period
presentation.
Recent
Accounting Pronouncements
On
January 1, 2007, we adopted Emerging Issues Task Force (EITF) Issue No. 06-2,
“Accounting for Sabbatical Leave and Other Similar Benefits
Pursuant to FASB Statement No. 43, Accounting for Compensated
Absences” (EITF 06-2). Prior to the adoption of EITF 06-2, we
recorded a liability for a sabbatical leave when the employee vested in the
benefit, which was only at the end of a six-year service period. Under EITF
06-2, we accrue an estimated liability for a sabbatical leave over the requisite
six-year service period, as the employee’s services are rendered. Upon our
adoption of EITF 06-2, we recorded an adjustment to retained earnings
(accumulated deficit) of $26 million, net of tax, as a cumulative effect of
a
change in accounting principle.
We
adopted the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (FIN 48), on January 1, 2007. Implementation of FIN 48 did
not result in a cumulative adjustment to retained earnings (accumulated
deficit). The total amount of unrecognized tax benefits as of the date of
adoption was $147 million. Of this total, $112 million represents the
amount of unrecognized tax benefits that, if recognized, would favorably affect
our effective income tax rate in any future period. As a result of the
implementation of FIN 48, we reclassified $147 million of unrecognized tax
benefits from current liabilities to long-term liabilities as of December 31,
2006 in the accompanying Condensed Consolidated Balance Sheets.
We
file income tax returns in the U.S. federal jurisdiction and various state
and
international jurisdictions. The Internal Revenue Service (IRS) is examining
our
U.S. federal income tax returns for 2002 through 2004. As of September 30,
2007,
the IRS has not proposed any adjustments. We are also
under examination by several state jurisdictions. As of September 30, 2007,
no
material adjustments related to these audits have been proposed.
We
accrue tax-related interest and penalties and include such expenses with income
tax expense in the Condensed Consolidated Statements of Income. We recognized
approximately $2 million and $6 million in tax-related interest expense during
the third quarter and first nine months of 2007, respectively, and had
approximately $10 million of tax-related interest accrued at January 1, 2007.
Interest amounts are net of tax benefit. No penalties have been
accrued.
Revenue
Recognition
We
recognize revenue from the sale of our products, royalties earned, and contract
arrangements. Our revenue arrangements that contain multiple elements are
divided into separate units of accounting if certain criteria are met, including
whether the delivered element has stand-alone value to the customer and whether
there is objective and reliable evidence of the fair value of the undelivered
items. The consideration we receive is allocated among the separate units based
on their respective fair values, and the applicable revenue recognition criteria
are applied to each of the separate units. Advance payments received in excess
of amounts earned are classified as deferred revenue until earned.
The
Avastin Patient Assistance Program is a voluntary program that enables eligible
patients who have received 10,000 milligrams of Avastin in a 12-month period
to
receive free Avastin in excess of the 10,000 milligrams during the remainder
of
the 12-month period. Based on the current wholesale acquisition cost, 10,000
milligrams is valued at $55,000 in gross revenue. We defer a portion of our
gross Avastin product sales revenue to reflect our estimate of the commitment
to
supply free Avastin to patients who elect to enroll in the program. To calculate
our deferred revenue, we estimate the number of patients who will receive free
Avastin and the amount of free Avastin that we expect them to receive. Based
on
those estimates, we defer a portion of Avastin revenue on product vials sold
through normal commercial channels. The deferred revenue is recognized when
free
Avastin vials are delivered or after the associated patient eligibility period
has passed.
Earnings
Per Share
Basic
earnings per share (EPS) are computed based on the weighted-average number
of
shares of our Common Stock outstanding. Diluted earnings per share are computed
based on the weighted-average number of shares of our Common Stock and other
dilutive securities.
The
following is a reconciliation of the numerators and denominators of the basic
and diluted earnings per share computations (in millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding used to compute basic earnings per
share
|
|
|
1,053
|
|
|
|
1,053
|
|
|
|
1,053
|
|
|
|
1,053
|
|
|
Effect
of dilutive stock options
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding and dilutive securities used to compute diluted
earnings per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding
employee stock options to purchase approximately 36 million and 35 million
shares of our Common Stock were excluded from the computation of diluted EPS
for
the third quarter and first nine months of 2007, respectively, because the
effect would have been anti-dilutive.
Comprehensive
Income
Comprehensive
income comprises net income and other comprehensive income (OCI). OCI includes
certain changes in stockholders’ equity that are excluded from net income.
Specifically, we include in OCI changes in the estimated fair value of
derivatives designated as effective cash flow hedges, and unrealized gains
and
losses on our securities available-for-sale. In accordance with our adoption
of
Statement of Financial Accounting Standards (FAS) No. 158,
“Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87,
88, 106, and 132(R),” in 2006, the gains or losses and prior
service costs or credits that arise during the period, but are not recognized
as
components of net periodic benefit cost, have been recognized in other
comprehensive income.
The
components of accumulated other comprehensive income, net of taxes, were as
follows (in millions):
| |
|
|
|
|
|
|
|
Net
unrealized gains on securities available-for-sale
|
|
$ |
224
|
|
|
$ |
214
|
|
|
Net
unrealized losses on cash flow hedges
|
|
|
(6 |
) |
|
|
(4 |
) |
|
Post-retirement
benefit obligation
|
|
|
(6 |
) |
|
|
(6 |
) |
|
Accumulated
other comprehensive income
|
|
$ |
|
|
|
$ |
|
|
The
activity in comprehensive income, net of income taxes, was as follows (in
millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
685
|
|
|
$ |
568
|
|
|
$ |
2,138
|
|
|
$ |
1,519
|
|
|
Increase
(decrease) in unrealized gains on securities
available-for-sale
|
|
|
19
|
|
|
|
16
|
|
|
|
10
|
|
|
|
(24 |
) |
|
(Decrease)
increase in unrealized gains on cash flow hedges
|
|
|
(13 |
) |
|
|
|
|
|
|
(2 |
) |
|
|
(19 |
) |
|
Comprehensive
income, net of income taxes
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Derivative
Instruments
Our
derivative instruments, designated as cash flow hedges, consist of foreign
currency exchange options and marketable equity collars. At September 30, 2007,
estimated net losses expected to be reclassified from accumulated OCI to “other
income, net” within the next 12 months are $6 million.
|
Note
2.
|
Employee
Stock-Based Compensation
|
Stock-Based
Compensation Expense under FAS 123R
Employee
stock-based compensation expense was calculated based on awards ultimately
expected to vest and has been reduced for estimated forfeitures. FAS No. 123(R),
“Share-Based Payment” (FAS 123R), requires
forfeitures to be estimated at the time of grant and revised, if necessary,
in
subsequent periods if actual forfeitures differ from those
estimates.
Employee
stock-based compensation expense recognized under FAS 123R was as follows
(in millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
$ |
16
|
|
|
$ |
–
|
|
|
$ |
49
|
|
|
$ |
–
|
|
|
Research
and development
|
|
|
37
|
|
|
|
35
|
|
|
|
114
|
|
|
|
101
|
|
|
Marketing,
general and administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
employee stock-based compensation expense
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
As
of September 30, 2007, total compensation cost related to unvested stock options
not yet recognized was $934 million, which is expected to
be allocated to expense and production costs over a weighted-average period
of
36 months.
The
carrying value of inventory on our Condensed Consolidated Balance Sheets as
of
September 30, 2007 and 2006 includes employee stock-based compensation costs
of
$77 million and $49 million, respectively. During the third quarter and first
nine months of 2007, $16 million and $49 million, respectively, of previously
capitalized employee stock-based compensation costs were recognized in cost
of
sales. Substantially all of the products sold during the first nine months
of
2006 were manufactured in previous periods when we did not include employee
stock-based compensation expense in our production costs.
Valuation
Assumptions
The
employee stock-based compensation expense recognized under FAS 123R was
determined using the Black-Scholes option valuation model. Option valuation
models require the input of subjective assumptions, and these assumptions can
vary over time. The weighted-average assumptions used were as
follows:
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-free
interest rate
|
|
|
4.3 |
% |
|
|
4.6 |
% |
|
|
4.3 |
% |
|
|
4.6 |
% |
|
Dividend
yield
|
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
Expected
volatility
|
|
|
25.0 |
% |
|
|
27.0 |
% |
|
|
25.0 |
% |
|
|
27.0 |
% |
|
Expected
term (years)
|
|
|
5.0
|
|
|
|
4.6
|
|
|
|
5.0
|
|
|
|
4.6
|
|
Due
to the redemption of our Special Common Stock in June 1999 by Roche Holdings,
Inc. (RHI), there is limited historical information available to support our
estimate of certain assumptions required to value our employee stock options
and
the stock issued under our employee stock purchase plan. In developing our
estimate of expected term, we have determined that our historical stock option
exercise experience is a relevant indicator of future exercise patterns. We
also
take into account other available information, including industry averages.
We
primarily base our determination of expected volatility on our assessment of
the
implied volatility of our Common Stock. Implied volatility is the volatility
assumption inherent in the market prices of a company’s traded
options.
|
Note
3.
|
Condensed
Consolidated Financial Statement
Detail
|
Inventories
The
components of inventories were as follows (in millions):
| |
|
|
|
|
|
|
|
Raw
materials and supplies
|
|
$ |
131
|
|
|
$ |
116
|
|
|
Work
in process
|
|
|
933
|
|
|
|
818
|
|
|
Finished
goods
|
|
|
|
|
|
|
|
|
|
Total
|
|
$ |
|
|
|
$ |
|
|
We
are a party to various legal proceedings, including patent infringement
litigation and licensing and contract disputes, and other matters.
On
October 4, 2004, we received a subpoena from the U.S. Department of Justice,
requesting documents related to the promotion of Rituxan, a prescription
treatment now approved for five indications. We are cooperating with the
associated investigation, which is both civil and criminal in nature, and
through counsel we are having continuing
discussions
with government representatives about the status of their investigation and
Genentech’s views on this matter. The government has called, and may continue to
call, former and current Genentech employees to appear before a grand jury
in
connection with this investigation. The outcome of this matter cannot be
determined at this time.
On
July 29, 2005, a former Genentech employee, whose employment ended in April
2005, filed a qui tam complaint under seal in the United States District Court
for the District of Maine against Genentech and Biogen Idec Inc., alleging
violations of the False Claims Act and retaliatory discharge of employment.
On
December 20, 2005, the United States filed notice of its election to decline
intervention in the lawsuit. The complaint was subsequently unsealed and we
were
served on January 5, 2006. Genentech filed a motion to dismiss the complaint,
and on December 14, 2006, the Magistrate Judge assigned to the case issued
a
Recommended Decision on that motion, which is subject to review by the District
Court Judge. The Magistrate Judge recommended that the False Claims Act portion
of the complaint be dismissed, leaving as the only remaining claim against
Genentech the plaintiff’s retaliatory discharge claim. Plaintiff, Biogen Idec,
and Genentech each subsequently filed objections with the District Court Judge
concerning certain aspects of the Magistrate Judge’s Recommended Decision. On
July 24, 2007, the District Court Judge affirmed the dismissal of both claims
related to the False Claims Act but denied Genentech’s motion to dismiss
plaintiff’s federal retaliatory discharge claim and granted plaintiff’s motion
for leave to file a Second Amended Complaint asserting an additional state
law
employment claim. The outcome of this matter cannot be determined at this
time.
We
and the City of Hope National Medical Center (COH) are parties to a 1976
agreement related to work conducted by two COH 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, we have entered into license
agreements with various companies to manufacture, use, and sell the products
covered by the Riggs/Itakura Patents. On August 13, 1999, the COH filed a
complaint against us in the Superior Court in Los Angeles County, California,
alleging that we owe royalties to the COH in connection with these license
agreements, as well as product license agreements that involve the grant of
licenses under the Riggs/Itakura Patents. On June 10, 2002, a jury voted to
award the COH approximately $300 million in compensatory damages. On June 24,
2002, a jury voted to award the COH an additional $200 million in punitive
damages. Such amounts were accrued as an expense in the second quarter of 2002
and are included in the accompanying Condensed Consolidated Balance Sheets
in
“litigation-related and other long-term liabilities” at September 30, 2007 and
December 31, 2006. We filed a notice of appeal of the verdict and damages awards
with the California Court of Appeal. On October 21, 2004, the California Court
of Appeal affirmed the verdict and damages awards in all respects. On November
22, 2004, the California Court of Appeal modified its opinion without changing
the verdict and denied Genentech’s request for rehearing. On November 24, 2004,
we filed a petition seeking review by the California Supreme Court. On February
2, 2005, the California Supreme Court granted that petition. The appeal to
the
California Supreme Court has been fully briefed, and we are waiting to be
assigned an oral argument date. The amount of cash paid, if any, or the timing
of such payment in connection with the COH matter will depend on the outcome
of
the California Supreme Court’s review of the matter. It may take longer than one
year to resolve the matter.
We
recorded accrued interest and bond costs related to the COH trial judgment
of
$14 million for the third quarter of 2007 and $13 million for the third quarter
of 2006, and $41 million for the first nine months of 2007 and $40 million
for
the first nine months of 2006. In conjunction with the COH judgment, we posted
a
surety bond and were required to pledge cash and investments of $788 million
at
September 30, 2007 and December 31, 2006 to secure the bond. These amounts
are
reflected in “restricted cash and investments” in the accompanying Condensed
Consolidated Balance Sheets. We expect that we will continue to incur interest
charges on the judgment and service fees on the surety bond each quarter through
the process of appealing the COH trial results.
On
April 11, 2003, MedImmune, Inc. filed a lawsuit against Genentech, COH, and
Celltech R & D Ltd. in the U.S. District Court for the Central District of
California (Los Angeles). The lawsuit relates to U.S. Patent No. 6,331,415
(the
Cabilly patent) that we co-own with COH and under which MedImmune and other
companies have been licensed and are paying royalties to us. The lawsuit
includes claims for violation of antitrust, patent, and unfair competition
laws.
MedImmune is seeking a ruling that the Cabilly patent is invalid and/or
unenforceable, a determination that MedImmune does not owe royalties under
the
Cabilly patent on sales of its Synagis® antibody product, an injunction to
prevent us from enforcing the Cabilly patent, an award of actual and exemplary
damages,
and
other relief. On January 14, 2004 (amending a December 23, 2003 order), the
U.S.
District Court granted summary judgment in our favor on all of MedImmune’s
antitrust and unfair competition claims. On April 23, 2004, the District Court
granted our motion to dismiss all remaining claims in the case. On October
18,
2005, the U.S. Court of Appeals for the Federal Circuit affirmed the judgment
of
the District Court in all respects. MedImmune filed a petition for certiorari
with the U.S. Supreme Court on November 10, 2005, seeking review of the decision
to dismiss certain of its claims. The Supreme Court granted MedImmune’s
petition, and the oral argument of this case before the Supreme Court occurred
on October 4, 2006. On January 9, 2007, the Supreme Court issued a decision
reversing the Federal Circuit’s decision and remanding the case to the lower
courts for further proceedings in connection with the patent and contract
claims. On August 16, 2007, the U.S. District Court entered a Claim Construction
Order defining several terms used in the ‘415 patent. Discovery and motion
practice are ongoing and the trial of this matter has been scheduled for June
23, 2008. The outcome of this matter cannot be determined at this
time.
On
May 13, 2005, a request was filed by a third party for reexamination of the
Cabilly patent. The request sought reexamination on the basis of non-statutory
double patenting over U.S. Patent No. 4,816,567. On July 7, 2005, the U.S.
Patent and Trademark Office (Patent Office) ordered reexamination of the Cabilly
patent. On September 13, 2005, the Patent Office mailed an initial non-final
Patent Office action rejecting the claims of the Cabilly patent. We filed our
response to the Patent Office action on November 25, 2005. On December 23,
2005,
a second request for reexamination of the Cabilly patent was filed by another
third party, and on January 23, 2006, the Patent Office granted that request.
On
June 6, 2006, the two reexaminations were merged into one proceeding. On August
16, 2006, the Patent Office mailed a non-final Patent Office action in the
merged proceeding, rejecting the claims of the Cabilly patent based on issues
raised in the two reexamination requests. We filed our response to the Patent
Office action on October 30, 2006. On February 16, 2007, the Patent Office
mailed a final Patent Office action rejecting all 36 claims of the Cabilly
patent. We responded to the final Patent Office action on May 21, 2007 and
requested continued reexamination. On May 31, 2007, the Patent Office granted
the request for continued reexamination, and in doing so withdrew the finality
of the February 2007 Patent Office action and agreed to treat our May 21, 2007
filing as a response to a first Patent Office action. The Cabilly patent, which
expires in 2018, relates to methods that we and others use to make certain
antibodies or antibody fragments, as well as cells and DNA used in these
methods. We have licensed the Cabilly patent to other companies and derive
significant royalties from those licenses. The claims of the Cabilly patent
remain valid and enforceable throughout the reexamination and appeals processes.
Because the above-described proceeding is ongoing, the outcome of this matter
cannot be determined at this time.
In
2006, we made development decisions involving our humanized anti-CD20 program,
and our collaborator, Biogen Idec, disagreed with certain of our development
decisions related to humanized anti-CD20 products. Under our 2003 collaboration
agreement with Biogen Idec, we believe that we are permitted under the agreement
to proceed with further trials of certain humanized anti-CD20 antibodies, and
Biogen Idec disagreed with our position. The disputed issues have been submitted
to arbitration. In the arbitration, Biogen Idec filed motions for a preliminary
injunction and summary judgment seeking to stop us from proceeding with certain
development activities, including planned clinical trials. On April 20, 2007,
the arbitration panel denied both Biogen Idec’s motion for a preliminary
injunction and Biogen Idec’s motion for summary judgment. Resolution of the
arbitration could require that both parties agree to certain development
decisions before moving forward with humanized anti-CD20 antibody clinical
trials, and possibly clinical trials of other collaboration products, including
Rituxan, in which case we may have to alter or cancel planned trials in order
to
obtain Biogen Idec’s approval. The hearing of this matter is scheduled to begin
in June 2008. We expect a final decision by the arbitrators by approximately
the
end of 2008, unless the parties are able to resolve the matter earlier through
settlement discussions or otherwise. The outcome of this matter cannot be
determined at this time.
|
Note
5.
|
Relationship
with Roche Holdings, Inc. and Related Party
Transactions
|
Roche
Holdings, Inc.’s Ability to Maintain Percentage Ownership
Interest in Our Stock
We
issue 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 RHI provides, among other things, that
with
respect
to any issuance of our Common Stock in the future, we will repurchase a
sufficient number of shares so that immediately after such issuance, the
percentage of our Common Stock owned by RHI will be no lower than 2% below
the
“Minimum Percentage” (subject to certain conditions). The Minimum Percentage
equals the lowest number of shares of Genentech Common Stock owned by RHI since
the July 1999 offering (to be adjusted in the future for dispositions of shares
of Genentech Common Stock by RHI as well as for stock splits or stock
combinations) divided by 1,018,388,704 (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, adjusted for stock
splits. We have repurchased shares of our Common Stock since 2001. The
affiliation agreement also provides that upon RHI’s request, we will repurchase
shares of our Common Stock to increase RHI’s ownership to the Minimum
Percentage. In addition, RHI will have a continuing option to buy stock from
us
at prevailing market prices to maintain its percentage ownership interest.
Under
the terms of the affiliation agreement, RHI’s Minimum Percentage is 57.7%, and
RHI’s ownership percentage is to be no lower than 55.7%. At September 30, 2007,
RHI’s ownership percentage was 55.8%.
Related
Party Transactions
We
enter into transactions with our related parties, Roche Holding AG and
affiliates (Roche) and Novartis AG and affiliates (Novartis). The
accounting policies that we apply to our transactions with our related parties
are consistent with those applied in transactions with independent third
parties.
In
our royalty and supply arrangements with related parties, we are the principal,
as defined under EITF Issue No. 99-19, “Reporting Revenue Gross as
a Principal versus Net as an Agent” (EITF 99-19), because we bear
the manufacturing risk, general inventory risk, and the risk to defend our
intellectual property. For circumstances in which we are the principal in the
transaction, we record the transaction on a gross basis in accordance with
EITF
99-19. Otherwise, our transactions are recorded on a net basis.
Roche
Under
our existing arrangements with Roche, including our licensing and marketing
agreements, we recognized the following amounts (in
millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales to Roche
|
|
$ |
135
|
|
|
$ |
86
|
|
|
$ |
651
|
|
|
$ |
217
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties
earned from Roche
|
|
$ |
317
|
|
|
$ |
230
|
|
|
$ |
855
|
|
|
$ |
602
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Roche
|
|
$ |
21
|
|
|
$ |
37
|
|
|
$ |
81
|
|
|
$ |
76
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales on product sales to Roche
|
|
$ |
98
|
|
|
$ |
60
|
|
|
$ |
356
|
|
|
$ |
173
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development (R&D) expenses incurred on joint development projects
with Roche
|
|
$ |
64
|
|
|
$ |
52
|
|
|
$ |
192
|
|
|
$ |
147
|
|
Certain
R&D
expenses are partially reimbursable to us by Roche. In addition, R&D
expenses may include the net settlement of amounts we owed to Roche on R&D
expenses that Roche incurred on joint development projects, less amounts
reimbursable to us by Roche on these
projects.
Novartis
Based
on information available to us at the time of filing this Form 10-Q, we believe
that Novartis holds approximately 33.3 percent of the outstanding voting shares
of Roche Holding AG. As a result of this ownership, Novartis is deemed to have
an indirect beneficial ownership interest under FAS 57, “Related
Party Disclosures,” of more than 10 percent of our voting
stock.
We
have an agreement with Novartis under which Novartis has the exclusive
right to develop and market Lucentis outside the U.S. for indications related
to
diseases or disorders of the eye. As part of this agreement, the parties will
share the cost of certain of our ongoing development expenses for Lucentis.
Novartis makes royalty payments to us on sales of Lucentis outside the
U.S.
We,
along with Novartis, are co-developing and co-promoting Xolair in the U.S.
We
record all sales and cost of sales in the U.S., and Novartis markets the product
in and records all sales and cost of sales in Europe. We and Novartis share
the
resulting U.S. and European operating profits, respectively, according to
prescribed profit sharing percentages, and our U.S. and European profit sharing
expenses are recorded as collaboration profit sharing expense. Effective with
our acquisition of Tanox on August 2, 2007, Novartis also makes royalty payments
to us on sales of Xolair worldwide and also pays us a manufacturing fee related
to Xolair. See Note 6, “Acquisition of Tanox, Inc.” for more information on the
acquisition.
Under
our existing arrangements with Novartis, we recognized the following amounts
(in millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales to Novartis
|
|
$ |
2
|
|
|
$ |
1
|
|
|
$ |
8
|
|
|
$ |
3
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties
earned from Novartis
|
|
$ |
40
|
|
|
$ |
–
|
|
|
$ |
59
|
|
|
$ |
1
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Novartis
|
|
$ |
9
|
|
|
$ |
15
|
|
|
$ |
53
|
|
|
$ |
38
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales on product sales to Novartis
|
|
$ |
2
|
|
|
$ |
3
|
|
|
$ |
9
|
|
|
$ |
5
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
R&D
expenses incurred on joint development projects with
Novartis
|
|
$ |
11
|
|
|
$ |
10
|
|
|
$ |
30
|
|
|
$ |
32
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collaboration
profit sharing expense to Novartis
|
|
$ |
47
|
|
|
$ |
46
|
|
|
$ |
143
|
|
|
$ |
137
|
|
Contract
revenue in the first nine months of 2007 included a $30 million milestone
payment from Novartis for European Union approval of Lucentis for the treatment
of neovascular (wet) age-related macular degeneration.
Certain
R&D
expenses are partially reimbursable to us by Novartis. In addition, R&D
expenses may include the net settlement of amounts we owed to Novartis on
R&D expenses that Novartis incurred on joint development projects, less
amounts reimbursable to us by Novartis on these
projects.
See
Note 6, “Acquisition of Tanox, Inc.” for information on Novartis proceeds
resulting from our acquisition of Tanox.
|
Note
6.
|
Acquisition
of Tanox, Inc.
|
On
August 2, 2007, we completed our acquisition of 100% of the outstanding shares
of Tanox, a biotechnology company specializing in the discovery and development
of biotherapeutics based on monoclonal antibody technology, for $925 million
in
cash, plus $8 million in transaction costs. The preliminary purchase price
allocation is as follows, and we may make further adjustments as we continue
to
evaluate the purchase price allocation within the next year.
|
(In
millions)
|
|
|
|
|
Assets
|
|
|
|
|
Cash
|
|
$ |
100
|
|
|
Investments
|
|
|
102
|
|
|
Working
capital and other, net
|
|
|
56
|
|
|
In-process
research and development (IPR&D)
|
|
|
77
|
|
|
Developed
product technology
|
|
|
780
|
|
|
Core
technology
|
|
|
34
|
|
|
Goodwill
|
|
|
259
|
|
|
Deferred
revenue
|
|
|
(185 |
) |
|
Deferred
tax liability, net
|
|
|
(217 |
) |
|
Total
acquisition consideration and gain
|
|
$ |
|
|
|
Consideration
and Gain
|
|
|
|
|
Consideration
|
|
$ |
925
|
|
|
Transaction
costs
|
|
|
8
|
|
|
Gain
on settlement of preexisting relationship, net of tax
|
|
|
|
|
| |
|
$ |
|
|
In
accordance with FAS No. 141, “Business Combinations” (FAS 141), assets
and liabilities acquired were valued at their fair values at the date of
acquisition. We recorded deferred revenue associated with Tanox’s intellectual
property license with Novartis related to Xolair of $185 million, which will
be
recognized as additional royalty revenue over the duration of the estimated
remaining patent lives of approximately 12 years.
In
connection with our acquisition of Tanox, we terminated certain officers and
employees of Tanox. The total amount of the severance packages offered to these
officers and employees was approximately $4 million. Tanox also leased a plant
in San Diego, California that has been certified by the U.S. Food and Drug
Administration (FDA) for clinical use. Our current estimate of the present
value
of the future lease payments we owe, less the expected sublease income if we
are
able to sublease the facility, is approximately $5 million. We expect these
restructuring programs to be substantially complete within the next six
months.
We
recorded a $77 million charge for in-process research and development. This
charge primarily represents acquired R&D for label extensions for Xolair
that have not yet been approved by the FDA and require significant further
development.
Under
FAS 141, acquired identifiable intangible assets are measured and
recognized apart from goodwill even if it would not be practical to sell or
exchange the acquired intangible assets and any related license agreements
apart
from one another. In our accounting for our acquisition of Tanox’s developed
product technology and core technology in accordance with FAS No. 142,
“Goodwill and Other Intangible Assets,” the fair value assigned to
those intangible assets was based on valuations using a present value technique
referred to as the income approach, with estimates and assumptions determined
by
management, including valuing Tanox’s intellectual property and rights thereon
at assumed current fair values, which, for developed product technology, were
in
excess of existing contractual rates. The developed product technology we valued
relates to intellectual property and rights thereon primarily related to the
Xolair molecule. The core technology asset we valued represents the value of
Tanox’s intellectual property and rights thereon expected to be leveraged in the
design and development of future products and indications. The developed product
technology and core technology, which totaled $814 million, are being amortized
over 12 years. The excess of purchase price over tangible assets, identifiable
intangible assets, and assumed liabilities represents goodwill.
The
intangible assets and goodwill acquired are not deductible for income tax
purposes. As a result, we recorded a net deferred tax liability of $262 million,
based on the tax effect of the amount of the acquired intangible assets other
than goodwill with no tax basis. We also recorded a net deferred tax asset
of
approximately $45 million, primarily related to net operating loss carryforwards
acquired in the transaction.
Under
EITF 04-1, “Accounting for Preexisting Relationships between the
Parties to a Business Combination” (EITF 04-1), a
business combination between parties with a preexisting relationship should
be
evaluated to determine if a settlement of a preexisting relationship exists.
The
acquisition of Tanox is considered to include the settlement of our 1996 license
of certain intellectual property and rights thereon from Tanox. We measured
the
amount that the preexisting license arrangement is favorable, from our
perspective, by comparing it to estimated pricing for current market
transactions for intellectual property rights similar to Tanox’s intellectual
property rights related to Xolair. In connection with the settlement of this
license arrangement, we recorded a gain of $121 million, or $73 million
net of tax, in accordance with EITF 04-1.
On
August 2, 2007, we understand that Novartis owned approximately 14% of the
outstanding shares of Tanox, representing approximately $127 million of the
total cash paid to acquire the outstanding shares of Tanox.
Assuming
that the Tanox acquisition was consummated as of January 1, 2006, pro forma
consolidated financial results of the company for the three and nine months
ended September 30, 2007 and 2006 would not have been materially different
from
the amounts reported.
The
effective income tax rate was 39% in the third quarter of 2007 compared to
37%
in the third quarter of 2006. The increase was primarily due to the
non-deductible IPR&D charge in the third quarter of 2007 resulting from our
acquisition of Tanox. The effective income tax rate was 38% in the first nine
months of 2007 and 2006.
On
October 11, 2007, we entered into a five-year, $1 billion revolving credit
facility with various financial institutions. The credit facility is expected
to
be used for general corporate and working capital purposes, including providing
support for our new $1 billion commercial paper program. As of October 26,
2007,
we had no borrowings under the credit facility and had $600 million outstanding
in commercial paper.
The
Board of Directors and Stockholders of Genentech, Inc.
We
have reviewed the condensed consolidated balance sheet of Genentech, Inc. as
of
September 30, 2007, and the related condensed consolidated statements of income
for the three-month and nine-month periods ended September 30, 2007 and 2006,
and the condensed consolidated statements of cash flows for the nine-month
periods ended September 30, 2007 and 2006. These financial statements are the
responsibility of the Company’s management.
We
conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based
on our review, we are not aware of any material modifications that should be
made to the condensed consolidated financial statements referred to above for
them to be in conformity with U.S. generally accepted accounting
principles.
We
have previously audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet
of
Genentech, Inc. as of December 31, 2006, and the related consolidated statements
of income, stockholders’ equity, and cash flows for the year then ended, not
presented herein, and in our report dated February 5, 2007, we expressed an
unqualified opinion on those consolidated financial statements including an
explanatory paragraph relating to the change in method of accounting for
stock-based compensation in accordance with guidance provided in Statement
of
Financial Accounting Standards No. 123(R), “Share-based Payment.” In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 2006, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
Palo
Alto, California
October
29, 2007
GENENTECH,
INC.
FINANCIAL
REVIEW
Overview
The
information included in this Quarterly Report on Form 10-Q should be read in
conjunction with the Consolidated Financial Statements and accompanying notes
included in our Annual Report on Form 10-K for the year ended December 31,
2006.
The
Company
Genentech
is a leading biotechnology company that discovers, develops, manufactures,
and
commercializes biotherapeutics for significant unmet medical needs. We
commercialize multiple biotechnology products and also receive royalties from
companies that are licensed to market products based on our
technology.
Major
Developments in the Third Quarter of 2007
We
primarily earn revenue and income and generate cash from product sales and
royalty revenue. In the third quarter of 2007, our total operating revenue
was
$2,908 million, an increase of 22% from $2,384 million in the third quarter
of
2006. Our net income for the third quarter of 2007 was $685 million, an increase
of 21% from $568 million in the third quarter of 2006. In the first nine months
of 2007, our total operating revenue was $8,755 million, an increase of 33%
from
$6,569 million in the first nine months of 2006. Our net income for the first
nine months of 2007 was $2,138 million, an increase of 41% from $1,519 million
in the first nine months of 2006.
On
August 2, 2007, we acquired 100% of the outstanding shares of Tanox, Inc. for
$925 million, including $8 million in transaction costs. The acquired assets
include $202 million of Tanox’s cash and investments, resulting in a net cash
and investment outlay of $731 million. Included in our operating results for
the
third quarter and first nine months of 2007 are items related to our acquisition
of Tanox, including a non-recurring in-process research and development
(IPR&D) charge of $77 million; a non-recurring gain of $121 million on a
pretax basis pursuant to the Emerging Issues Task Force (EITF) Issue 04-1,
“Accounting for Preexisting Relationships between the Parties
to a
Business Combination” (EITF 04-1); the recognition
of deferred royalty revenue; and amortization of intangible assets. Tanox’s
post-acquisition operating results were not material to our consolidated results
for the third quarter of 2007. See “Write-off of In-process Research and
Development Related to Acquisition” and “Gain on Acquisition” in the “Results of
Operations” section for more information on these items.
On
August 24, 2007, we resubmitted a supplemental Biologics License Application
(sBLA) to the United States (U.S.) Food and Drug Administration (FDA) for
Avastin, in combination with paclitaxel chemotherapy, for patients who have
not
received chemotherapy for their locally recurrent or metastatic breast cancer
(BC). We have been informed that an Oncologic Drugs Advisory Committee meeting
will be held in December 2007, and the FDA action date is February 23,
2008.
Our
Strategy and Goals
As
announced in 2006, our business objectives for the years 2006 through 2010
include bringing at least 20 new molecules into clinical development, bringing
at least 15 major new products or indications onto the market, becoming the
number one U.S. oncology company in sales, and achieving certain financial
growth measures. These objectives are reflected in our revised Horizon 2010
strategy and goals summarized on our website at
www.gene.com/gene/about/corporate/growthstrategy.
Economic,
Industry-wide, and Other Factors
Our
strategy and goals are challenged by economic and industry-wide factors that
affect our business. Key factors that affect our future growth are discussed
below:
-
We
face significant competition in the diseases of interest to us from
pharmaceutical companies and biotechnology companies. The introduction
of new
competitive products or follow-on biologics, and/or new information about
existing products, and/or pricing decisions by us or our competitors, may
result in lost market share for us, reduced utilization of our products,
lower
prices, and/or reduced product sales, even for products protected by
patents.
-
Our
long-term business growth depends upon our ability to continue to successfully
develop and commercialize important novel therapeutics to treat unmet
medical
needs, such as cancer. We recognize that the successful development of
biotherapeutics is highly difficult and uncertain, and that it will be
challenging for us to continue to discover and develop innovative treatments.
Our business requires significant investment in research and development
(R&D) over many years, often for products that fail during the R&D
process. Once a product receives FDA approval, it remains subject to
ongoing
FDA regulation, including changes to the product label, new or revised
regulatory requirements for manufacturing practices, written advisement
to
physicians, and/or product recalls or withdrawals.
-
Our
near-term growth will depend on our ability to execute on recent product
approvals, including Lucentis for the treatment of neovascular (wet)
age-related macular degeneration (AMD) and Avastin for the treatment
of
non-small cell lung cancer, and to successfully obtain FDA approvals
for
potential new indications for our existing products such as Avastin
for the
treatment of metastatic BC and anti-CD20 molecules for the treatment
of
immunological disorders.
-
Our
business model requires appropriate pricing and reimbursement for
our products
to offset the costs and risks of drug development. The pricing and
distribution of our products have received negative press coverage
and public
scrutiny. We will continue to meet with patient groups, payers, and
other
stakeholders in the healthcare system to understand their issues
and concerns.
The reimbursement environment for our products may change in the
future and
become more challenging.
-
As
the Medicare and Medicaid programs are the largest payers for our
products,
rules related to coverage and reimbursement continue to represent
an important
issue for our business. New regulations related to hospital and
physician
payment continue to be implemented annually. To date, we have not
seen any
detectable effects of the new rules on our product sales. As a
result of the
Deficit Reduction Act, new regulations will take effect in the
fourth quarter
of 2007 that will impact the discounted price for our products
paid by
Medicaid and government-affiliated customers. While pricing continues
to be an
important area of focus, we anticipate minimal impact on our revenue
for the
remainder of 2007.
-
Intellectual
property protection of our products is crucial to our business.
Loss of
effective intellectual property protection could result in lost
sales to
competing products and may negatively affect our sales, royalty
revenue, and
operating results. We are often involved in disputes over contracts
and
intellectual property, and we work to resolve these disputes
in confidential
negotiations or litigation. We expect legal challenges in this
area to
continue. We plan to continue to build upon and defend our intellectual
property position.
-
Manufacturing
biotherapeutics is difficult and complex, and requires facilities specifically
designed and validated to run biotechnology production processes. The
manufacture of a biotherapeutic requires developing and maintaining a process
to reliably manufacture and formulate the product at an appropriate scale,
obtaining regulatory approval to manufacture the product, and is subject
to
changes in regulatory requirements or standards that may require modifications
to the manufacturing process. Additionally, we may have an excess of available
capacity, which could lead to an idling of a portion of our manufacturing
facilities and incurring unabsorbed or idle plant charges, or other excess
capacity charges, resulting in an increase in our cost of sales.
-
Our
ability to attract and retain highly qualified and talented people in
all
areas of the company, and our ability to maintain our unique culture,
will be
critical to our success over the long-term. We are working diligently
across
the company to make sure that we successfully hire, train, and integrate
new
employees into the Genentech culture and
environment.
We
commercialize the biotechnology products listed below in the
U.S.:
Avastin
(bevacizumab) is an anti-VEGF humanized antibody approved for use in combination
with intravenous 5-fluorouracil-based chemotherapy as a treatment for patients
with first- or second-line metastatic cancer of the colon or rectum. It is
also
approved for use in combination with carboplatin and paclitaxel chemotherapy
for
the first-line treatment of unresectable, locally advanced, recurrent or
metastatic non-squamous, non-small cell lung cancer.
Rituxan
(rituximab) is an anti-CD20 antibody that we commercialize with Biogen
Idec, Inc. It is approved for first-line treatment of patients with follicular,
CD20-positive, B-cell non-Hodgkin’s lymphoma in combination with
cyclophosphamide, vincristine, and prednisone (CVP) chemotherapy regimens or
following CVP chemotherapy in patients with stable disease or who achieve a
partial or complete response following first-line treatment with CVP
chemotherapy. Rituxan is also approved for use in the follicular setting for
treatment of patients with relapsed or refractory, low-grade or follicular,
CD20-positive, B-cell non-Hodgkin’s lymphoma, including retreatment and bulky
diseases. Rituxan is indicated for first-line treatment of patients with diffuse
large B-cell, CD20-positive, non-Hodgkin’s lymphoma in combination with
cyclophosphamide, doxorubicin, vincristine, and prednisone (CHOP) or other
anthracycline-based chemotherapy. Rituxan is also indicated for use in
combination with methotrexate for reducing signs and symptoms in adult patients
with moderately to severely active rheumatoid arthritis who have had an
inadequate response to one or more tumor necrosis factor antagonist
therapies.
Herceptin
(trastuzumab) is a humanized anti-HER2 antibody approved for use as an
adjuvant treatment of node-positive breast cancer as part of a treatment regimen
containing doxorubicin, cyclophosphamide, and paclitaxel for patients who have
tumors that overexpress the human epidermal growth factor receptor 2 (HER2)
protein. It is also approved for use as a first-line therapy in combination
with
paclitaxel and as a single agent in second- and third-line therapy for patients
with HER2-positive metastatic BC.
Lucentis
(ranibizumab) is an anti-VEGF antibody fragment approved for the treatment
of
neovascular (wet) AMD.
Xolair
(omalizumab) is a humanized anti-IgE antibody, which we commercialize with
Novartis Pharma AG (a wholly owned subsidiary of Novartis AG; Novartis AG
and affiliates are collectively referred to herein as Novartis). Xolair is
approved for adults and adolescents (age 12 or older) with moderate to severe
persistent asthma who have a positive skin test or in vitro reactivity to a
perennial aeroallergen and whose symptoms are inadequately controlled with
inhaled corticosteroids.
Tarceva
(erlotinib), which we commercialize with OSI Pharmaceuticals, Inc., is
a
small-molecule tyrosine kinase inhibitor of the HER1/epidermal growth factor
receptor signaling pathway. Tarceva is approved for the treatment of patients
with locally advanced or metastatic non-small cell lung cancer after failure
of
at least one prior chemotherapy regimen. It is also approved,
in combination with gemcitabine chemotherapy, for the first-line treatment
of patients with locally advanced, unresectable, or metastatic pancreatic
cancer.
Nutropin
(somatropin [rDNA origin] for injection) and Nutropin AQ are
growth hormone products approved for the treatment of growth hormone deficiency
in children and adults, growth failure associated with chronic renal
insufficiency prior to kidney transplantation, short stature associated with
Turner syndrome, and long-term treatment of idiopathic short
stature.
Activase
(alteplase, recombinant) is a tissue plasminogen activator (t-PA) approved
for the treatment of acute myocardial infarction (heart attack), acute ischemic
stroke (blood clots in the brain) within three hours of the onset of symptoms,
and acute massive pulmonary embolism (blood clots in the lungs).
TNKase
(tenecteplase) is a modified form of t-PA approved for the treatment of
acute myocardial infarction (heart attack).
Cathflo
Activase (alteplase, recombinant) is a t-PA approved in adult and pediatric
patients for the restoration of function to central venous access devices that
have become occluded due to a blood clot.
Pulmozyme
(dornase alfa, recombinant) is an inhalation solution of deoxyribonuclease
(rhDNase) I, approved for the treatment of cystic fibrosis.
Raptiva
(efalizumab) is a humanized anti-CD11a antibody approved for the treatment
of
chronic moderate-to-severe plaque psoriasis in adults age 18 or older who are
candidates for systemic therapy or phototherapy.
Licensed
Products
We
receive royalty revenue from various licensees, including significant royalty
revenue from Roche Holding AG and affiliates (Roche) on sales of:
See
Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements of Part I, Item 1 of this Form 10-Q for information regarding certain
patent-related legal proceedings.
Available
Information
The
following information is found on our website at www.gene.com, or can be
obtained free of charge by contacting our Investor Relations Department at
(650)
225-1599 or sending an e-mail message to
investor.relations@gene.com:
-
Our
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports
on
Form 8-K, and all amendments to those reports as soon as reasonably
practicable after such material is electronically filed with the U.S.
Securities and Exchange Commission;
-
Our
policies related to corporate governance, including our Principles of
Corporate Governance, Good Operating Principles, and Code of Ethics,
which
apply to our Chief Executive Officer, Chief Financial Officer, and senior
financial officials; and
-
The
charters of the Audit Committee and the Compensation Committee of our
Board of
Directors.
Critical
Accounting Policies and the Use of Estimates
The
accompanying discussion and analysis of our financial condition and results
of
operations are based on our Condensed Consolidated Financial Statements and
the
related disclosures, which have been prepared in accordance with U.S. generally
accepted accounting principles (GAAP). The preparation of these Condensed
Consolidated Financial Statements requires management to make estimates,
assumptions, and judgments that affect the reported amounts in our Condensed
Consolidated Financial Statements and accompanying notes. These estimates form
the basis for making judgments about the carrying values of assets and
liabilities. We base our estimates and judgments on historical experience and
on
various other assumptions that we believe to be reasonable under the
circumstances, and we have established internal controls related to the
preparation of these estimates. Actual results and the timing of the results
could differ materially from these estimates.
We
believe the following policies to be critical to understanding our financial
condition, results of operations, and expectations for 2007, because these
policies require management to make significant estimates, assumptions, and
judgments about matters that are inherently uncertain.
Contingencies
We
are currently, and have been, involved in certain legal proceedings, including
patent infringement litigation. We are also involved in licensing and contract
disputes, and other matters. See Note 4, “Contingencies,” in the Notes to
Condensed Consolidated Financial Statements of Part I, Item 1 of this Form
10-Q
for more information on these matters. We assess the likelihood of any adverse
judgments or outcomes for these legal matters as well as potential ranges of
probable losses. We record an estimated loss as a charge to income if we
determine that, based on information available at the time, the loss is probable
and the amount of loss can be reasonably estimated. Included in
“litigation-related and other long-term liabilities” in the accompanying
Condensed Consolidated Balance Sheet at September 30, 2007 is $764 million,
which represents our estimate of the costs for the current resolution of the
City of Hope National Medical Center (COH) matter. The nature of these matters
is highly uncertain and subject to change; as a result, the amount of our
liability for certain of these matters could exceed or be less than the amount
of our current estimates, depending on the final outcome of these matters.
The
outcomes of such matters that are different from our current estimates could
have a material effect on our financial position or our results of operations
in
any one quarter.
Revenue
Recognition – Avastin U.S. Product Sales
In
February 2007, we launched the Avastin Patient Assistance Program, which is
a
voluntary program that enables eligible patients who have received 10,000
milligrams of Avastin in a 12-month period to receive free Avastin in excess
of
the 10,000 milligrams during the remainder of the 12-month period. Based on
the
current wholesale acquisition cost, the 10,000 milligrams is valued at $55,000
in gross revenue. Eligible patients include those who are being treated for
an
FDA-approved indication and who meet the household income criteria for this
program. The program is available for eligible patients who enroll, regardless
of whether they are insured. We defer a portion of our gross Avastin product
sales revenue to reflect our estimate of the commitment to supply free Avastin
to patients who elect to enroll in the program.
In
order to make our estimate of the amount of free Avastin to be provided to
patients under the program, we need to estimate several factors, most notably:
the number of patients who are currently being treated for FDA-approved
indications and the start date for their treatment regimen, the extent to which
doctors and patients may elect to enroll in the program, the number of patients
who will meet the financial eligibility requirements of the program, and the
duration and extent of treatment for the FDA-approved indications, among other
factors. We have based our enrollment assumptions on physician surveys and
other
information that we consider relevant. We will continue to update our estimates
in each reporting period as new information becomes available. If the actual
results underlying this deferred revenue accounting vary significantly from
our
estimates, we will need to make adjustments to these estimates, which could
have
a material effect on revenue and earnings in the period of adjustment. Based
on
these estimates, we defer a portion of Avastin revenue on product vials sold
through normal commercial channels. The deferred revenue will be recognized
when
free Avastin vials are delivered. Enrollment in the program was lower than
expected in the first nine months of 2007, and we recorded net decreases in
deferred revenue, and
corresponding
net increases to product sales, of $5 million in the third quarter of 2007
and
$2 million in the first nine months of 2007 for Avastin U.S. product sales,
resulting in a remaining deferred revenue liability in connection with the
Avastin Patient Assistance Program of $7 million in our Condensed Consolidated
Balance Sheet at September 30, 2007. As we continue to evaluate the amount
of
revenue to defer related to the Avastin Patient Assistance Program, we may
recognize previously deferred revenue in Avastin U.S. product sales in future
periods or we may increase the amount of revenue deferred.
Product
Sales Allowances
Revenue
from U.S. product sales is recorded net of allowances and accruals for rebates,
healthcare provider contractual chargebacks, prompt-pay sales discounts, product
returns, and wholesaler inventory management allowances, all of which are
established at the time of sale. Sales allowances and accruals are based
on estimates of the amounts earned or to be claimed on the related sales.
The amounts reflected in our Condensed Consolidated Statements of Income as
product sales allowances have been relatively consistent at approximately six
to
eight percent of gross sales. In order to prepare our Condensed Consolidated
Financial Statements, we are required to make estimates regarding the amounts
earned or to be claimed on the related product sales.
Definitions
for the product sales allowance types are as follows:
-
Rebate
allowances and accruals include both direct and indirect rebates. Direct
rebates are contractual price adjustments payable to direct customers,
mainly
to wholesalers and specialty pharmacies that purchase products directly
from
us. Indirect rebates are contractual price adjustments payable to healthcare
providers and organizations such as clinics, hospitals, pharmacies, Medicaid,
and group purchasing organizations that do not purchase products directly
from
us;
-
Prompt-pay
sales discounts are credits granted to wholesalers for remitting payment
on
their purchases within established cash payment incentive
periods;
-
Product
return allowances are established in accordance with our Product
Returns
Policy. Our returns policy allows product returns within the period
beginning
two months prior to and six months following product
expiration;
-
Wholesaler
inventory management allowances are credits granted to wholesalers
for
compliance with various contractually defined inventory management
programs.
These programs were created to align purchases with underlying
demand for our
products and to maintain consistent inventory levels, typically
at two to
three weeks of sales depending on the product;
and
-
Healthcare
provider contractual chargebacks are the result of contractual
commitments by
us to provide products to healthcare providers at specified prices
or
discounts.
We
believe that our estimates related to product returns allowances
and wholesaler
inventory management payments are not material amounts, based on
the historical
levels of credits and allowances as a percentage of product sales.
We believe
that our estimates related to healthcare provider contractual chargebacks
and
prompt-pay sales discounts do not have a high degree of estimation
complexity or
uncertainty, as the related amounts are settled within a short period
of time.
We consider rebate allowances and accruals to be the only estimations
that
involve material amounts and require a higher degree of subjectivity
and
judgment necessary. As a result of the uncertainties involved in
estimating
rebate allowances and accruals, there is a likelihood that materially
different
amounts could be reported under different conditions or using different
assumptions.
Our
rebates are based on definitive agreements or legal requirements (such as
Medicaid). These rebates are primarily estimated using historical and other
data, including patient usage, customer buying patterns, applicable contractual
rebate rates, and contract performance by the benefit providers. Direct rebates
are accrued at the time of sale and recorded as allowances against trade
accounts receivable; indirect (including Medicaid) rebates are accrued at the
time of sale and recorded as liabilities. Rebate estimates are evaluated
quarterly and may require changes to better align our estimates with actual
results. As part of this evaluation, we review changes to Medicaid
legislation,
changes
to state rebate contracts, changes in the level of discounts, and significant
changes in product sales trends. Although rebates are accrued at the time of
sale, rebates are typically paid out, on average, up to six months after the
sale. We believe that our rebate allowances and accruals estimation process
provides a high degree of confidence in the amounts established and that the
annual allowance amounts provided for would not vary by more than approximately
3% based on our estimate that our changes in rebate allowances and accruals
estimates related to prior years have not exceeded 3%. To illustrate our
sensitivity to changes in the rebate allowances and accruals process, as much
as
a 10% change in our annualized rebate allowances and accruals provision
experienced to date in 2007 (which is in excess of three times the level of
variability that we reasonably expect to observe for rebates) would have an
approximate $18 million effect on our income before taxes (or approximately
$0.01 per share after taxes). The total rebate allowances and accruals recorded
in our Condensed Consolidated Balance Sheet were $63 million as of September
30,
2007.
All
of the aforementioned categories of allowances and accruals are evaluated
quarterly and adjusted when trends or significant events indicate that a change
in estimate is appropriate. Such changes in estimate could materially affect
our
results of operations or financial position; however, to date they have not
been
material. It is possible that we may need to adjust our estimates in future
periods. As of September 30, 2007, our Condensed Consolidated Balance Sheet
reflected estimated product sales allowance reserves and accruals totaling
approximately $166 million.
Royalties
For
substantially all of our agreements with licensees, we estimate royalty revenue
and royalty receivables in the period the royalties are earned, which is in
advance of collection. Our estimates of royalty revenue and receivables in
those
instances are based on communication with some licensees, historical
information, forecasted sales trends, and collectibility. Differences between
actual royalty revenue and estimated royalty revenue are adjusted for in the
period in which they become known, typically the following quarter. If the
collectibility of a royalty amount is doubtful, royalty revenue is not recorded.
In the case of a receivable related to previously recognized royalty revenue
that is subsequently determined to be uncollectible, the receivable is reserved
for in the period in which the circumstances that make collectibility doubtful
are determined. Historically, adjustments to our royalty receivables have not
been material to our consolidated financial condition or results of
operations.
We
have confidential licensing agreements with a number of companies on U.S. Patent
No. 6,331,415 (the Cabilly patent), under which we receive royalty revenue
on
sales of products that are covered by the patent. The Cabilly patent, which
expires in 2018, relates to methods that we and others use to make certain
antibodies or antibody fragments, as well as cells and DNA used in those
methods. The U.S. Patent and Trademark Office (Patent Office) is performing
a
reexamination of the patent and on February 16, 2007 issued a final Patent
Office action rejecting all 36 claims of the Cabilly patent. We responded to
the
final Patent Office action on May 21, 2007 and requested continued
reexamination. On May 31, 2007, the Patent Office granted the request for
continued reexamination, and in so doing withdrew the finality of the February
2007 Patent Office action and agreed to treat our May 21, 2007 filing as a
response to a first Patent Office action. The claims of the patent remain valid
and enforceable throughout the reexamination and appeals processes. In addition,
MedImmune, Inc. has filed a lawsuit against us challenging the Cabilly
patent. See also Note 4, “Contingencies,” in the Notes to Condensed
Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for more
information on our Cabilly patent reexamination and the MedImmune
lawsuit.
Cabilly
patent royalties are generally due 60 days after the end of the quarter.
Additionally, we pay COH a percentage of our Cabilly patent royalty revenue
60
days after the quarter in which we receive payments from our licensees. As
of
September 30, 2007, our Condensed Consolidated Balance Sheet included Cabilly
patent receivables totaling approximately $57 million and the related COH
payable totaling approximately $23 million.
Income
Taxes
Income
tax provision is based on income before taxes and is computed using the
liability method. Deferred tax assets and liabilities are determined based
on
the difference between the financial statement and tax basis of assets and
liabilities using tax rates projected to be in effect for the year in which
the
differences are expected to reverse. Significant estimates are required in
determining our provision for income taxes. Some of these estimates are
based
on
interpretations of existing tax laws or regulations, or the findings or expected
results from any tax examinations. Various internal and external factors may
have favorable or unfavorable effects on our future effective income tax rate.
These factors include, but are not limited to, changes in tax laws, regulations
and/or rates, the results of any tax examinations, changing interpretations
of
existing tax laws or regulations, changes in estimates of prior years’ items,
past and future levels of R&D spending, acquisitions, and changes in overall
levels of income before taxes.
On
January 1, 2007, we adopted the provisions of Financial Accounting Standards
Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (FIN 48). As a result of the implementation of FIN
48, we evaluated our income tax position and reclassified $147 million of
unrecognized tax benefits from current liabilities to long-term liabilities
as
of January 1, 2007, and we also reclassified the balance as of December 31,
2006, for consistency, in the accompanying Condensed Consolidated Balance
Sheets.
Inventories
Inventories
may include currently marketed products manufactured under a new process or
at
facilities awaiting regulatory licensure. These inventories are capitalized
based on management’s judgment of probable near-term regulatory licensure.
Excess or idle capacity costs, based on estimated plant capabilities, are
expensed in the period in which they are incurred. The valuation of inventory
requires us to estimate the value of inventory that may expire prior to use
or
that may fail to be released for commercial sale. The determination of obsolete
inventory requires us to estimate the future demands for our products, and
in
the case of pre-approval inventories, to estimate the regulatory approval date
for the product or for the licensure of either the manufacturing facility or
the
new manufacturing process. We may be required to expense previously capitalized
inventory costs upon a change in our estimate, due to, among other potential
factors, the denial or delay of approval of a product or the licensure of either
a manufacturing facility or a new manufacturing process by the necessary
regulatory bodies, or new information that suggests that the inventory will
not
be saleable.
Valuation
of Acquired Intangible Assets
We
have acquired intangible assets in connection with our acquisition of Tanox.
These intangible assets consist of developed product technology and core
technologies associated with intellectual property and rights thereon, primarily
related to the Xolair molecule, and assets related to the fair value write-up
of
Tanox’s royalty contracts, as well as goodwill. When significant identifiable
intangible assets are acquired, we engage an independent third-party valuation
firm to assist in determining the fair values of these assets as of the
acquisition date. Discounted cash flow models are typically used in these
valuations, and these models require the use of significant estimates and
assumptions including but not limited to determining the timing and expected
costs to complete the in-process projects, projecting regulatory approvals,
estimating future cash flows from product sales resulting from completed
products and in-process projects, and developing appropriate discount rates
and
probability rates by project.
We
believe that the fair values assigned to the intangible assets acquired are
based on reasonable estimates and assumptions, given the available facts and
circumstances as of the acquisition date. However, we may record adjustments
to
goodwill resulting from our acquisition of Tanox for the resolution of
preacquisition contingencies, our restructuring activities, tax matters, and
other estimates related to the acquisition. Further, we will have to
continuously evaluate whether any or all intangible assets valued have been
impaired.
Employee
Stock-Based Compensation
Under
the provisions of Statement of Financial Accounting Standards (FAS) No. 123(R),
“Share-Based Payment” (FAS 123R), employee
stock-based compensation is estimated at the date of grant based on the employee
stock award’s fair value using the Black-Scholes option-pricing model and is
recognized as expense ratably over the requisite service period in a manner
similar to other forms of compensation paid to employees. The Black-Scholes
option-pricing model requires the use of certain subjective assumptions. The
most significant of these assumptions are our estimates of the expected
volatility of the market price of our stock and the expected term of the award.
Due to the redemption of our Special Common Stock in June 1999 (Redemption)
by
Roche Holdings, Inc. (RHI), there is limited historical information available
to
support our estimate of certain assumptions required to value our stock options.
When establishing an estimate of the expected term of an award, we consider
the
vesting period for the
award,
our recent historical experience of employee stock option exercises (including
forfeitures), the expected volatility, and a comparison to relevant peer group
data. As required under the accounting rules, we review our valuation
assumptions at each grant date, and, as a result, our valuation assumptions
used
to value employee stock-based awards granted in future periods may change.
See
also Note 2, “Employee Stock-Based Compensation,” in the Notes to Condensed
Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for more
information.
Results
of Operations
(In
millions, except per share amounts)
| |
|
Three
Months
Ended
September 30,
|
|
|
|
|
|
Nine
Months
Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales
|
|
$ |
2,321
|
|
|
$ |
1,941
|
|
|
|
20 |
% |
|
$ |
7,094
|
|
|
$ |
5,395
|
|
|
|
31 |
% |
|
Royalties
|
|
|
524
|
|
|
|
364
|
|
|
|
44
|
|
|
|
1,427
|
|
|
|
966
|
|
|
|
48
|
|
|
Contract
revenue
|
|
|
|
|
|
|
|
|
|
|
(20 |
) |
|
|
|
|
|
|
|
|
|
|
13
|
|
|
Total
operating revenue
|
|
|
|
|
|
|
|
|
|
|
22
|
|
|
|
|
|
|
|
|
|
|
|
33
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
406
|
|
|
|
297
|
|
|
|
37
|
|
|
|
1,227
|
|
|
|
843
|
|
|
|
46
|
|
|
Research
and development
|
|
|
615
|
|
|
|
454
|
|
|
|
35
|
|
|
|
1,828
|
|
|
|
1,218
|
|
|
|
50
|
|
|
Marketing,
general and administrative
|
|
|
541
|
|
|
|
501
|
|
|
|
8
|
|
|
|
1,564
|
|
|
|
1,414
|
|
|
|
11
|
|
|
Collaboration
profit sharing
|
|
|
276
|
|
|
|
250
|
|
|
|
10
|
|
|
|
805
|
|
|
|
735
|
|
|
|
10
|
|
|
Write-off
of in-process research and development related to
acquisition
|
|
|
77
|
|
|
|
–
|
|
|
|
–
|
|
|
|
77
|
|
|
|
–
|
|
|
|
–
|
|
|
Gain
on acquisition
|
|
|
(121 |
) |
|
|
–
|
|
|
|
–
|
|
|
|
(121 |
) |
|
|
–
|
|
|
|
–
|
|
|
Recurring
charges related to redemption and acquisition
|
|
|
38
|
|
|
|
26
|
|
|
|
46
|
|
|
|
90
|
|
|
|
79
|
|
|
|
14
|
|
|
Special
items: litigation-related
|
|
|
|
|
|
|
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
Total
costs and expenses
|
|
|
|
|
|
|
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
27
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
1,062
|
|
|
|
843
|
|
|
|
26
|
|
|
|
3,244
|
|
|
|
2,240
|
|
|
|
45
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income, net
|
|
|
84
|
|
|
|
74
|
|
|
|
14
|
|
|
|
233
|
|
|
|
249
|
|
|
|
(6 |
) |
|
Interest
expense
|
|
|
(18 |
) |
|
|
(19 |
) |
|
|
(5 |
) |
|
|
(53 |
) |
|
|
(56 |
) |
|
|
(5 |
) |
|
Total
other income, net
|
|
|
|
|
|
|
|
|
|
|
20
|
|
|
|
|
|
|
|
|
|
|
|
(7 |
) |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before taxes
|
|
|
1,128
|
|
|
|
898
|
|
|
|
26
|
|
|
|
3,424
|
|
|
|
2,433
|
|
|
|
41
|
|
|
Income
tax provision
|
|
|
|
|
|
|
|
|
|
|
34
|
|
|
|
|
|
|
|
|
|
|
|
41
|
|
|
Net
income
|
|
$ |
|
|
|
$ |
|
|
|
|
21
|
|
|
$ |
|
|
|
$ |
|
|
|
|
41
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
|
|
|
$ |
|
|
|
|
20
|
|
|
$ |
|
|
|
$ |
|
|
|
|
41
|
|
|
Diluted
|
|
$ |
|
|
|
$ |
|
|
|
|
21 |
% |
|
$ |
|
|
|
$ |
|
|
|
|
42 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales as a % of product sales
|
|
|
17 |
% |
|
|
15 |
% |
|
|
|
|
|
|
17 |
% |
|
|
16 |
% |
|
|
|
|
|
Research
and development as a % of operating revenue
|
|
|
21
|
|
|
|
19
|
|
|
|
|
|
|
|
21
|
|
|
|
19
|
|
|
|
|
|
|
Marketing,
general and administrative as a % of operating revenue
|
|
|
19
|
|
|
|
21
|
|
|
|
|
|
|
|
18
|
|
|
|
22
|
|
|
|
|
|
|
Pretax
operating margin
|
|
|
37
|
|
|
|
35
|
|
|
|
|
|
|
|
37
|
|
|
|
34
|
|
|
|
|
|
|
Effective
income tax rate
|
|
|
39 |
% |
|
|
37 |
% |
|
|
|
|
|
|
38 |
% |
|
|
38 |
% |
|
|
|
|
________________________
Percentages
in this table and throughout management’s discussion and analysis of financial
condition and results of operations may reflect rounding
adjustments.
Total
Operating Revenue
Total
operating revenue increased 22% in the third quarter of 2007 and 33% in the
first nine months of 2007 from the comparable periods in 2006. These increases
were primarily due to higher product sales and royalty revenue, and are further
discussed below.
Total
Product Sales
(In
millions)
| |
|
Three
Months
|
|
|
|
|
|
Nine
Months
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
U.S. product sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Avastin
|
|
$ |
597
|
|
|
$ |
435
|
|
|
|
37 |
% |
|
$ |
1,694
|
|
|
$ |
1,256
|
|
|
|
35 |
% |
|
Rituxan
|
|
|
572
|
|
|
|
509
|
|
|
|
12
|
|
|
|
1,689
|
|
|
|
1,511
|
|
|
|
12
|
|
|
Herceptin
|
|
|
320
|
|
|
|
302
|
|
|
|
6
|
|
|
|
960
|
|
|
|
912
|
|
|
|
5
|
|
|
Lucentis
|
|
|
198
|
|
|
|
153
|
|
|
|
29
|
|
|
|
618
|
|
|
|
163
|
|
|
|
279
|
|
|
Xolair
|
|
|
121
|
|
|
|
107
|
|
|
|
13
|
|
|
|
352
|
|
|
|
307
|
|
|
|
15
|
|
|
Tarceva
|
|
|
101
|
|
|
|
100
|
|
|
|
1
|
|
|
|
304
|
|
|
|
296
|
|
|
|
3
|
|
|
Nutropin
products
|
|
|
93
|
|
|
|
92
|
|
|
|
1
|
|
|
|
278
|
|
|
|
277
|
|
|
|
0
|
|
|
Thrombolytics
|
|
|
67
|
|
|
|
60
|
|
|
|
12
|
|
|
|
202
|
|
|
|
181
|
|
|
|
12
|
|
|
Pulmozyme
|
|
|
57
|
|
|
|
50
|
|
|
|
14
|
|
|
|
164
|
|
|
|
146
|
|
|
|
12
|
|
|
Raptiva
|
|
|
|
|
|
|
|
|
|
|
26
|
|
|
|
|
|
|
|
|
|
|
|
21
|
|
|
Total
U.S. product sales(1)
|
|
|
2,155
|
|
|
|
1,830
|
|
|
|
18
|
|
|
|
6,341
|
|
|
|
5,116
|
|
|
|
24
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
product sales to collaborators
|
|
|
|
|
|
|
|
|
|
|
50
|
|
|
|
|
|
|
|
|
|
|
|
169
|
|
|
Total
product sales
|
|
$ |
|
|
|
$ |
|
|
|
|
20 |
% |
|
$ |
|
|
|
$ |
|
|
|
|
31 |
% |
______________________
|
(1)
|
The
totals may not appear to sum due to
rounding.
|
Total
product sales increased 20% in the third quarter and 31% in the first nine
months of 2007 from the comparable periods in 2006. Total U.S. product sales
increased 18% to $2,155 million in the third quarter and
24% to $6,341 million in the first nine months of 2007 from the comparable
periods in 2006. This increase in U.S. sales over the comparable periods was
due
to higher sales across most products, in particular higher sales of our oncology
products and resulting from the approval of Lucentis on June 30, 2006. Increased
U.S. sales volume accounted for 82%, or $266 million, of the increase in U.S.
net product sales in the third quarter of 2007, and 85%, or $1,041 million,
of
the increase in the first nine months of 2007. Changes in net U.S. sales prices
across the portfolio accounted for most of the remaining increase in net U.S.
product sales in the third quarter and first nine months of 2007.
Our
references below to market adoption and penetration, as well as patient share,
are derived from our analyses of market tracking studies and surveys that we
undertake with physicians. We consider these tracking studies and surveys
indicative of trends and information with respect to our direct customers’
buying patterns. We use statistical analyses to extrapolate the data that we
obtain, and as such, the adoption, penetration, and patient share data presented
herein represents estimates. Limitations in sample size and the timeliness
in
receiving and analyzing this data result in inherent margins of error; thus,
where presented, we have rounded our percentage estimates to the nearest
5%.
Avastin
Net
U.S. sales of Avastin increased 37% to $597 million in the
third quarter and 35% to $1,694 million in the first nine months of 2007 from
the comparable periods in 2006. Net U.S. sales in the third quarter and in
the
first nine months of 2007 included the net recognition of $5 million and $2
million, respectively, of previously deferred revenue due to lower than expected
enrollment in our Avastin Patient Assistance Program. There have been no price
increases on Avastin.
The
increases in sales were primarily a result of increased use of Avastin in
metastatic non-small cell lung cancer (NSCLC), approved on October 11, 2006,
and, to a lesser extent, in metastatic colorectal cancer (CRC) and in metastatic
BC, an unapproved use of Avastin. Among all first-line metastatic NSCLC
patients, we estimate that Avastin penetration was approximately 30% in the
third quarter of 2007, an increase from the adoption rate in the third quarter
of 2006, but remained flat compared to the second quarter of 2007. We estimate
that approximately 55% of first-line lung cancer patients are eligible for
treatment with Avastin. With respect to dose, use of the
15mg/kg/every-three-weeks dose decreased from approximately 75% in the second
quarter of 2007 to approximately 60% in the third quarter of 2007. This decrease
reflects physician adoption of a lower dose of Avastin following the
presentation of the results from the Roche-sponsored Phase III BO17704 study
at
the American Society of Clinical Oncology in June 2007. The BO17704 study
evaluated two different doses of Avastin in combination with gemcitabine and
cisplatin chemotherapy compared to chemotherapy alone in patients with
previously untreated, advanced NSCLC. The study evaluated a
15mg/kg/every-three-weeks dose of Avastin (the dose approved in the U.S. for
use
in combination with carboplatin and paclitaxel) and a 7.5mg/kg/every-three-weeks
dose of Avastin (a dose not approved for use in the U.S.). Both doses met the
primary endpoint of prolonging progression-free survival (PFS) compared to
chemotherapy alone. Although the study was not designed to compare the Avastin
doses, a similar treatment effect in PFS was observed between the two arms.
We
expect greater adoption by physicians of the lower Avastin dose of
7.5mg/kg/every-three-weeks. Efficacy data from other clinical studies conducted
by any party in the U.S. or internationally (such as AVADO, Roche’s study
evaluating two doses of Avastin in first-line metastatic BC), showing or
perceived to be showing a similar or an improved treatment benefit at a lower
dose, could further negatively affect future sales of Avastin.
In
first-line metastatic CRC, we estimate that penetration remained flat in the
third quarter of 2007 compared to the third quarter of 2006 and the second
quarter of 2007. Growth in metastatic CRC during this period resulted primarily
from a slight increase in treatment duration. In combined second- and third-line
CRC, we estimate that Avastin penetration decreased in the third quarter of
2007
compared to the third quarter of 2006, due to increased competition, and was
flat compared to the second quarter of 2007. In metastatic BC, we estimate
that Avastin adoption increased in the third quarter of 2007 compared to the
third quarter of 2006 and the second quarter of 2007. We believe that Avastin
sales growth for the remainder of 2007 will depend on increased penetration
in
the first-line treatment of metastatic NSCLC and the extent to which physicians
prescribe Avastin at its approved dose.
Rituxan
Net
U.S. sales of Rituxan increased 12% to $572 million in the
third quarter and 12% to $1,689 million in the first nine months of 2007 from
the comparable periods in 2006. It remains difficult to precisely determine
the
sales split between Rituxan use in oncology and immunology settings, since
many
treatment centers treat both types of patients. However, based on our
market research, we believe that the sales growth resulted from the increased
use of Rituxan in treating rheumatoid arthritis (RA), an indication that was
approved on February 28, 2006. The increase in market share was driven by both
current and new prescribing physicians. Rituxan in RA continued its market
share
growth in the patient population with an inadequate response to anti-TNF
inhibitors, with an estimated market share of more than 10% in the third quarter
of 2007. We believe that sales growth also resulted from the increased use
of
Rituxan following first-line therapy in indolent non-Hodgkin’s lymphoma (NHL),
and from increased adoption in front-line chronic lymphocytic leukemia (CLL),
an
unapproved use. Rituxan’s overall adoption rate in other areas of NHL and
CLL remained flat in the first nine months of 2007 and throughout 2006.
Also contributing to the increase in product sales were price increases in
2006
and 2007.
Herceptin
Net
U.S. sales of Herceptin increased 6% to $320 million in
the third quarter and 5% to $960 million in the first nine months of 2007 from
the comparable periods in 2006. The increases in product sales resulted
primarily from price increases in 2006 and 2007. Also contributing to the growth
in sales was increased use of Herceptin in the treatment of adjuvant
(early-stage) HER2-positive breast cancer, approved on November 16, 2006. We
estimate that Herceptin’s penetration in adjuvant HER2-positive breast cancer
patients was approximately 70% in the third quarter of 2007, an increase from
the adoption rate in the third quarter of 2006. We believe that due to the
significant adoption in the adjuvant population, further volume growth
opportunities for Herceptin may be limited.
Lucentis
Lucentis
was approved by the FDA for the treatment of neovascular (wet) AMD on June
30,
2006. Net U.S. sales of Lucentis increased 29% to $198 million in the third
quarter and 279% to $618 million in the first nine months of 2007 from the
comparable periods in 2006, and decreased 5% from $209 million in the second
quarter of 2007. New patient share in the third quarter of 2007 was
approximately 50%, a decrease from 55% in the second quarter of 2007. We
believe that the main factors affecting Lucentis sales are the continued
off-label use of Avastin by some retinal specialists and reimbursement concerns
from retinal specialists. We believe that some of the reimbursement concerns
may
be addressed when Lucentis receives a permanent J-code classification from
the
Centers for Medicare and Medicaid Services, expected in January 2008, which
will
allow for automated processing of claims. Sales in the third quarter of 2007
also may have been affected by some patients not returning for repeat treatments
during the summer months. We expect that Lucentis sales for the remainder of
2007 will be affected by the continued off-label use of Avastin, reimbursement
concerns, the extent to which patients return for treatment after the first
year
of therapy and the frequency with which those patients receive treatment, and
reactions by physicians to our decision regarding compounding pharmacies
discussed below.
Given
the FDA approval of Lucentis; concerns related to the sterility and
repackaging of Avastin for ocular use; and the fact that Avastin is not
designed, manufactured, tested in rigorous clinical trials, or approved for
ocular use, in October 2007 we announced that we would no longer allow
compounding pharmacies the ability to purchase Avastin directly from wholesale
distributors. We expect this change in distribution to be effective as of
January 1, 2008. However, compounding pharmacies and retinal specialists may
continue to obtain Avastin through other established channels.
Xolair
Net
U.S. sales of Xolair increased 13% to $121 million in the
third quarter and 15% to $352 million in the first nine months of 2007 from
the
comparable periods in 2006. The sales growth was primarily driven by increased
penetration in the asthma market and, to a lesser extent, price increases in
2006 and 2007. We believe that the FDA’s request that we strengthen the existing
warning of the potential risk for anaphylaxis in patients receiving Xolair
by
adding a boxed warning to the product label and implementing a Risk Minimization
Action Plan (RiskMAP), including providing a medication guide for patients,
had
a modest negative effect on sales in the first nine months of 2007. We and
Novartis, our co-promotion collaborator, agreed on a new U.S. label and are
working with the FDA to produce a RiskMAP that emphasizes the incidence of
anaphylaxis and instruct physicians that patients should be closely observed
for
an appropriate period of time after Xolair administration. We believe that
this
update to the label and RiskMAP will not have a significant effect on the way
physicians prescribe Xolair.
Tarceva
Net
U.S. sales of Tarceva increased 1% to $101 million in the
third quarter and 3% to $304 million in the first nine months of 2007 from
the
comparable periods in 2006. Sales results were positively affected by price
increases in 2006 and 2007, but these increases were substantially offset by
product returns and return reserve requirements, which were higher than expected
in the second and third quarters of 2007, and by modest decreases in volume.
In
second-line NSCLC, Tarceva’s overall penetration decreased in the first nine
months of 2007 relative to the same period in 2006. However, duration of therapy
in second-line NSCLC increased in the third quarter and first nine months of
2007 compared to the same periods in 2006. Future sales growth in NSCLC
will depend on increases in duration of therapy and penetration, particularly
against chemotherapy within select second-line NSCLC patient subsets. In
first-line pancreatic cancer, Tarceva’s penetration decreased in the first nine
months of 2007 compared to the first nine months of 2006 and was flat in the
third quarter of 2007 compared to third quarter of 2006.
Nutropin
Products
Combined
net U.S. sales of our Nutropin products increased 1% to
$93 million in the third quarter and remained flat at $278
million in the first nine months of 2007 from the comparable periods in 2006.
Sales in the third quarter and first nine months of 2007 were positively
affected by price increases in 2007, but these increases were substantially
offset by lower sales volume, partially resulting from the loss of managed
care
product placement due to pricing.
Thrombolytics
Combined
net U.S. sales of our three thrombolytic products—Activase, Cathflo Activase,
and TNKase—increased 12% to $67 million in the third quarter and 12% to $202
million in the first nine months of 2007 from the comparable periods in 2006.
The increases were primarily due to growth in Cathflo Activase sales in the
catheter clearance market and increased Activase sales in the acute ischemic
stroke market, partially offset by lower sales of TNKase. Also contributing
to
the increases in product sales were price increases in 2006 and
2007.
Pulmozyme
Net
U.S. sales of Pulmozyme increased 14% to $57 million in the third quarter and
12% to $164 million in the first nine months of 2007 from the comparable periods
in 2006. The increases reflected price increases in 2006 and 2007, and, to
a
lesser extent, increased penetration in certain patient segments.
Raptiva
Net
U.S. sales of Raptiva increased 26% to $29 million in the third quarter and
21%
to $80 million in the first nine months of 2007 from the comparable periods
in
2006. Contributing to the growth in sales were price increases in 2006 and
2007
and increased use of Raptiva in certain patient sub-populations.
Sales
to Collaborators
Product
sales to collaborators, for use in non-U.S. markets, increased 50% to
$166 million in the third quarter and 169% to $753 million
in the first nine months of 2007 from the comparable periods in 2006. The
increases were primarily due to more favorable Herceptin pricing terms to
Genentech that were part of the supply agreement with Roche signed in the third
quarter of 2006 and higher sales volumes of Herceptin, Avastin, and Rituxan
to
Roche. The favorable Roche Herceptin pricing terms will continue through the
end
of 2008.
For
the full year 2007, we expect sales to collaborators to be approximately 90%
higher than the 2006 level; however, sales to collaborators vary depending
on
contractual purchase obligations, production schedules and actual demand by
collaborators. Therefore, our quarterly sales to collaborators do not directly
predict our collaborators’ sales to end users outside the U.S., nor are they
always an indicator of the extent and timing of royalties expected to be
received from the sales of our products in non-U.S. markets.
Royalties
Royalty
revenue increased 44% to $524 million in the third quarter
and 48% to $1,427 million in the first nine months of 2007 from the comparable
periods in 2006. The increases were primarily due to higher sales by Roche
of
our Herceptin, Rituxan, and Avastin products and sales of our Lucentis product
by Novartis. The increase from the first nine months of 2006 was also due to
an
acceleration of royalties in the second quarter of 2007, as discussed below.
Of
the overall royalties received, royalties from Roche represented approximately
60% in the third quarter and first nine months of 2007 compared to approximately
63% in the third quarter and 62% in the first nine months of 2006. Royalties
from other licensees included royalty revenue on our patent licenses, including
our Cabilly patent, as discussed below.
In
June 2007, we entered into a transaction with an existing licensee to license
from them the right to co-develop and commercialize certain molecules. In
exchange, we released the licensee from its obligation to make certain royalty
payments to us that would have otherwise been owed over the
three-and-a-half-year period ending June 2010, and that period may be extended
contingent upon certain events as defined in the agreement. We estimate that
the
fair value of the royalty revenue owed to us over the three-and-a-half-year
period, less any amount recognized in the first quarter of 2007, was
approximately $65 million, and this amount was recognized as royalty revenue
in
the second quarter of 2007. We also recognized a similar amount as R&D
expense for the purchase of the new license, and thus the net earnings per
share
(EPS) effect of entering into this new collaboration was not
significant.
We
have confidential licensing agreements with a number of companies on the Cabilly
patent, under which we receive royalty revenue on sales of products covered
by
the patent. The Cabilly patent expires in December 2018. The net pretax
contributions related to the Cabilly patent were as follows (in
millions):
| |
|
Three
Months Ended
September
30, 2007
|
|
|
Nine
Months Ended
September
30, 2007
|
|
|
Royalty
revenue
|
|
$ |
75
|
|
|
$ |
183
|
|
| |
|
|
|
|
|
|
|
|
|
Gross
expenses(1)
|
|
$ |
30
|
|
|
$ |
87
|
|
| |
|
|
|
|
|
|
|
|
|
Net
of tax effect of Cabilly patent on diluted EPS
|
|
$ |
0.03
|
|
|
$ |
0.06
|
|
______________________
|
(1)
|
Gross
expenses include COH’s share of royalty revenue and royalty cost of sales
on our U.S. product sales
|
See
also Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements of Part I, Item 1 of this Form 10-Q for more information on our
Cabilly patent reexamination and the MedImmune lawsuit relating to the Cabilly
patent.
Cash
flows from royalty income include revenue denominated in foreign currencies.
We
currently enter into foreign currency option contracts (options) and forwards
to
hedge these foreign currency cash flows. These options and forwards are due
to
expire between 2007 and 2009.
For
the full year 2007, we expect royalty revenue to increase approximately 40%
over
the 2006 level of $1,354 million; however, royalties are difficult to forecast
because of the number of licensees and products involved, and potential
licensing and intellectual property disputes.
Contract
Revenue
Contract
revenue decreased 20% to $63 million in the third quarter
and increased 13% to $234 million in the first nine months of 2007 from the
comparable periods in 2006. The decrease in the third quarter of 2007 was mainly
due to the receipt of a Herceptin milestone payment in the third quarter of
2006
and fewer projects in 2007 on which we received reimbursements. The increase
in
the first nine months of 2007 was primarily due to recognition of a $30 million
milestone payment from Novartis for European Union approval of Lucentis for
the
treatment of patients with AMD, higher reimbursements from Roche related to
R&D efforts on Avastin and higher reimbursements from Biogen Idec related to
R&D efforts on Rituxan. See “Related Party Transactions” below for more
information on contract revenue from Roche and Novartis.
Contract
revenue varies each quarter and is dependent on a number of factors, including
the timing and level of reimbursements from ongoing development efforts,
milestones, and opt-in payments received, and new contract arrangements. For
the
full year 2007, we expect contract revenue to be approximately 90% of the 2006
level; however, contract revenue is difficult to forecast because it can vary
based on the mix of spending by us and our collaborators and the related
reimbursements that we will receive.
Cost
of Sales
Cost
of sales as a percentage of product sales was 17% in the third quarter and
first
nine months of 2007 compared to 15% in the third quarter and 16% in the first
nine months of 2006. Cost of sales in the third quarter and first nine months
of
2007 included a non-recurring charge of approximately $53 million resulting
from
our decision to cancel and buy out a future manufacturing obligation. The
increases in cost of sales as a percentage of product sales were also due to
the
recognition of employee stock-based compensation expense of $16 million in
the
third quarter and $49 million in the first nine months of 2007, related to
products sold for which employee stock-based compensation expense was previously
capitalized as part of inventory costs in 2006, and higher volume of lower
margin sales to collaborators. However, cost of sales as a percentage of product
sales was favorably affected by the U.S. product sales mix (increased sales
of
our higher margin products, primarily Lucentis, Avastin, and Herceptin in the
first nine months of 2007) and a price increase on sales of Herceptin to Roche,
which started in the third quarter of 2006.
Research
and Development
Research
and development (R&D) expenses increased 35% to
$615 million in the third quarter and 50% to $1,828
million in the first nine months of 2007 from the comparable periods in 2006.
The higher levels of expenses in the third quarter and first nine months of
2007
reflected increased development activity across our entire product portfolio,
including increased spending on clinical trials, post-marketing studies,
clinical manufacturing expenses (notably for Rituxan, Avastin, Xolair, and
Lucentis), early-stage projects, and higher research expenses. The increase
in
the first nine months of 2007 was also due to an increase in up-front,
in-licensing expense for new collaborations.
R&D
as a percentage of operating revenue was 21% in the third
quarter and first nine months of 2007 compared to 19% in the third quarter
and
first nine months of 2006.
The
major components of R&D expenses were as follows (in
millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
|
|
|
Nine
Months
Ended
September 30,
|
|
|
|
|
|
Research
and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
development (including post-marketing)
|
|
$ |
479
|
|
|
$ |
316
|
|
|
|
52 |
% |
|
$ |
1,277
|
|
|
$ |
900
|
|
|
|
42 |
% |
|
Research
|
|
|
109
|
|
|
|
83
|
|
|
|
31
|
|
|
|
304
|
|
|
|
232
|
|
|
|
31
|
|
|
In-licensing
(up-front and ongoing fees)
|
|
|
|
|
|
|
|
|
|
|
(51 |
) |
|
|
|
|
|
|
|
|
|
|
187
|
|
|
Total
R&D
|
|
$ |
|
|
|
$ |
|
|
|
|
35 |
% |
|
$ |
|
|
|
$ |
|
|
|
|
50 |
% |
Marketing,
General and Administrative
Marketing,
general and administrative (MG&A) expenses increased 8% to
$541 million in the third quarter and 11% to $1,564
million in the first nine months of 2007 from the comparable periods in 2006.
The increase from the third quarter of 2006 was primarily due to (i) an increase
in royalty expense, primarily to Biogen Idec, resulting from higher Roche sales
of Rituxan and (ii) an increase in marketing and sales expenses primarily in
support of commercial activities for Lucentis and Rituxan (RA setting). The
increase from the first nine months of 2006 was primarily due to: (i) an
increase in royalty expense, primarily to Biogen Idec resulting from higher
Roche sales of Rituxan, (ii) an increase in general and administrative expenses,
including charitable donations and losses on property and equipment disposals,
and (iii) an increase in marketing and sales expense, primarily in support
of
Herceptin (adjuvant setting) and commercial activities related to Lucentis
and
Rituxan (RA setting).
MG&A
as a percentage of operating revenue was 19% in the third quarter and 18% in
the
first nine months of 2007 compared to 21% in the third quarter and 22% in the
first nine months of 2006.
Collaboration
Profit Sharing
Collaboration
profit sharing expenses increased 10% to $276 million in
the third quarter and 10% to $805 million in the first nine months of 2007
from
the comparable periods in 2006 primarily due to higher sales of Rituxan and
Xolair.
The
following table summarizes the amounts resulting from the respective profit
sharing collaborations for the periods presented (in
millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
|
|
|
Nine
Months
Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Rituxan profit sharing expense
|
|
$ |
187
|
|
|
$ |
165
|
|
|
|
13 |
% |
|
$ |
541
|
|
|
$ |
490
|
|
|
|
10 |
% |
|
U.S.
Tarceva profit sharing expense
|
|
|
42
|
|
|
|
39
|
|
|
|
8
|
|
|
|
121
|
|
|
|
108
|
|
|
|
12
|
|
|
Total
Xolair profit sharing expense
|
|
|
|
|
|
|
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
Total
collaboration profit sharing expense
|
|
$ |
|
|
|
$ |
|
|
|
|
10 |
% |
|
$ |
|
|
|
$ |
|
|
|
|
10 |
% |
Currently,
our most significant collaboration profit sharing agreement is with Biogen
Idec,
with whom we co-promote Rituxan in the U.S. Under the collaboration agreement,
Biogen Idec granted us a worldwide license to develop, commercialize, and market
Rituxan in multiple indications. In exchange for these worldwide rights, Biogen
Idec has co-promotion rights in the U.S. and a contractual arrangement under
which we share a portion of the pretax U.S. co-promotion profits of Rituxan
and
royalty revenue on sales of Rituxan by collaborators. In June 2003, we amended
and restated the collaboration agreement with Biogen Idec to include the
development and commercialization of one or more anti-CD20 antibodies targeting
B-cell disorders, in addition to Rituxan, for a broad range of
indications.
Under
the amended and restated collaboration agreement, our share of the current
pretax U.S. co-promotion profit sharing formula is approximately 60% of
operating profits, and Biogen Idec’s share is approximately 40% of operating
profits. For each calendar year or portion thereof following the approval date
of the first new anti-CD20 product, after a period of transition, our share
of
the pretax U.S. co-promotion profits will change to approximately 70% of
operating profits, and Biogen Idec’s share will be approximately 30% of
operating profits.
Collaboration
profit sharing expense, exclusive of R&D expenses, related to Biogen Idec
for the periods ended September 30, 2007 and 2006 consisted of the following
(in millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
|
|
|
Nine
Months
Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales, net
|
|
$ |
572
|
|
|
$ |
509
|
|
|
|
12 |
% |
|
$ |
1,689
|
|
|
$ |
1,511
|
|
|
|
12 |
% |
|
Combined
commercial and manufacturing costs and expenses
|
|
|
|
|
|
|
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
15
|
|
|
Combined
co-promotion profits
|
|
$ |
|
|
|
$ |
|
|
|
|
14
|
|
|
$ |
|
|
|
$ |
|
|
|
|
11
|
|
|
Amount
due to Biogen Idec for their share of co-promotion profits – included in
collaboration profit sharing expense
|
|
$ |
187
|
|
|
$ |
165
|
|
|
|
13 |
% |
|
$ |
541
|
|
|
$ |
490
|
|
|
|
10 |
% |
In
addition to Biogen Idec’s share of the operating profits for Rituxan,
collaboration profit sharing expense includes the quarterly settlement of
Biogen Idec’s portion of the combined commercial costs. Since we and Biogen Idec
each individually incur commercial costs related to Rituxan, and the spending
mix between the parties can vary, collaboration profit sharing expense as a
percentage of sales can also vary accordingly.
Revenue
and expenses related to our collaboration with Biogen Idec separately included
the following (in millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
|
|
|
Nine
Months
Ended
September 30,
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Biogen Idec (R&D reimbursement)
|
|
$ |
27
|
|
|
$ |
20
|
|
|
|
35 |
% |
|
$ |
83
|
|
|
$ |
59
|
|
|
|
41 |
% |
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty
expense on sales of Rituxan by Roche and to Zenyaku, and other patent
costs – included in MG&A expense
|
|
$ |
69
|
|
|
$ |
46
|
|
|
|
50 |
% |
|
$ |
175
|
|
|
$ |
126
|
|
|
|
39 |
% |
Write-off
of In-process Research and Development Related to
Acquisition
In
connection with the acquisition of Tanox in the third quarter of 2007, we
recorded a $77 million charge for in-process research and development. This
charge primarily represents acquired R&D for label extensions for Xolair
that have not yet been approved by the FDA and require significant further
development. We expect to continue further developing these label extensions
until a decision is made to file for a label extension or to discontinue
development efforts. We expect these development efforts to be completed from
2009 to 2013, if not abandoned sooner.
Gain
on Acquisition
Under
EITF 04-1, a business combination between parties with a preexisting
relationship should be evaluated to determine if a settlement of that
preexisting relationship exists. The acquisition of Tanox is considered to
include the settlement of our 1996 license arrangement of certain
intellectual property and rights thereon from Tanox. We measured the amount
that
the license arrangement is favorable, from our perspective, by comparing it
to
estimated pricing for current market transactions for intellectual property
rights similar to Tanox’s intellectual property rights related to Xolair.
In connection with the settlement of this license arrangement, we recorded
a
gain of $121 million on a pretax basis, in accordance with EITF
04-1.
Recurring
Charges Related to Redemption and Acquisition
On
June 30, 1999, RHI exercised its option to cause us to redeem all of our Special
Common Stock held by stockholders other than RHI. The Redemption was reflected
as the purchase of a business, which under GAAP required push-down accounting
to
reflect in our financial statements the amounts paid for our stock in excess
of
our net book value.
On
August 2, 2007, we acquired Tanox. In connection with the acquisition, we
recorded approximately $814 million of intangible assets, representing developed
product technology and core technology, which are being amortized over 12
years.
We
recorded recurring charges related to the amortization of intangibles associated
with the Redemption and push-down accounting and our acquisition of Tanox in
the
third quarter of 2007. These charges were $38 million in the third quarter
of
2007 and $26 million in the third quarter of 2006, and $90 million in the first
nine months of 2007 and $79 million in the first nine months of
2006.
Special
Items: Litigation-Related
We
recorded accrued interest and bond costs related to the COH trial judgment
of
$14 million for the third quarter of 2007 and $13 million for the third quarter
of 2006, and $41 million for the first nine months of 2007 and $40 million
for
the first nine months of 2006. We expect that we will continue to incur interest
charges on the judgment and service fees on the surety bond each quarter through
the process of appealing the COH trial results. The amount of cash to be paid,
if any, or the timing of such payment in connection with the COH matter will
depend on the outcome of the California Supreme Court’s review. It may take
longer than one year to resolve this matter. See Note 4, “Contingencies,” in the
Notes to the Condensed Consolidated Financial Statements of Part I, Item 1
of
this Form 10-Q for more information regarding our litigation.
Operating
Income
Operating
income was $1,062 million in the third quarter of 2007, a 26% increase from
the
third quarter of 2006, and $3,244 million in the first nine months of 2007,
a
45% increase from the first nine months of 2006. Our operating income as a
percentage of operating revenue (pretax operating margin) was 37% in the third
quarter of 2007 and 35% in the third quarter of 2006, and was 37% in the first
nine months of 2007 and 34% in the first nine months of 2006.
Other
Income (Expense)
The
components of “other income (expense)” were as follows (in
millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
|
|
|
Nine
Months
Ended
September 30,
|
|
|
|
|
|
Other
Income, Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gains
on sales of biotechnology equity securities, net
|
|
$ |
5
|
|
|
$ |
11
|
|
|
|
(55 |
)% |
|
$ |
17
|
|
|
$ |
81
|
|
|
|
(79 |
)% |
|
Write-downs
of biotechnology debt and equity securities
|
|
|
–
|
|
|
|
(1 |
) |
|
|
(100 |
) |
|
|
(4 |
) |
|
|
(1 |
) |
|
|
300
|
|
|
Interest
income
|
|
|
80
|
|
|
|
64
|
|
|
|
25
|
|
|
|
219
|
|
|
|
166
|
|
|
|
32
|
|
|
Interest
expense
|
|
|
(18 |
) |
|
|
(19 |
) |
|
|
(5 |
) |
|
|
(53 |
) |
|
|
(56 |
) |
|
|
(5 |
) |
|
Other
miscellaneous income (expense)
|
|
|
(1 |
) |
|
|
|
|
|
|
–
|
|
|
|
|
|
|
|
|
|
|
|
(67 |
) |
|
Total
other income, net
|
|
$ |
|
|
|
$ |
|
|
|
|
20 |
% |
|
$ |
|
|
|
$ |
|
|
|
|
(7 |
)% |
Other
income, net increased 20% to $66 million in the third quarter of 2007 and
decreased 7% to $180 million in the first nine months of 2007 over the
comparable periods in 2006. Gains on sales of biotechnology equity securities,
net were lower, resulting from approximately $70 million in gains from sales
of
certain of our biotechnology equity investments in the first nine months of
2006. Interest income increased, primarily due to higher yields and higher
average cash balances in the third quarter and first nine months of 2007 from
the comparable periods in 2006. For the full year 2007, we expect other income,
net to be approximately 90% of 2006 levels, although this may vary with
fluctuations in interest rates and unexpected gains or losses from our
biotechnology equity and investment portfolio.
Income
Tax Provision
The
effective income tax rate was 39% in the third quarter of 2007 and 37% in the
third quarter of 2006. The increase was primarily due to the non-deductible
IPR&D charge in the third quarter of 2007 resulting from our acquisition of
Tanox. The effective income tax rate was 38% in the first nine months of 2007
and 2006.
We
adopted the provisions of FIN 48 on January 1, 2007. Implementation of FIN
48
did not result in any adjustment to our Condensed Consolidated Statements of
Income or a cumulative adjustment to retained earnings (accumulated deficit).
As
a result of the implementation of FIN 48, we reclassified $147 million of
unrecognized tax benefits from current liabilities to long-term liabilities
as
of January 1, 2007, and we also reclassified the balance as of December 31,
2006, for consistency, in the accompanying Condensed Consolidated Balance
Sheets, none of which would have been considered due in 2007 in the presentation
of our Contractual Obligations table in our Annual Report on Form 10-K for
the
year ended December 31, 2006.
Liquidity
and Capital Resources
(In
millions)
| |
|
|
|
|
|
|
|
Unrestricted
cash, cash equivalents, short-term investments, and long-term marketable
debt and equity securities
|
|
$ |
4,872
|
|
|
$ |
4,325
|
|
|
Net
receivable equity hedge instruments
|
|
|
|
|
|
|
|
|
|
Total
unrestricted cash, cash equivalents, short-term investments, long-term
marketable debt and equity securities, and equity hedge
instruments
|
|
$ |
|
|
|
$ |
|
|
|
Working
capital
|
|
$ |
4,615
|
|
|
$ |
3,694
|
|
|
Current
ratio
|
|
3.2:1
|
|
|
2.8:1
|
|
Total
unrestricted cash, cash equivalents, short-term investments, and long-term
marketable securities, including the fair value of the equity hedge instruments,
was $4,876 million at September 30, 2007, an increase of $501 million from
December 31, 2006. This increase primarily reflects cash generated from
operations and cash increases from stock option exercises, partially offset
by
cash used for our acquisition of Tanox in the third quarter of
2007,
repurchases
of our Common Stock, and capital expenditures. To mitigate the risk of market
value fluctuation, certain of our biotechnology marketable equity securities
are
hedged with zero-cost collars and forward contracts, which are carried at fair
value. See Note 4, “Investment Securities and Financial Instruments,” in the
Notes to the Consolidated Financial Statements of Part II, Item 8 of our Form
10-K for the year ended December 31, 2006 for more information regarding
activity in our marketable investment portfolio and derivative
instruments.
See
“Our affiliation agreement with Roche Holdings, Inc. could adversely affect
our
cash position” among other risk factors below in Part II, Item 1A, “Risk
Factors,” of this Form 10-Q and Note 4, “Contingencies,” in the Notes to
Condensed Consolidated Financial Statements of Part I, Item 1 of this Form
10-Q
for factors that could negatively affect our cash position.
Cash
Provided by Operating Activities
Cash
provided by operating activities is primarily driven by increases in our net
income. However, operating cash flows differ from net income as a result of
non-cash charges or differences in the timing of cash flows and earnings
recognition. Significant components of cash provided by operating activities
were as follows:
Our
“accounts receivable—product sales” was $1,012 million at September 30, 2007, an
increase of $47 million from December 31, 2006. The increase was primarily
due
to higher product sales of Avastin. The average collection period of our
“accounts receivable—product sales” as measured in days’ sales outstanding (DSO)
was 40 days for both the third quarter and second quarter of 2007 compared
to 37
days for the third quarter of 2006. The increase from the third quarter of
2006
was primarily due to the extended payment terms of approximately 100 days in
addition to our customary terms that we offered certain wholesalers in
conjunction with the launch of Lucentis on June 30, 2006. This program ended
on
June 30, 2007 and was revised to an extended payment term of approximately
60
days in addition to our customary terms. We expect the revised payment term
to
continue into the first quarter of 2008.
Our
inventory balance was $1,425 million at September 30, 2007, an increase of
$247
million from December 31, 2006. The increase was primarily due to finished
goods
of our Herceptin and Avastin products, as well as bulk campaign production
of
our Avastin product. In the first nine months of 2007, we capitalized into
inventory $59 million of non-cash employee stock-based compensation costs
pursuant to FAS 123R, and recognized $49 million of previously capitalized
employee stock-based compensation costs in cost of sales.
Accounts
payable, other accrued liabilities, and other long-term liabilities increased
$215 million in the first nine months of 2007. This increase was mainly due
to
increases in accrued clinical expenses, accrued royalties, accrued marketing
expenses, and other liabilities, which were mainly due to the growth in the
business, partially offset by decreases in taxes payable due to payments made
during the first nine months of 2007.
Cash
Used in Investing Activities
Cash
used in investing activities was primarily related to our acquisition of Tanox,
capital expenditures and purchases, sales, and maturities of investments. Our
net cash and cash equivalent outlay to acquire Tanox in the third quarter of
2007 was $833 million, which represents the $933 million cash consideration,
less approximately $100 million of Tanox’s cash and cash equivalents that we
acquired. Capital expenditures were $692 million during the first nine months
of
2007 compared to $888 million during the first nine months of 2006. Capital
expenditures in the first nine months of 2007 included ongoing construction
of
our second manufacturing facility in Vacaville,
California, leasehold improvements for newly constructed
buildings on our South San Francisco, California campus, construction of our
fill/finish facility in Hillsboro, Oregon, and purchases of equipment and
information systems.
Cash
Used in Financing Activities
Cash
used in financing activities was primarily related to activities under our
employee stock plans and our stock repurchase program. We used cash for stock
repurchases of $815 million during the first nine months of 2007 and $758
million during the first nine months of 2006 pursuant to our stock repurchase
program approved by our Board of Directors. We also received $381 million during
the first nine months of 2007 and $286 million during the first
nine
months of 2006 related to stock option exercises and stock issuances under
our
employee stock plans. The excess tax benefits from stock-based compensation
arrangements were $160 million in the first nine months of 2007 and $142 million
in the first nine months of 2006.
On
October 11, 2007, we entered into a five-year, $1 billion revolving credit
facility with various financial institutions. The credit facility is expected
to
be used for general corporate and working capital purposes, including providing
support for our new $1 billion commercial paper program. As of October 26,
2007,
we had no borrowings under the credit facility and had $600 million outstanding
in commercial paper.
Under
a stock repurchase program approved by our Board of Directors in December 2003
and most recently extended in April 2007, we are authorized to repurchase up
to
100 million shares of our Common Stock for an aggregate price of up to $8.0
billion through June 30, 2008. In this program, as in previous stock repurchase
programs, purchases may be made in the open market or in privately negotiated
transactions from time to time at management’s discretion. We also may engage in
transactions in other Genentech securities in conjunction with the repurchase
program, including certain derivative securities, though as of September 30,
2007, we have not engaged in any such transactions. We intend to use the
repurchased stock to offset dilution caused by the issuance of shares in
connection with our employee stock plans. Although there are currently no
specific plans for the shares that may be purchased under the program, our
goals
for the program are (i) to address provisions of our affiliation agreement
with
RHI related to maintaining RHI’s minimum ownership percentage, (ii) to make
prudent investments of our cash resources, and (iii) to allow for an effective
mechanism to provide stock for our employee stock plans. See “Relationship with
Roche Holdings, Inc.” for more information on RHI’s minimum ownership
percentage.
We
enter into Rule 10b5-1 trading plans to repurchase shares in the open market
during those periods each quarter when trading in our stock is restricted under
our insider trading policy. The most recent trading plan covered approximately
one million shares and expired on October
16, 2007.
Our
shares repurchased during the first nine months of 2007 were as follows
(shares in millions):
| |
|
Total
Number of Shares Purchased
|
|
|
Average
Price Paid per Share
|
|
|
January
1–31, 2007
|
|
|
3.0
|
|
|
$ |
87.33
|
|
|
February
1–28, 2007
|
|
|
0.9
|
|
|
|
86.54
|
|
|
March
1–31, 2007
|
|
|
0.6
|
|
|
|
82.33
|
|
|
April
1–30, 2007
|
|
|
0.8
|
|
|
|
82.14
|
|
|
May
1–31, 2007
|
|
|
1.4
|
|
|
|
79.65
|
|
|
June
1–30, 2007
|
|
|
1.3
|
|
|
|
75.84
|
|
|
August
1–31, 2007
|
|
|
0.8
|
|
|
|
73.66
|
|
|
September
1–30, 2007
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
10.0
|
|
|
$ |
81.90
|
|
As
of September 30, 2007, 72 million cumulative shares had been purchased under
our
stock repurchase program for $5.2 billion, and a maximum of 28 million
additional shares may be purchased under the program through June 30,
2008.
Off-Balance
Sheet Arrangements
We
have certain contractual arrangements that create potential risk for us and
are
not recognized in our Condensed Consolidated Balance Sheets. We believe that
there have been no significant changes in the off-balance sheet arrangements
disclosed in our Annual Report on Form 10-K for the year ended December 31,
2006
that have or are reasonably likely to have a material current or future effect
on our financial condition, changes in financial condition, revenue or expenses,
results of operations, liquidity, capital expenditures, or capital
resources.
Contractual
Obligations
During
the first nine months of 2007, we believe that there have been no significant
changes in our payments due under contractual obligations, as disclosed in
our
Annual Report on Form 10-K for the year ended December 31, 2006, except as
noted
above in “Income Tax Provision.”
Contingencies
We
are party to various legal proceedings, including patent infringement litigation
and licensing and contract disputes, and other matters. See Note 4,
“Contingencies,” in the Notes to Condensed Consolidated Financial Statements of
Part I, Item 1 of this Form 10-Q for more information.
Relationship
with Roche Holdings, Inc.
Roche
Holdings, Inc.’s Ability to Maintain Percentage Ownership Interest in Our
Stock
We
issue 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 RHI provides, among other things, that with respect
to any issuance of our Common Stock in the future, we will repurchase a
sufficient number of shares so that immediately after such issuance, the
percentage of our Common Stock owned by RHI will be no lower than 2% below
the
“Minimum Percentage” (subject to certain conditions). The Minimum Percentage
equals the lowest number of shares of Genentech Common Stock owned by RHI since
the July 1999 offering (to be adjusted in the future for dispositions of shares
of Genentech Common Stock by RHI as well as for stock splits or stock
combinations) divided by 1,018,388,704 (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 stock
splits. We have repurchased shares of our Common Stock since 2001 (see
discussion above in “Liquidity and Capital Resources”). The affiliation
agreement also provides that, upon RHI’s request, we will repurchase shares of
our Common Stock to increase RHI’s ownership to the Minimum Percentage. In
addition, RHI will have a continuing option to buy stock from us at prevailing
market prices to maintain its percentage ownership interest. Under the terms
of
the affiliation agreement, RHI’s Minimum Percentage is 57.7% and RHI’s ownership
percentage is to be no lower than 55.7%. At September 30, 2007, RHI’s ownership
percentage was 55.8%.
Related
Party Transactions
We
enter into transactions with our related parties, Roche Holding AG and
affiliates (Roche) and Novartis. The accounting policies that we apply to our
transactions with our related parties are consistent with those applied in
transactions with independent third parties, and all related party agreements
are negotiated on an arm’s-length basis.
In
our royalty and supply arrangements with related parties, we are the principal,
as defined under EITF Issue No. 99-19, “Reporting Revenue Gross as
a Principal versus Net as an Agent” (EITF 99-19), because we bear
the manufacturing risk, general inventory risk, and the risk to defend our
intellectual property. For circumstances in which we are the principal in the
transaction, we record the transaction on a gross basis in accordance with
EITF
99-19. Otherwise our transactions are recorded on a net basis.
Roche
Under
our existing arrangements with Roche, including our licensing and marketing
agreement, we recognized the following amounts (in
millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales to Roche
|
|
$ |
135
|
|
|
$ |
86
|
|
|
$ |
651
|
|
|
$ |
217
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties
earned from Roche
|
|
$ |
317
|
|
|
$ |
230
|
|
|
$ |
855
|
|
|
$ |
602
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Roche
|
|
$ |
21
|
|
|
$ |
37
|
|
|
$ |
81
|
|
|
$ |
76
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales on product sales to Roche
|
|
$ |
98
|
|
|
$ |
60
|
|
|
$ |
356
|
|
|
$ |
173
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
R&D
expenses incurred on joint development projects with Roche
|
|
$ |
64
|
|
|
$ |
52
|
|
|
$ |
192
|
|
|
$ |
147
|
|
Certain
R&D expenses are partially reimbursable to us by Roche. In addition, R&D
expenses may include the net settlement of amounts that we owed to Roche for
R&D expenses that Roche incurred on joint development projects, less amounts
reimbursable to us by Roche on these projects.
Novartis
Based
on information available to us at the time of filing this Form 10-Q, we believe
that Novartis holds approximately 33.3 percent of the outstanding voting shares
of Roche Holding AG. As a result of this ownership, Novartis is deemed to have
an indirect beneficial ownership interest under FAS 57, “Related
Party Disclosures,” of more than 10 percent of our voting
stock.
We
have an agreement with Novartis under which Novartis has the exclusive right
to
develop and market Lucentis outside the U.S. for indications related to diseases
or disorders of the eye. As part of this agreement, the parties will share
the
cost of certain of our ongoing development expenses for Lucentis. Novartis
makes
royalty payments to us on sales of Lucentis outside the U.S.
We,
along with Novartis, are co-developing and co-promoting Xolair in the U.S.
We
record all sales and cost of sales in the U.S., and Novartis markets the product
in and records all sales and cost of sales in Europe. We and Novartis share
the
resulting U.S. and European operating profits according to prescribed profit
sharing percentages, and our U.S. and European profit sharing expenses are
recorded as collaboration profit sharing expense. Effective with our acquisition
of Tanox on August 2, 2007, Novartis also makes royalty payments to us on sales
of Xolair worldwide and also pays us a manufacturing fee related to Xolair.
See
Note 6, “Acquisition of Tanox, Inc.” in Part I, Item 1 of this Form 10-Q for
more information on the acquisition.
Under
our existing arrangements with Novartis, we recognized the following amounts
(in millions):
| |
|
Three
Months
Ended
September 30,
|
|
|
Nine
Months
Ended
September 30,
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales to Novartis
|
|
$ |
2
|
|
|
$ |
1
|
|
|
$ |
8
|
|
|
$ |
3
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties
earned from Novartis
|
|
$ |
40
|
|
|
$ |
–
|
|
|
$ |
59
|
|
|
$ |
1
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Novartis
|
|
$ |
9
|
|
|
$ |
15
|
|
|
$ |
53
|
|
|
$ |
38
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales on product sales to Novartis
|
|
$ |
2
|
|
|
$ |
3
|
|
|
$ |
9
|
|
|
$ |
5
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
R&D
expenses incurred on joint development projects with
Novartis
|
|
$ |
11
|
|
|
$ |
10
|
|
|
$ |
30
|
|
|
$ |
32
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collaboration
profit sharing expense to Novartis
|
|
$ |
47
|
|
|
$ |
46
|
|
|
$ |
143
|
|
|
$ |
137
|
|
Contract
revenue in the first nine months of 2007 included a $30 million milestone
payment from Novartis for European Union approval of Lucentis for the treatment
of AMD.
Certain
R&D expenses are partially reimbursable to us by Novartis. In addition,
R&D expenses may include the net settlement of amounts that we owed to
Novartis for R&D expenses that Novartis incurred on joint development
projects, less amounts reimbursable to us by Novartis on these
projects.
See
Note 6, “Acquisition of Tanox, Inc.” in Part I, Item 1 of this Form 10-Q
for information on Novartis proceeds resulting from our acquisition of
Tanox.
Stock
Options
Option
Program Description
Our
employee stock option program is a broad-based, long-term retention program
that
is intended to attract and retain talented employees and to align stockholder
and employee interests. Our program primarily consists of our 2004 Equity
Incentive Plan (the Plan), a broad-based plan under which stock options,
restricted stock, stock appreciation rights, and performance shares and units
may be granted to employees, directors, and other service providers.
Substantially all of our employees participate in our stock option program.
In
the past, we granted options under our amended and restated 1999 Stock Plan,
1996 Stock Option/Stock Incentive Plan, our amended and restated 1994 Stock
Option Plan, and our amended and restated 1990 Stock Option/Stock Incentive
Plan. Although we no longer grant options under these plans, exercisable options
granted under these plans are still outstanding.
All
stock option grants are made with the approval of the Compensation Committee
of
the Board of Directors or an authorized delegate.
General
Option Information
Summary
of Option Activity
(Shares
in millions)
| |
|
|
|
|
|
|
| |
|
Shares
Available
for
Grant
|
|
|
|
|
|
Weighted-Average
Exercise
Price
|
|
|
December
31, 2005
|
|
|
83.7
|
|
|
|
82.8
|
|
|
$ |
46.64
|
|
|
Grants
|
|
|
(17.5 |
) |
|
|
17.5
|
|
|
|
79.85
|
|
|
Exercises
|
|
|
–
|
|
|
|
(9.5 |
) |
|
|
30.42
|
|
|
Cancellations
|
|
|
|
|
|
|
(2.5 |
) |
|
|
62.09
|
|
|
December
31, 2006
|
|
|
68.7
|
|
|
|
88.3
|
|
|
$ |
54.53
|
|
|
Grants
|
|
|
(17.4 |
) |
|
|
17.4
|
|
|
|
79.55
|
|
|
Exercises
|
|
|
–
|
|
|
|
(8.9 |
) |
|
|
32.31
|
|
|
Cancellations
|
|
|
|
|
|
|
(2.5 |
) |
|
|
75.51
|
|
|
September
30, 2007 (Year to Date)
|
|
|
|
|
|
|
|
|
|
$ |
60.69
|
|
In-the-Money
and Out-of-the-Money Option Information
(Shares
in millions)
| |
|
|
|
|
|
|
|
|
|
|
As
of September 30, 2007
|
|
|
|
|
Weighted-Average
Exercise
Price
|
|
|
|
|
|
Weighted-Average
Exercise
Price
|
|
|
|
|
|
Weighted-Average
Exercise
Price
|
|
|
In-the-Money
|
|
|
40
|
|
|
$ |
34.85
|
|
|
|
5
|
|
|
$ |
55.55
|
|
|
|
45
|
|
|
$ |
37.20
|
|
|
Out-of-the-Money(1)
|
|
|
|
|
|
|
83.97
|
|
|
|
|
|
|
|
81.09
|
|
|
|
|
|
|
|
81.81
|
|
|
Total
Options Outstanding
|
|
|
52
|
|
|
|
|
|
|
|
42
|
|
|
|
|
|
|
|
94
|
|
|
|
|
|
___________
|
(1)
|
Out-of-the-money
options are those options with an exercise price equal to or greater
than
the fair market value of Genentech Common Stock, $78.02, at the close
of
business on September 28, 2007.
|
Dilutive
Effect of Options
Grants,
net of cancellations, as a percentage of outstanding shares were 1.42% for
the first nine months of 2007, 1.43% for the year ended
December 31, 2006, and 1.70% for the year ended December 31, 2005.
Equity
Compensation Plan Information
Our
stockholders have approved all of our equity compensation plans under which
options are outstanding.
******
This
report contains forward-looking statements regarding our Horizon 2010 strategy
of bringing 20 new molecules into clinical development, bringing at least 15
major new products or indications onto the market, becoming the number one
U.S.
oncology company in sales, and achieving certain financial growth measures;
the
impact of new regulations related to coverage and reimbursement; Avastin,
Lucentis and Tarceva sales growth; the effect of a new label and RiskMAP on
the
use of Xolair; sales to collaborators; royalty and contract revenue; other
income, net; days of sales outstanding; revised payment terms for Lucentis;
purchase price allocation for and the completion of restructuring programs
related to the acquisition of Tanox; further development of label extensions
for
Xolair; and our credit facility.
These
forward-looking statements involve risks and uncertainties, and the cautionary
statements set forth below and those contained in “Risk Factors” in this Form
10-Q identify important factors that could cause actual results to differ
materially from those predicted in any such forward-looking statements. Such
factors include, but are not
limited
to, difficulty in enrolling patients in clinical trials; additional time
requirements for data analysis; efficacy data concerning any of our products
which shows or is perceived to show similar or improved treatment benefit at
a
lower dose or shorter duration of therapy; BLA preparation and decision making;
FDA actions or delays; failure to obtain or maintain FDA approval; the need
for
additional data or clinical studies; difficulty in obtaining materials from
suppliers; unexpected safety, efficacy or manufacturing issues for us or our
contractors/collaborators; the ability to supply product and meet demand for
our
products; product withdrawals; competition; pricing decisions by us or our
competitors; our ability to protect our proprietary rights; the outcome of,
and
expenses associated with, litigation or legal settlements; increased cost of
sales, R&D, MG&A and stock based compensation expenses; variations in
collaborator sales and expenses; actions by Roche Holdings, Inc. that are
adverse to our interests; decreases in third party reimbursement rates; the
ability to repay our indebtedness; and new accounting pronouncements or
guidance. We disclaim and do not undertake any obligation to update or revise
any forward-looking statement in this Form 10-Q.
Our
market risks at September 30, 2007 have not changed materially from those
discussed in Item 7A of our Form 10-K for the year ended December 31, 2006
on
file with the U.S. Securities and Exchange Commission.
See
also Note 1, “Summary of Significant Accounting Policies—Derivative Instruments”
in the Notes to Condensed Consolidated Financial Statements in Part I, Item
1 of
this Form 10-Q.
Evaluation
of Disclosure Controls and Procedures: Our principal executive
and financial officers reviewed and evaluated our disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the
period covered by this Form 10-Q. Based on that evaluation, our principal
executive and financial officers concluded that our disclosure controls and
procedures are effective in timely providing them with material information
related to Genentech, as required to be disclosed in the reports that we file
under the Exchange Act of 1934.
Changes
in Internal Controls over Financial Reporting: There were no changes in our
internal control over financial reporting that occurred during our last fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
PART
II—OTHER INFORMATION
See
Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements of Part I, Item 1 of this Form 10-Q for a description of legal
proceedings as well as certain other matters.
See
also Item 3 of our Annual Report on Form 10-K for the year ended December 31,
2006 and Part II, Item 1 of our Quarterly Reports on Form 10-Q for the quarters
ended March 31, 2007 and June 30, 2007.
This
Form 10-Q contains forward-looking information based on our current
expectations. Because our actual results may differ materially from any
forward-looking statements that we make or that are made on our behalf, 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 revenue, expenses, net income, and earnings per share.
The
successful development of biotherapeutics is highly uncertain and requires
significant expenditures and time.
Successful
development of biotherapeutics is highly uncertain. Products that appear
promising in research or development may be delayed or fail to reach later
stages of development or the market for several reasons, including:
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. If our large-scale clinical trials are not successful,
we
will not recover our substantial investments in the product.
Factors
affecting our research and development (R&D) productivity and the amount of
our R&D expenses include, but are not limited to:
We
may be unable to obtain or maintain regulatory approvals for our
products.
We
are subject to stringent regulation with respect to product safety and efficacy
by various international, 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 biotherapeutic cannot be marketed in the U.S. until it has been approved
by
the FDA, and then can be marketed for only the indications 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 BLA or New Drug Application are substantial and can require a number of
years. In addition, even if our products receive regulatory approval, they
remain subject to ongoing FDA regulations, including, for example, obligations
to conduct additional clinical trials or other testing, changes to the product
label, new or revised regulatory requirements for manufacturing practices,
written advisements to physicians, and/or a product recall or
withdrawal.
We
may not obtain necessary regulatory approvals on a timely basis, if at all,
for
any of the products we are developing or manufacturing, or we may not maintain
necessary regulatory approvals for our existing products, and all of the
following could have a material adverse effect on our business:
-
Loss
of, or changes to, previously obtained approvals, including those resulting
from post-approval safety or efficacy issues.
-
Failure
to comply with existing or future regulatory requirements.
-
Changes
to manufacturing processes, manufacturing process standards or Good
Manufacturing Practices (GMP) following approval or changing interpretations
of these factors.
In
addition, the current regulatory framework could change or additional
regulations could arise at any stage during our product development or
marketing, which may affect our ability to obtain or maintain approval
of our
products or require us to make significant expenditures to obtain or maintain
such approvals.
We
face competition.
We
face competition from pharmaceutical companies and biotechnology
companies.
The
introduction of new competitive products or follow-on biologics, and/or new
information about existing products or pricing decisions by us or our
competitors, may result in lost market share for us, reduced utilization of
our
products, lower prices, and/or reduced product sales, even for products
protected by patents.
Avastin: Avastin
competes in metastatic colorectal cancer (CRC) with Erbitux®
(Imclone/Bristol-Myers Squibb), which is an epidermal growth factor receptor
(EGFR) inhibitor approved for the treatment of irinotecan refractory or
intolerant metastatic CRC patients; and with Vectibix™ (Amgen), which is
indicated for the treatment of patients with EGFR-expressing metastatic CRC
who
have disease progression on or following fluoropyrimidine-, oxaliplatin-, and
irinotecan- containing regimens. Avastin could also face competition from
Erbitux® in metastatic non-small cell lung cancer (NSCLC). In the third quarter
of 2007, ImClone Systems Incorporated and Bristol-Myers Squibb Company announced
that a Phase III study of Erbitux® in combination with vinorelbine plus
cisplatin met its primary endpoint of increasing overall survival compared
with
chemotherapy alone. Data from this study are expected either later in 2007
or in
2008. In addition, Avastin competes with Nexavar® (sorafenib, Bayer
Corporation/Onyx Pharmaceuticals, Inc.), Sutent® (sunitinib malate, Pfizer,
Inc.), and Torisel® (Wyeth) for the treatment of patients with advanced renal
cell carcinoma (an unapproved use of Avastin).
Avastin
could face competition from products in development that currently do not have
regulatory approval. Sanofi-Aventis is developing a VEGF inhibitor VEGF-Trap
in
multiple indications, including metastatic CRC and metastatic NSCLC. There
are also ongoing head-to-head clinical trials comparing both Sutent®
and
AZD2171 (AstraZeneca) to Avastin. Likewise, Amgen has initiated
head-to-head clinical trials comparing AMG 706 and Avastin in NSCLC and
metastatic breast cancer (BC). Overall,
there are more than 65 molecules that target VEGF inhibition, and over 130
companies are developing molecules that, if successful in clinical trials,
may
compete with Avastin.
Rituxan: Rituxan’s
current competitors in hematology-oncology include Bexxar® (GlaxoSmithKline
[GSK]) and Zevalin® (Biogen Idec Inc.), both of which are radioimmunotherapies
indicated for the treatment of patients with relapsed or refractory low-grade,
follicular or transformed B-cell non-Hodgkin’s lymphoma (NHL). Other potential
competitors include Campath® (Bayer Corporation/Genzyme) in relapsed chronic
lymphocytic leukemia (CLL) (an unapproved use of Rituxan); Velcade®
(Millennium Pharmaceuticals, Inc.), which is indicated for multiple myeloma
and
more recently, mantle cell lymphoma (both unapproved uses of Rituxan); and
Revlimid® (Celgene), which is indicated for multiple myeloma and myelodysplastic
syndromes (both unapproved uses of Rituxan).
Rituxan’s
current competitors in rheumatoid arthritis (RA) include Enbrel® (Amgen/Wyeth),
Humira® (Abbott Laboratories), Remicade® (Johnson & Johnson), Orencia®
(Bristol-Myers Squibb), and Kineret® (Amgen). These products are approved for
use in a broader RA patient population than the approved population for Rituxan.
In addition, molecules in development that, if successful in clinical trials,
may compete with Rituxan in RA include: Actemra™, an anti-interleukin-6
receptor being developed by Chugai and Roche; Cimzia™ (certolizumab pegol), an
anti-TNF antibody being developed by UCB; and CNTO 148 (golimumab), an anti-TNF
antibody being developed by Centocor, Inc. (a wholly owned subsidiary of
Johnson & Johnson).
Rituxan
may face future competition in both hematology-oncology and RA from Humax CD20™
(Ofatumumab), an anti-CD20 antibody being co-developed by Genmab and
GSK. Genmab and GSK announced their plans to file for approval and launch
of Humax™ in the fourth quarter of 2008 for monotherapy use in refractory CLL
and monotherapy use in Rituxan refractory NHL. In addition, we are aware of
other anti-CD20 molecules in development that, if successful in clinical trials,
may compete with Rituxan.Rituxan could also face competition from Treanda®
(Cephalon, Inc.), a non-Hodgkin’s lymphoma treatment candidate that showed
positive results in a Phase III clinical trial involving indolent NHL patients
who no longer responded to Rituxan. Full results of the trial are expected
to be
released in December 2007.
Herceptin: Herceptin
faces competition in the relapsed metastatic setting from Tykerb® (lapatinib
ditosylate), manufactured by GSK. On March 13, 2007, the FDA approved Tykerb®,
in combination with capecitabine, for the treatment of patients with advanced
or
metastatic BC whose tumors overexpress HER2 and who have received prior therapy,
including an anthracycline, a taxane, or Herceptin. Market research indicates
that lapatinib use in the third quarter is primarily within the later lines
of
metastatic BC. We will continue to monitor the clinical development of lapatinib
in early lines of metastatic and adjuvant breast cancer.
Lucentis: We
are aware that retinal specialists are currently using Avastin to treat the
wet
form of age-related macular degeneration (AMD), an unapproved use for Avastin,
which results in significantly less revenue to us per treatment compared to
Lucentis. Although we will no longer allow compounding pharmacies the ability
to
purchase Avastin from wholesale distributors as of January 1, 2008, we expect
ocular use of Avastin to continue. Additionally, an independent head-to-head
trial of Avastin and Lucentis in wet AMD, partially funded by the National
Eye
Institute, is expected to begin enrollment in the next few months. Lucentis
also
competes with Macugen® (Pfizer/OSI Pharmaceuticals), and with Visudyne®
(Novartis) alone, in combination with Lucentis, in combination with Avastin,
or
in combination with the off-label steroid triamcinolone in wet AMD. In addition,
if successful in recently initiated Phase III clinical trials,
VEGF-Trap-Eye, a vascular endothelial growth factor blocker being developed
by
Bayer Corporation and Regeneron, may compete with Lucentis.
Xolair: Xolair
faces competition from other asthma therapies, including inhaled
corticosteroids, long-acting beta agonists, combination products such as
fixed-dose inhaled corticosteroids/long-acting beta agonists and leukotriene
inhibitors, as well as oral corticosteroids and immunotherapy.
Tarceva: Tarceva
competes with the chemotherapy agents Taxotere® (Sanofi-Aventis) and Alimta®
(Eli Lilly and Company), both of which are indicated for the treatment of
relapsed NSCLC. Astra Zeneca recently announced equivalent survival data when
comparing the use of Iressa® versus the use of Taxotere® for the treatment of
relapsed NSCLC in an international study. The results of this study have not
yet
been published, and it is unclear whether a re-filing with U.S. regulatory
authorities is pending. Eli Lilly and BMS/ImClone/Merck KGaA recently announced
positive data on the use of Alimta® and Erbitux® (Bristol-Myers Squibb),
respectively, in combination with chemotherapy for the treatment of front-line
NSCLC (an unapproved use of Tarceva). This may have a material impact on the
landscape of treatment options for the management of patients with relapsed
NSCLC. In front-line pancreatic cancer, Tarceva primarily competes with Gemzar®
(Eli Lilly) monotherapy and Gemzar® in combination with other chemotherapeutic
agents. Tarceva could also face competition in the future from products in
late-phase development, such as Zactima® (Astra Zeneca) and Erbitux® in the
treatment of relapsed NSCLC and Xeloda® (Roche), in the treatment of pancreactic
cancer; none of these products currently have regulatory approval for use in
NSCLC or pancreatic cancer.
Nutropin: Nutropin
faces competition in the growth hormone market from other companies currently
selling growth hormone products. Nutropin’s current competitors are Genotropin®
(Pfizer), Norditropin® (Novo Nordisk), Humatrope® (Eli Lilly and Company),
Tev-Tropin® (Teva Pharmaceutical Industries Ltd.), and Saizen® (Serono, Inc.).
In addition, follow-on biologics that are not therapeutically equivalent (not
substitutable) for current growth hormone products are beginning to enter the
market. Omnitrope® (Sandoz), a biologic similar to Genotropin®, launched in
January 2007. In March 2007, Cangene received an approvable letter from the
FDA
for its growth hormone Accretropin™ as a biologic similar to Humatrope®.
Valtropin® (LG Life Sciences along with its partner Biopartners) also received
FDA approval in April 2007 as a biologic similar to Humatrope® for three
indications: short stature associated with growth hormone deficiency and Turner
Syndrome in pediatrics, and growth hormone deficiency in adults. Furthermore,
as
a result of multiple competitors, we have experienced, and may continue
to
experience,
a loss of patient share and increased competition for managed care product
placement. Obtaining placement on the preferred product lists of managed care
companies may require that we further discount the price of
Nutropin.
Thrombolytics: Our
thrombolytic products face competition in the acute myocardial infarction
market, with sales of TNKase and Activase affected by the adoption by physicians
of mechanical reperfusion strategies. We expect that the use of mechanical
reperfusion, in lieu of thrombolytic therapy for the treatment of acute
myocardial infarction, will continue to grow. TNKase, for acute myocardial
infarction, also faces competition from Retavase® (PDL BioPharma
Inc.).
Pulmozyme: Pulmozyme
currently faces competition from the use of hypertonic saline, an inexpensive
approach to clearing sputum from the lungs of cystic fibrosis patients.
Approximately 25% of cystic fibrosis patients receive hypertonic saline and
it
is estimated that in a small percentage of patients (less than 5%) this use
will
impact how they use Pulmozyme.
Raptiva: Raptiva
competes with established therapies for moderate-to-severe psoriasis, including
oral systemics such as methotrexate and cyclosporin as well as ultraviolet
light
therapies. In addition, Raptiva competes with biologic agents Amevive®
(Astellas), Enbrel® (Amgen), and Remicade® (Centocor). Raptiva also competes
with the biologic agent Humira® (Abbott), which is currently used off-label in
the psoriasis market. Abbott is expecting FDA approval of Humira® for the
treatment of psoriasis in the first quarter of 2008.
In
addition to the commercial and late-stage development products listed above,
numerous products are in earlier stages of development at other biotechnology
and pharmaceutical companies that, if successful in clinical trials, may compete
with our products.
Decreases
in third-party reimbursement rates may affect our product sales, results of
operations, and financial condition.
Sales
of our products will depend significantly on the extent to which reimbursement
for the cost of our products and related treatments will be available to
physicians and patients from government health administration authorities,
private health insurers, and other organizations. Third-party payers and
government health administration authorities increasingly attempt to limit
and/or regulate the reimbursement of medical products and services, including
branded prescription drugs. Changes in government legislation or regulation,
such as the Medicare Prescription Drug Improvement and Modernization Act of
2003, the Deficit Reduction Act of 2005 and the Food and Drug Administration
Amendments Act of 2007, or changes in private third-party payers’ policies
toward reimbursement for our products may reduce reimbursement of our products’
costs to physicians. Decreases in third-party reimbursement for our products
could reduce physician usage of the products and may have a material adverse
effect on our product sales, results of operations, and financial
condition.
Difficulties
or delays in product manufacturing or in obtaining materials from our suppliers,
or difficulties in accurately forecasting manufacturing capacity needs, could
harm our business and/or negatively affect our financial
performance.
Manufacturing
biotherapeutics is difficult and complex, and requires facilities specifically
designed and validated for this purpose. It can take longer than five years
to
design, construct, validate, and license a new biotechnology manufacturing
facility. We currently produce our products at our manufacturing facilities
located in South San Francisco, Vacaville, and Oceanside, California and through
various contract-manufacturing arrangements. Maintaining an adequate supply
to
meet demand for our products depends on our ability to execute on our production
plan. Any significant problem in the operations of our or our contractors’
manufacturing facilities could result in cancellation of shipments; loss of
product in the process of being manufactured; a shortfall, stock-out, or recall
of available product inventory; or unplanned increases in production costs,
any
of which could have a material adverse effect on our business. A number of
factors could cause significant production problems or interruptions,
including:
In
addition, there are inherent uncertainties associated with forecasting future
demand, especially for newly introduced products of ours or of those for whom
we
produce products, and as a consequence we may have inadequate capacity to meet
our own actual demands and/or the actual demands of those for whom we produce
products. Alternatively, we may have an excess of available capacity, which
could lead to an idling of a portion of our manufacturing facilities and
incurring unabsorbed or idle plant charges, or other excess capacity charges,
resulting in an increase in our cost of sales.
Furthermore,
certain of our raw materials and supplies required for the production of our
principal products, or products that we make for others, are available only
through sole-source suppliers (the only recognized supplier available to us)
or
single-source suppliers (the only approved supplier for us among other sources),
and we may not be able to obtain such raw materials without significant delay
or
at all. If such sole-source or single-source suppliers were to limit or
terminate production or otherwise fail to supply these materials for any reason,
such failures could also have a material adverse effect on our product sales
and
our business.
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 or our contractors’ manufacturing and supply of existing or new
products could increase our costs, cause us to lose revenue or market share,
damage our reputation, and result in a material adverse effect on our product
sales, financial condition, and results of operations.
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 with certainty the breadth of claims allowed in companies’
patents. Patent disputes are frequent and may ultimately preclude the
commercialization of products. We have in the past been, are currently, and
may
in the future be involved in material litigation and other legal proceedings
related to our proprietary rights, such as the Cabilly reexamination (discussed
in Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements of Part I, Item 1 of this Form 10-Q) and disputes in connection
with
licenses granted to or obtained from third parties. Such litigation and other
legal proceedings are costly in their own right and could subject us to
significant liabilities with third parties, including the payment of significant
royalty expenses, the loss of significant royalty income, or other expenses
or
losses. Furthermore, an adverse decision or ruling could force us to either
obtain third-party licenses at a material cost or cease using the technology
or
commercializing the product in dispute. An adverse decision or ruling with
respect to
one
or more of our patents or other intellectual property rights could cause us
to
incur a material loss of royalties and other revenue from licensing arrangements
that we have with third parties, and could significantly interfere with our
ability to negotiate future licensing arrangements.
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, or to a loss of
our entire investment in the product and subject us to infringement
claims.
If
there is an adverse outcome in our pending litigation or other legal actions,
our business may be harmed.
Litigation
and other legal actions to which we are currently or have been subjected relate
to, among other things, our patent and other intellectual property rights,
licensing arrangements and other contracts with third parties, and product
liability. We cannot predict with certainty the eventual outcome of pending
proceedings, which may include an injunction against the development,
manufacture, or sale of a product or potential product; a judgment with a
significant monetary award including the possibility of punitive damages; or
a
judgment that certain of our patent or other intellectual property rights are
invalid or unenforceable. Furthermore, we may have to incur substantial expense
in these proceedings, and such matters could divert management’s attention from
ongoing business concerns.
Our
activities related to the sale and marketing of our products are subject to
regulation under the U.S. Federal Food, Drug, and Cosmetic Act and other federal
statutes. Violations of these laws may be punishable by criminal and/or civil
sanctions, including fines and civil monetary penalties, as well as the
possibility of exclusion from federal healthcare programs (including Medicare
and Medicaid). In 1999, we agreed to pay $50 million to settle a federal
investigation related to our past clinical, sales, and marketing activities
associated with human growth hormone. We are currently being investigated by
the
Department of Justice with respect to our promotional practices, and may in
the
future be investigated for our promotional practices related to any of our
products. If the government were to bring charges against us or convict us
of
violating these laws, or if we were subject to third-party litigation related
to
the same promotional practices, there could be a material adverse effect on
our
business, including our financial condition and results of
operations.
We
are subject to various U.S. federal and state laws pertaining to healthcare
fraud and abuse, including anti-kickback and false claims laws. Anti-kickback
laws make it illegal for a prescription drug manufacturer to solicit, offer,
receive, or pay any remuneration in exchange for, or to induce, the referral
of
business, including the purchase or prescription of a particular drug. Due
to
the breadth of the statutory provisions and the absence of guidance in the
form
of regulations or court decisions addressing some of our practices, it is
possible that our practices might be challenged under anti-kickback or similar
laws. False claims laws prohibit anyone from knowingly and willingly presenting,
or causing to be presented for payment to third-party payers (including Medicare
and Medicaid), claims for reimbursed drugs or services that are false or
fraudulent, claims for items or services not provided as claimed, or claims
for
medically unnecessary items or services. Violations of fraud and abuse laws
may
be punishable by criminal and/or civil sanctions, including fines and civil
monetary penalties, as well as the possibility of exclusion from federal
healthcare programs (including Medicare and Medicaid). If a court were to find
us liable for violating these laws, or if the government were to allege against
us or convict us of violating these laws, there could be a material adverse
effect on our business, including our stock price.
Other
factors could affect our product sales.
Other
factors that could affect our product sales include, but are not limited
to:
Any
of these factors could have a material adverse effect on
our sales and results
of
operations.
Our
results of operations are affected by our royalty and contract revenue, and
sales to collaborators.
Royalty
and contract revenue, and sales to collaborators in future periods, could vary
significantly. Major factors affecting this revenue include, but are not limited
to:
We
may be unable to manufacture certain of our products if there is BSE
contamination of our bovine source raw
material.
Most
biotechnology companies, including Genentech, have historically used bovine
source raw materials to support cell growth in our production processes. Bovine
source raw materials from within or outside the U.S. are subject to public
and
regulatory scrutiny because of the perceived risk of contamination with the
infectious agent that causes bovine spongiform encephalopathy (BSE). Should
such
BSE contamination occur, it would likely negatively affect our ability to
manufacture certain products for an indefinite period of time (or at least
until
an alternative process is approved), negatively affect our reputation, and
could
result in a material adverse effect on our product sales, financial condition,
and results of operations.
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
(i)
attract and retain highly qualified management, scientific, manufacturing,
and
sales and marketing personnel, (ii) successfully integrate large numbers of
new
employees into our corporate culture, and (iii) develop and maintain important
relationships with leading research and medical institutions and key
distributors. Competition for these types of personnel and relationships is
intense. We cannot be sure that we will be able to attract or retain skilled
personnel or maintain key relationships, or that the costs of retaining such
personnel or maintaining such relationships will not materially
increase.
Our
affiliation agreement with Roche Holdings, Inc. could adversely affect our
cash
position.
Our
affiliation agreement with Roche Holdings, Inc. (RHI) provides that we establish
a stock repurchase program designed to maintain RHI’s percentage ownership
interest in our Common Stock based on an established Minimum Percentage. For
more information on our stock repurchase program, see “Liquidity and Capital
Resources—Cash Used in Financing Activities” above. For information on the
Minimum Percentage, see Note 5, “Relationship with Roche Holdings, Inc. and
Related Party Transactions,” in the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this Form 10-Q.
RHI’s
ownership percentage is diluted by the exercise of stock options to purchase
shares of our Common Stock by our employees and the purchase of shares of our
Common Stock through our employee stock purchase plan. See Note 2, “Employee
Stock-Based Compensation,” in the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this Form 10-Q for information regarding
employee stock plans. In order to maintain RHI’s Minimum Percentage, we
repurchase shares of our Common Stock under the stock repurchase program. While
the dollar amounts associated with future stock repurchase programs cannot
currently be determined, future stock repurchases could have a material adverse
effect on our liquidity, credit rating, and ability to access additional capital
in the financial markets.
Our
affiliation agreement with Roche Holdings, Inc. could limit our ability to
make
acquisitions.
Our
affiliation agreement with RHI contains provisions that:
-
Require
the approval of the directors designated by RHI to make any acquisition
or any
sale or disposal of all or a portion of our business representing 10 percent
or more of our assets, net income, or revenue.
-
Enable
RHI to maintain its percentage ownership interest in our Common
Stock.
-
Require
us to establish a stock repurchase program designed to maintain RHI’s
percentage ownership interest in our Common Stock based on an established
Minimum Percentage. For information regarding the Minimum Percentage,
see Note
5, “Relationship with Roche Holdings, Inc. and Related Party Transactions,” in
the Notes to Condensed Consolidated Financial Statements in Part I,
Item 1 of
this Form 10-Q.
These
provisions may have the effect of limiting our ability to make
acquisitions.
Future
sales of our Common Stock by Roche Holdings, Inc. could cause the price of
our
Common Stock to decline.
As
of September 30, 2007, RHI owned 587,189,380 shares of our Common Stock, or
55.8
percent of our outstanding shares. All of our shares owned by RHI are eligible
for sale in the public market subject to compliance with the applicable
securities laws. We have agreed that, upon RHI’s request, we will file one or
more registration statements under the Securities Act of 1933 in order to permit
RHI to offer and sell shares of our Common Stock. Sales of a substantial number
of shares of our Common Stock by RHI in the public market could adversely affect
the market price of our Common Stock.
Roche
Holdings, Inc., our controlling stockholder, may seek to influence our business
in a manner that is adverse to us or adverse to other stockholders who may
be
unable to prevent actions by Roche Holdings, Inc.
As
our majority stockholder, RHI controls the outcome of most actions requiring
the
approval of our stockholders. Our bylaws provide, among other things, that
the
composition of our Board of Directors shall consist of at least three directors
designated by RHI, three independent directors nominated by the Nominations
Committee, and one Genentech executive officer nominated by the Nominations
Committee. Our bylaws also provide that RHI will have the right to obtain
proportional representation on our Board until such time that RHI owns less
than
five percent of our stock. Currently, three of our directors—Mr. William Burns,
Dr. Erich Hunziker, and Dr. Jonathan K. C. Knowles—also serve as officers and
employees of Roche Holding Ltd and its affiliates. As long as RHI owns in excess
of 50 percent of our Common Stock, RHI directors will be two of the three
members of the Nominations Committee. Our certificate of incorporation includes
provisions related to competition by RHI affiliates with Genentech, offering
of
corporate opportunities, transactions with interested parties, intercompany
agreements, and provisions limiting the liability of specified employees. We
cannot assure that RHI will not seek to influence our business in a manner
that
is contrary to our goals or strategies or the interests of other stockholders.
Moreover, persons who are directors and/or officers of Genentech and who are
also directors and/or officers of RHI may decline to take action in a manner
that might be favorable to us but adverse to RHI.
Additionally,
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 related to
competition with RHI, conflicts of interest with RHI, the offer of corporate
opportunities to RHI, and intercompany agreements with RHI. This deemed consent
might restrict our ability to challenge transactions carried out in compliance
with these provisions.
We
may incur material product liability costs.
The
testing and marketing of medical products entail an inherent risk of product
liability. Liability exposures for biotherapeutics could be extremely large
and
pose a material risk. Our business may be materially and adversely affected
by a
successful product liability claim or claims in excess of any insurance coverage
that we may have.
Insurance
coverage may be more difficult and costly to obtain or
maintain.
While
we currently have a certain amount of insurance to minimize our direct exposure
to certain business risks, we may be exposed to an increase in premiums and
a
narrowing of scope of coverage. As a result, we may be required to assume more
risk in the future or make significant expenditures to maintain our current
levels of insurance. If we are subject to third-party claims or suffer a loss
or
damages in excess of our insurance coverage, we will incur the cost of the
portion of the retained risk. Furthermore, any claims made on our insurance
policies may affect our ability to obtain or maintain insurance coverage at
reasonable costs.
We
are subject to environmental and other risks.
We
use certain hazardous materials in connection with our research and
manufacturing activities. In the event that such hazardous materials are stored,
handled, or released into the environment in violation of law or any permit,
we
could be subject to loss of our permits, government fines, or penalties and/or
other adverse governmental or private actions. The levy of a substantial fine
or
penalty, the payment of significant environmental remediation costs, or the
loss
of a permit or other authorization to operate or engage in our ordinary course
of business could materially adversely affect our business.
We
also have acquired, and may continue to acquire in the future, land and
buildings as we expand our operations. Some of these properties are
“brownfields” for which redevelopment or use is complicated by the presence or
potential presence of a hazardous substance, pollutant, or contaminant. Certain
events that could occur may require us to pay significant clean-up or other
costs in order to maintain our operations on those properties. Such events
include, but are not limited to, changes in environmental laws, discovery of
new
contamination, or unintended exacerbation of existing contamination. The
occurrence of any such event could materially affect our ability to continue
our
business operations on those properties.
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,
but not limited to, the following:
-
The
efficacy and safety of our various products as determined both in clinical
testing and by the accumulation of additional information on each product
after the FDA approves it for sale.
-
The
rate of adoption by physicians and the use of our products for approved
indications and additional indications. Among other things, the rate
of
adoption by physicians and the use of our products may be affected
by the
results of clinical studies reporting on the benefits or risks of a
product.
-
The
potential introduction of new products and additional indications
for existing
products.
-
The
ability to successfully manufacture sufficient quantities of any
particular
marketed product.
-
Pricing
decisions that we or our competitors have adopted or may adopt,
as well as our
Avastin Patient Assistance Program.
-
Our
distribution strategy, including the termination of, or change
in, an existing
arrangement with any major wholesalers who supply our
products.
Our
integration of new information systems could disrupt our internal operations,
which could decrease our revenue and increase our
expenses.
Portions
of our information technology infrastructure may experience interruptions,
delays, or cessations of service or produce errors. As part of our enterprise
resource planning efforts, we are implementing new information systems, but
we
may not be successful in implementing all of the new systems, and transitioning
data and other aspects of the process could be expensive, time consuming,
disruptive, and resource intensive. Any disruptions that may occur in the
implementation of new systems or any future systems could adversely affect
our
ability to report in an accurate and timely manner the results of our
consolidated operations, financial position, and cash flows. Disruptions to
these systems also could adversely affect our ability to fulfill orders and
interrupt other operational processes. Delayed sales, lower margins, or lost
customers resulting from these disruptions could adversely affect our financial
results.
Our
stock price, like that of many biotechnology companies, is
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, the market price of our Common Stock has been and may continue to
be
volatile.
The
following factors may have a significant effect on the market price of our
Common Stock:
Our
effective income tax rate may vary significantly.
Various
internal and external factors may have favorable or unfavorable effects on
our
future effective income tax rate. These factors include but are not limited
to
changes in tax laws, regulations, and/or rates; the results of any tax
examinations; changing interpretations of existing tax laws or regulations;
changes in estimates of prior years’ items; past and future levels of R&D
spending; acquisitions; changes in our corporate structure; and changes in
overall levels of income before taxes.
To
pay our indebtedness will require a significant amount of cash and may adversely
affect our operations and financial results.
As
of October 26, 2007, we had approximately $2.0 billion of long-term debt and
$600 million of commercial paper debt. Our ability to make payments on and
to
refinance our indebtedness, including our long-term debt obligations, and to
fund planned capital expenditures, R&D, as well as stock repurchases and
expansion efforts will depend on our ability to generate cash in the future.
This risk, to a certain extent, is subject to general economic, financial,
competitive, legislative, regulatory, and other factors that are and will remain
beyond our control. Additionally, our indebtedness may increase our
vulnerability to general adverse economic and industry conditions, and require
us to dedicate a substantial portion of our cash flow from operations to
payments on our indebtedness, which would reduce the availability of our cash
flow to fund working capital, capital expenditures, R&D, expansion efforts,
and other general corporate purposes, and limit our flexibility in planning
for,
or reacting to, changes in our business and the industry in which we
operate.
Accounting
pronouncements may affect our future financial position and results of
operations.
Under
Financial Accounting Standards Board Interpretation No. 46R (FIN 46R), a
revision to FIN 46, “Consolidation of Variable Interest
Entities,” we are required to assess new business
development collaborations as well as reassess, upon certain events, some of
which are outside our control, the accounting treatment of our existing business
development collaborations based on the nature and extent of our variable
interests in the entities, as well as the extent of our ability to exercise
influence over the entities, with which we have such collaborations. Our
continuing compliance with FIN 46R may result in our consolidation of companies
or related entities with which we have a collaborative arrangement, and this
may
have a material effect on our financial condition and/or results of operations
in future periods.
Under
a stock repurchase program approved by our Board of Directors in December 2003
and most recently extended in April 2007, we are authorized to repurchase up
to
100 million shares of our Common Stock for an aggregate price of up to $8.0
billion through June 30, 2008. In this program, as in previous stock repurchase
programs, purchases may be made in the open market or in privately negotiated
transactions from time to time at management’s discretion. We also may engage in
transactions in other Genentech securities in conjunction with the repurchase
program, including certain derivative securities. As of September 30, 2007,
we
have not engaged in any such transactions. We intend to use the repurchased
stock to offset dilution caused by the issuance of shares in connection with
our
employee stock plans. Although we do not currently have specific plans for
the
shares that may be purchased under the program, our goals for the program are
(i) to address provisions of our affiliation agreement with Roche Holdings,
Inc.
(RHI) related to maintaining RHI’s minimum ownership percentage, (ii) to make
prudent investments of our cash resources, and (iii) to allow for an effective
mechanism to provide stock for our employee stock plans. See Note 5,
“Relationship with Roche Holdings, Inc. and Related Party Transactions,” in the
Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this
Form 10-Q for more information on RHI’s minimum ownership
percentage.
We
enter into Rule 10b5-1 trading plans to repurchase shares in the open market
during those periods each quarter when trading in our stock is restricted under
our insider trading policy. The most recent trading plan covered approximately
one million shares and expired on October 16, 2007.
Our
shares repurchased during the third quarter of 2007 were as follows (shares
in millions):
| |
|
Total
Number of
Shares
Purchased
|
|
|
Average
Price Paid
per
Share
|
|
|
Total
Number of
Shares
Purchased as
Part
of Publicly
Announced
Plans or
Programs
|
|
|
Maximum
Number
of
Shares that May
Yet
Be Purchased
Under
the Plans or
Programs
|
|
|
August
1–31, 2007
|
|
|
0.8
|
|
|
|
73.66
|
|
|
|
|
|
|
|
|
September
1–30, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
2.0
|
|
|
$ |
76.69
|
|
|
|
72
|
|
|
|
28
|
|
The
par value method of accounting is used for Common Stock repurchases. The excess
of the cost of shares acquired over the par value is allocated to additional
paid-in capital with the amounts in excess of the estimated original sales
price
charged to accumulated deficit.
|
Exhibit
No.
|
Description
|
Location
|
|
15.1
|
Letter
regarding Unaudited Interim Financial Information.
|
Filed
herewith
|
|
31.1
|
Certification
of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a)
promulgated under the Securities Exchange Act of 1934, as
amended
|
Filed
herewith
|
|
31.2
|
Certification
of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a)
promulgated under the Securities Exchange Act of 1934, as
amended
|
Filed
herewith
|
|
32.1
|
Certifications
of Chief Executive Officer and Chief Financial Officer pursuant to
18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
|
Furnished
herewith
|
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.
| |
|
|
GENENTECH,
INC.
|
|
Date:
|
|
|
|
| |
|
|
Arthur
D. Levinson, Ph.D.
Chairman
and Chief Executive Officer
|
| |
|
|
|
| |
|
|
|
|
Date:
|
|
|
|
| |
|
|
David
A. Ebersman
Executive
Vice President and
Chief
Financial Officer
|
| |
|
|
|
| |
|
|
|
|
Date:
|
|
|
|
| |
|
|
Robert
E. Andreatta
Controller
and Chief Accounting Officer
|