SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarterly period ended September 30, 1995.
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the transition period from to .
Commission File Number
1-9813
GENENTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2347624
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
460 Point San Bruno Boulevard, South San Francisco, California 94080
(Address of principal executive offices and zip code)
(415) 225-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock $.02 par value 118,779,146
Class Outstanding at September 30, 1995
<TABLE>
<CAPTION>
GENENTECH, INC.
INDEX
<S> <C>
PART I. FINANCIAL INFORMATION PAGE NO.
Condensed Consolidated Statements of Income -
for the three months and nine months ended
September 30, 1995 and 1994 3
Condensed Consolidated Statements of Cash Flows -
for the nine months ended September 30, 1995 and 1994 4
Condensed Consolidated Balance Sheets -
September 30, 1995 and December 31, 1994 5
Notes to Condensed Consolidated Financial Statements 6-9
Management's Discussion and Analysis of Financial Condition
and Results of Operations 10-15
Independent Accountants' Review Report 16
PART II. OTHER INFORMATION 17-18
SIGNATURES 19
</TABLE>
Page 2
PART I. FINANCIAL INFORMATION
<TABLE>
GENENTECH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(thousands, except per share amounts)
(unaudited)
<CAPTION>
Three Months Nine Months
Ended September 30 Ended September 30
--------------------- --------------------
1995 1994 1995 1994
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Product sales $ 158,478 $ 142,555 $ 481,781 $ 442,927
Royalties 45,642 33,118 142,215 92,896
Contract and other 4,494 7,187 28,577 21,556
Interest 15,297 10,978 43,358 30,251
--------- --------- --------- ---------
Total revenues 223,911 193,838 695,931 587,630
Costs and expenses:
Cost of sales 24,369 24,460 75,431 71,156
Research and development 85,971 73,208 268,097 220,592
Marketing, general and administrative 55,249 59,341 187,386 180,269
Special charge
(primarily merger related) 9,000 - 17,000 -
Interest 1,994 1,843 5,904 5,375
--------- --------- --------- ---------
Total costs and expenses 176,583 158,852 553,818 477,392
Income before taxes 47,328 34,986 142,113 110,238
Income tax provision 7,099 1,400 21,317 4,410
--------- --------- --------- ---------
Net income $ 40,229 $ 33,586 $ 120,796 $ 105,828
========= ========= ========= =========
Net income per share $ .33 $ .28 $ 1.00 $ .89
========= ========= ========= =========
Weighted average number of shares used
in computing per share amounts 121,334 119,819 120,909 119,222
========= ========= ========= =========
<FN>
See notes to condensed consolidated financial statements.
</TABLE>
Page 3
<TABLE>
GENENTECH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
(unaudited)
<CAPTION>
Nine Months
Ended September 30
-----------------------
1995 1994
----------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 120,796 $ 105,828
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 43,702 37,857
Gain on sales of securities available-for-sale (5,897) -
Writedown of securities available-for-sale 6,609 4,000
Gain on sale of a non-marketable equity security (703) -
Writedown of non-marketable equity securities 469 1,965
Changes in assets and liabilities:
Receivables and other current assets (47,015) 4,638
Inventories 10,500 (16,085)
Accounts payable, accrued liabilities
and other long-term liabilities 10,471 (221)
---------- ----------
Net cash provided by operating activities 138,932 137,982
Cash flows from investing activities:
Purchases of securities held-to-maturity (481,551) (963,034)
Proceeds from maturities of securities held-to-maturity 666,366 756,677
Purchases of securities available-for-sale (243,729) (7,302)
Proceeds from sales of securities available-for-sale 35,800 -
Proceeds from sale of a non-marketable equity security 703 -
Capital expenditures (38,290) (58,861)
Change in other assets (32,594) 198
---------- ----------
Net cash used in investing activities (93,295) (272,322)
Cash flows from financing activities:
Stock issuances 45,607 55,762
Additions to long-term debt and short-term borrowings 27,224 -
Repayment of long-term debt, including current portion (646) (588)
---------- ----------
Net cash provided by financing activities 72,185 55,174
---------- ----------
Net increase (decrease) in cash and cash equivalents 117,822 (79,166)
Cash and cash equivalents at beginning of period 66,713 117,473
---------- ----------
Cash and cash equivalents at end of period $ 184,535 $ 38,307
========== ==========
<FN>
See notes to condensed consolidated financial statements.
</TABLE>
Page 4
<TABLE>
GENENTECH, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands)
<CAPTION>
September 30, December 31,
1995 1994
------------ ------------
ASSETS (unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 184,535 $ 66,713
Short-term investments 640,321 652,461
Accounts receivable, net (including amounts from
a related party: 1995-$22,814; 1994-$13,184) 176,249 146,267
Inventories 92,700 103,200
Prepaid expenses and other current assets 39,145 28,475
------------ ------------
Total current assets 1,132,950 997,116
Long-term marketable securities 255,371 201,726
Property, plant and equipment, less
accumulated depreciation
(1995-$257,978; 1994-$215,255) 485,544 485,293
Other assets 91,712 60,989
------------ ------------
Total assets $ 1,965,577 $ 1,745,124
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts and notes payable $ 25,074 $ 30,963
Other current liabilities (including amounts due
to a related party: 1995-$7,087; 1994-$2,280) 205,319 189,536
------------ ------------
Total current liabilities 230,393 220,499
Long-term debt 176,082 150,358
Other long-term liabilities 26,515 25,483
------------ ------------
Total liabilities 432,990 396,340
Stockholders' equity:
Preferred stock - -
Redeemable common stock - 1,002
Common stock 2,376 1,343
Other stockholders' equity 1,530,211 1,346,439
------------ ------------
Total stockholders' equity 1,532,587 1,348,784
------------ ------------
Total liabilities and stockholders' equity $ 1,965,577 $ 1,745,124
============ ============
<FN>
See notes to condensed consolidated financial statements.
</TABLE>
Page 5
GENENTECH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Statement of Accounting Presentation
In the opinion of Genentech, Inc. (the Company), the accompanying unaudited
condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10
of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all
adjustments (consisting only of adjustments of a normal recurring nature)
considered necessary for a fair presentation have been included. Operating
results for the three-month and nine-month periods ended September 30, 1995
and 1994 are not necessarily indicative of the results that may be expected
for the year ending December 31, 1995. The condensed consolidated balance
sheet as of December 31, 1994 has been derived from the audited financial
statements as of that date. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report to Stockholders for the year ended December 31,
1994.
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (FAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
which requires the Company to review for impairment long-lived assets, certain
identifiable intangibles, and goodwill related to those assets whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. In certain situations, an impairment loss would be
recognized. FAS 121 is effective for the Company's 1996 fiscal year. In
October 1995, the FASB issued FAS 123 "Accounting for Stock Based
Compensation" which also will be effective for the Company's 1996 fiscal year.
FAS 123 allows companies which have stock-based compensation arrangements with
employees to adopt a new fair-value basis of accounting for stock options and
other equity instruments, or to continue to apply the existing accounting
rules under APB Opinion 25 "Accounting for Stock Issued to Employees" but with
additional financial statement disclosure. The Company is evaluating the
impact of both of these new standards on its financial position, results of
operations, and cash flows.
Note 2. Transaction with Roche Holdings, Inc.
On October 25, 1995 the Company's non-Roche stockholders approved an
agreement with Roche to extend for four years Roche's option to cause
Genentech to redeem the outstanding callable putable common stock ("special
common stock") of the Company at predetermined prices. During the quarter
beginning October 1, 1995, the option price is $62.50 per share, and it
increases by $1.25 per share each quarter through June 30, 1997, thereafter
escalating at $1.50 per share each quarter, to $82.00 per share at the end
of the option period on June 30, 1999. If Roche does not cause the
redemption as of June 30, 1999, Genentech's stockholders will have the
option to cause the Company to redeem (put) none, some, or all of their
shares of special common stock at $60.00 per share (and Roche will
concurrently purchase a like number of shares of common stock at $60.00 per
share) within thirty business days commencing July 1, 1999. Under the
agreement Roche may increase its ownership of the Company up to 79.9% by
making purchases on the open market. Roche currently holds approximately
65% of the outstanding common equity of the Company. As part of the
Page 6
GENENTECH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
agreement, Roche is granted an option at terms discussed below for ten
years for licenses to use and sell certain of Genentech's products in non-
U.S. markets. As a general matter, such option for a Genentech product
must be exercised at, or prior to, the conclusion of phase II clinical
trials for each product. In general, for each product for which Roche
exercises its option, the Company and Roche will share equally all
development expenses, including preclinical, clinical, process development
and related expenses, incurred by the Company through that date and
prospectively, with respect to the development of the product in the United
States. Roche will pay all non-U.S. development expenses. In general,
Roche will pay a royalty of 12.5% until a product reaches $100 million in
aggregate sales outside of the U.S., when the royalty rate increases to
15%. As part of the agreement, Roche has exclusive rights to, and will pay
the Company 20% royalties on, Canadian sales of the Company's existing
products and Western European sales of Pulmozyme. The Company will supply
its products to Roche for sales outside of the U.S. at cost plus 20
percent.
As part of an agreement in principle to settle stockholder lawsuits, as more
fully discussed in Note 4 "Legal Proceedings", the "call" price at which Roche
may cause Genentech to redeem the common stock will be increased, upon
approval of the settlement agreement by the Delaware Chancery Court, by $0.50
per share each quarter with a final redemption price of $82.50. The put price
will remain unchanged at $60.00 per share.
Note 3. Special Charge
The Company recorded a $9.0 million special charge in the third quarter of
1995 ($17.0 million year-to-date) related to the agreement with Roche
discussed in Note 2 "Transaction with Roche Holdings, Inc." and the
resignation of the Company's former President and Chief Executive Officer.
$5.0 million of the third quarter special charge ($13.0 million year-to-
date) relates to the Roche transaction and includes legal expenses,
investment banking fees, filing fees and other costs related to the
agreement, as well as charges associated with the proposed settlement of
stockholder lawsuits filed after the transaction was announced (see Note 4
"Legal Proceedings"). $4.0 million relates to the resignation of the
Company's former President and CEO. The Company expects to incur
approximately $8.0 million in additional merger-related special charges in
the fourth quarter of 1995.
Note 4. Legal Proceedings
The Company is a party to various legal proceedings including patent
infringement cases involving human growth hormone and Activase; a patent
infringement and trade secret misappropriation case involving antibodies to
IgE (a protein central to allergic reactions); and product liability cases
involving Activase. The Company and its directors are defendants in two suits
filed in California challenging their actions in connection with the Company's
1990 merger with a wholly owned subsidiary of Roche Holdings, Inc. (Roche).
In addition, the Company, its directors, two former directors and Roche are
defendants in a number of suits filed in Delaware, which have been
consolidated in a single action, by certain individual stockholders purporting
to represent stockholders as a class alleging, in general, breach of their
fiduciary duties to the Company in connection with the proposed extension of
Roche's option to cause the Company to redeem the outstanding non-Roche owned
common stock and transactions related thereto. The Company, Roche and the
attorneys representing the plaintiff stockholders have entered into a
Page 7
GENENTECH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
memorandum of understanding settling all claims against the defendants in
these actions except the 1990 suits. In connection with the settlement, if
approved by the court, Roche would increase the prices at which it could cause
Genentech to redeem the non-Roche owned common stock by $0.50 per share per
quarter, to a final price of $82.50 in the quarter ending June 30, 1999, and
Genentech would pay the plaintiffs' attorneys up to $3.5 million in attorneys
fees, and in connection with the proposed merger, Genentech will absorb the
termination costs of six Europe-based Genentech employees.
The Company has received grand jury document subpoenas from the United States
District Court for the Northern District of California for documents relating
to Genentech's clinical, sales, and marketing activities associated with human
growth hormone.
Based upon the nature of the claims made and the investigations completed to
date by the Company and its counsel, the Company believes the outcome of the
above actions will not have a material adverse effect on the financial
position, results of operations or cash flows of the Company.
Note 5. Inventories
Inventories at September 30, 1995 and December 31, 1994 are summarized below:
1995 1994
---------- ----------
(thousands)
Raw materials $ 13,105 $ 13,145
Work in process 63,781 76,974
Finished goods 15,814 13,081
---------- ----------
Total $ 92,700 $ 103,200
========== ==========
Note 6. Common Stock, Redeemable Common Stock and Special Common Stock
After the close of business on June 30, 1995 each share of Genentech
redeemable common stock automatically converted to one share of Genentech
common stock. The conversion was in accordance with the terms of the
redeemable common stock put in place at the time of its issuance in 1990 and
as described in Genentech's Certificate of Incorporation. Pursuant to the
approval of the Roche agreement by the majority of outstanding shares of
common stock held by non-Roche stockholders on October 25, 1995, as discussed
in Note 2 "Transaction with Roche Holdings, Inc.", each share of Genentech
common stock (other than shares held by Roche and its affiliates) converted to
one share of Genentech special common stock. The special common stock began
trading on October 26, 1995.
Note 7. Quasi-Reorganization
On February 18, 1988 the Company's Board of Directors approved the
elimination of the Company's accumulated deficit through an accounting
reorganization of its stockholders' equity accounts (a quasi-reorganization)
effective October 1, 1987 that did not involve any revaluation of assets or
liabilities. The quasi-reorganization did not involve any revaluation of
assets or liabilities because for similar classes of assets their fair
Page 8
GENENTECH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
values were no less than their book values and for similar classes of
liabilities their book values were no less than their fair values. The
accumulated deficit of $329.5 million was eliminated by a transfer from
additional paid-in capital in an amount equal to the accumulated deficit.
Simultaneously with the quasi-reorganization, the Company adopted Financial
Accounting Standards Board Statement (FAS) 96. FAS 96 provided for
recognition of the tax benefits of operating loss and tax credit carryforward
items that arose prior to a quasi-reorganization involving only the
elimination of a deficit in retained earnings being reported in the
income statement and then being reclassified from retained earnings to
additional paid-in capital. Subsequently, in September 1989, the staff of
the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin (SAB) 86 which states that a quasi-reorganization cannot involve
only an elimination of a deficit in retained earnings and, therefore, the
tax benefits of prior operating loss and tax credit carryforwards must be
reported as a direct addition to additional paid-in capital rather than
being recorded in the income statement.
In February 1992, the Financial Accounting Standards Board issued FAS 109,
which supersedes FAS 96. FAS 109 requires companies that have previously
both adopted FAS 96 and effected a quasi-reorganization that involves only a
deficit elimination, as did the Company, to continue to report the tax
benefits of prior operating losses and tax credit carryforwards in a manner
consistent with FAS 96. FAS 109 also provides that companies effecting a
quasi-reorganization after February 1992 that involves only a deficit
elimination shall report the tax benefits of prior operating losses and tax
credit carryforwards in a manner consistent with SAB 86.
The Company has continued to report in income the recognition of operating
loss and tax credit carryforward items arising prior to the quasi-
reorganization due to the Company's adoption of its quasi-reorganization in
the context of its interpretation of FAS 96 and the quasi-reorganization
literature existing at the date the quasi-reorganization was effected. The
SEC staff has indicated that it would not object to the Company's
accounting for such tax benefits. If the provisions of SAB 86 had been
applied, net income for the nine months ended September 30, 1995 would have
been reduced by approximately $11.8 million or $.10 per share (1994 - net
income reduced by $36.4 million or $.31 per share). As of June 30, 1995,
the operating loss and tax credit carryforwards arising prior to the quasi-
reorganization had been fully utilized; thus, there was no impact for the
quarter ended September 30, 1995 (the impact in the third quarter of 1994
was $11.5 million or $.10 per share).
Page 9
GENENTECH, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
As discussed in Note 2 in the Notes to Condensed Consolidated Financial
Statements, under the approved agreement with Roche, Roche is granted an
option at terms discussed below for ten years for licenses to use and sell
certain of Genentech's products in non-U.S. markets. As a general matter,
such option for a Genentech product must be exercised at, or prior to, the
conclusion of phase II clinical trials for each product. In general, for
each product for which Roche exercises its option, the Company and Roche
will share equally all development expenses, including preclinical,
clinical, process development and related expenses, incurred by the Company
through that date and prospectively, with respect to the development of the
product in the United States. Roche will pay all non-U.S. development
expenses. In general, Roche will pay a royalty of 12.5% until a product
reaches $100 million in aggregate sales outside of the U.S., when the
royalty rate increases to 15%. As part of the agreement, Roche has
exclusive rights to, and will pay the Company 20% royalties on, Canadian
sales of the Company's existing products and Western European sales of
Pulmozyme. The Company will supply its products to Roche for sales outside
of the U.S. at cost plus 20 percent. Subject to Roche's exercise of rights
to develop or sell the Company's products, product sales, royalties and
contract revenue, as well as R & D and other expenses, could be
significantly affected in future periods compared to the current quarter
and year-to-date periods.
<TABLE>
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
<CAPTION>
Quarter ended Nine months ended
September 30 September 30
---------------------- ------------------------
REVENUES 1995 1994 % Change 1995 1994 % Change
- ------------------------ ------ ------ -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C>
Revenues $223.9 $193.8 16% $695.9 $587.6 18%
====== ====== ======== ====== ====== ========
PRODUCT SALES
- ----------------------
Activase $ 73.2 $ 65.1 12 % $225.5 $208.7 8%
Protropin and Nutropin 54.2 54.6 (1) 164.5 167.6 (2)
Pulmozyme 30.1 21.0 43 88.9 62.1 43
Actimmune 1.0 1.9 (47) 2.9 4.5 (36)
------ ------ -------- ------ ------ --------
Total product sales $158.5 $142.6 11% $481.8 $442.9 9%
====== ====== ======== ====== ====== ========
</TABLE>
Net sales of Activase, registered trademark,(Alteplase, recombinant) tissue-
plasminogen activator increased 12% in the third quarter of 1995 compared to
the third quarter of 1994, and increased 8% for the year-to-date period
ended September 30, 1995 over the comparable prior year period. The
increase primarily reflects growth in U.S. market share; an increase in the
number of patients receiving thrombolytic therapy in the U.S. for the year-
Page 10
to-date 1995 period; and $3.8 million of sales of bulk product to Japanese
licensees in the year-to-date period of 1995. In April 1995, the Food and
Drug Administration (FDA) approved for marketing an accelerated infusion of
Activase, allowing revised labeling for the product incorporating data from
the Global Utilization of Activase and Streptokinase in Occluded Coronary
Arteries (GUSTO) study. Also during the second quarter, an analysis of the
GUSTO trial published in the New England Journal of Medicine determined that
Activase is cost-effective relative to other medical treatments. As part of
the approved agreement with Roche discussed in Note 2 of the Notes to
Condensed Consolidated Financial Statements, Roche now has exclusive rights to
sell Activase in Canada, and Genentech will receive a royalty from Roche on
such sales.
Net sales of the Company's two growth hormone products - Protropin, registered
trademark, (somatrem for injection) and Nutropin, registered trademark,
(somatropin [rDNA origin] for injection) - remained essentially flat for the
third quarter of 1995 compared to the same period in 1994. Growth hormone
sales decreased 2% year-to-date 1995 compared to 1994, as a slight volume
increase in sales was offset by the impact of pricing programs for
distribution channels and for the managed care sector. Genentech faces the
possibility of additional competition from four competitors in the growth
hormone market. Three of these companies, BioTechnology General (BTG), Novo
Nordisk and Pharmacia AB, have received FDA approval to market their growth
hormone products for the treatment of growth hormone inadequacy in children.
However, as a result of the assertion of certain Genentech patents, a court
has temporarily prohibited two of these products - Novo Nordisk's and BTG's -
from entering the market pending a full trial. Future court decisions will
determine whether these two products will be permanently enjoined from the
market. Pharmacia's product may enter the market at any time. Genentech has
a clear competitive strategy in place, but additional competition will have
some impact on growth hormone sales. As part of the approved agreement with
Roche discussed in Note 2 of the Notes to Condensed Consolidated Financial
Statements, Roche now has exclusive rights to sell Protropin and Nutropin in
Canada, and Genentech will receive a royalty from Roche on such sales.
Net sales of Pulmozyme, registered trademark, (dornase alfa), increased 43%
for the quarter and year-to-date periods ended September 30, 1995 over the
comparable periods in 1994. The increase primarily reflects market launches
in additional European countries and continued adoption of the product by
physicians to treat cystic fibrosis patients. The Company currently markets
the drug in the United States. Under the previously existing collaboration
with F. Hoffmann-LaRoche, Ltd. (HLR), Genentech Europe Limited and its
affiliates promoted Pulmozyme in the United Kingdom, Ireland, the Netherlands
and Germany, while HLR was responsible for promoting the product in the
remaining Western European countries in the collaboration. As a result of the
stockholder approval of the new agreement with Roche discussed in Note 2 in
the Notes to Condensed Consolidated Financial Statements, Roche now has
exclusive rights to sell Pulmozyme in Canada and in all countries in Western
Europe, and Genentech Europe Limited and its affiliates will no longer promote
Pulmozyme. Instead, Genentech will receive a royalty on sales of Pulmozyme in
these countries.
<TABLE>
<CAPTION>
Quarter ended Nine months ended
September 30 September 30
ROYALTIES, CONTRACT AND ---------------------- ------------------------
OTHER, AND INTEREST INCOME 1995 1994 % Change 1995 1994 % Change
- ----------------------------- ------ ------ -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C>
Royalties $45.6 $33.1 38% $142.2 $92.9 53%
Contract and other 4.5 7.2 (38) 28.6 21.5 33
Interest income 15.3 10.9 40 43.4 30.2 44
</TABLE>
Page 11
Royalty income increased as a result of increases in licensees' net sales
subject to royalties, new royalty arrangements, and the receipt and
recognition of $22.5 million of royalties in 1995 ($7.5 million in the third
quarter) relating to the December 1994 settlement with Eli Lilly and Company.
The impact on total royalties of changes in foreign currency translation
rates, net of gains and losses recognized on foreign exchange hedging
instruments and the amortization of expense related to foreign currency
options outstanding during the period, was not material. Under the new
agreement with Roche, Genentech will receive royalties on Canadian sales of
Genentech's existing products and Western European sales of Pulmozyme, and
potentially will receive royalities on non-U.S. sales of future products
should Roche exercise its option to use and sell such products.
Contract revenues decreased between quarters but remained even in the 1995
year-to-date period compared to 1994 due to variations in the timing of
contract benchmark achievements, varying payment amounts and the initiation of
new arrangements. Other revenues for the nine months ended September 30, 1995
included $6.4 million of gains recorded from the sales of biotechnology equity
securities previously owned by the Company. Under the new agreement with
Roche, contract revenue may increase in future periods if Roche exercises its
option to co-develop future products.
The increase in interest income occurred due to a larger investment portfolio
in 1995 than in 1994 and higher average market interest rates in the twelve
months preceding September 30, 1995 than in the twelve months preceding
September 30, 1994. The total investment portfolio, consisting of cash and
cash equivalents, and short- and long-term marketable securities, increased to
$1,080.2 million as of September 30, 1995 from $874.8 million as of September
30, 1994, and from $920.9 million as of December 31, 1994.
<TABLE>
<CAPTION>
Quarter ended Nine months ended
September 30 September 30
---------------------- ------------------------
COSTS AND EXPENSES 1995 1994 % Change 1995 1994 % Change
- ----------------------------- ------ ------ -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C>
Cost of sales $ 24.4 $ 24.5 -% $ 75.4 $ 71.2 6%
Research and development 86.0 73.2 17 268.1 220.6 22
Marketing, general and
administrative 55.2 59.3 (7) 187.4 180.2 4
Special charge
(primarily merger related) 9.0 - - 17.0 - -
Interest expense 2.0 1.8 11 5.9 5.4 9
------ ------ -------- ------ ------ --------
Total costs and expenses $176.6 $158.8 11% $553.8 $477.4 16%
====== ====== ======== ====== ====== ========
</TABLE>
Cost of sales remained flat in the third quarter of 1995 compared to the third
quarter of 1994, although product sales increased during the period, because
1994 cost of sales included a $1.3 million reserve primarily for expected
product expiration of Pulmozyme inventories. Cost of sales for the year-to-
date period ended September 30, 1995 increased over 1994 due to higher product
sales and changes in the product mix. These increases were partly offset by a
decrease in inventory reserves provided, from $11.5 million in the 1994 year-
to-date period to $2.2 million in 1995. The reserves recorded in 1994 were
primarily for the likely expiration of Pulmozyme and Nutropin product prior to
sale. These products were launched in the beginning of 1994 and did not meet
the Company's initial expectations for sales that year.
Page 12
R&D expenses increased 17% in the third quarter period of 1995 over the
comparable period in 1994 due to increased production of products for clinical
trials and expenses related to anti-HER2 Phase III worldwide clinical trials
as a therapy for breast cancer, IGF-1 Phase II trials for diabetes, and Phase
II NGF trials related to peripheral neuropathies. R&D for the year-to-date
period ended September 30, 1995 increased over 1994 for the reasons stated
above plus expenses incurred during the first six months of 1995 for
investigating Pulmozyme in a Phase III trial as a treatment for patients with
Chronic Obstructive Pulmonary Disease (COPD); and higher first quarter 1995
in-licensing expenses. The Company halted its research program for Pulmozyme
for use in COPD in the beginning of the third quarter due to the lack of
demonstrable benefit shown at the time of an interim analysis of the Phase III
trial results. The findings of the analysis do not change current treatment
recommendations for patients with cystic fibrosis, for which Pulmozyme has a
proven record of safety and efficacy. The Company intends to continue its
commitment to investment in research and development and has announced plans
to accelerate product development activities.
Marketing, general and administrative expenses decreased in the quarter ended
September 30, 1995 over the comparable prior year period primarily due to a
$4.0 million charge for the writedown of a biotechnology marketable equity
security during the third quarter of 1994. The increase in the 1995 year-to-
date period over the comparable 1994 period is due to an overall increase in
corporate expenses.
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (FAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
which requires the Company to review for impairment long-lived assets, certain
identifiable intangibles, and goodwill related to those assets whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. In certain situations, an impairment loss would be
recognized. FAS 121 is effective for the Company's 1996 fiscal year. In
October 1995, the FASB issued FAS 123 "Accounting for Stock Based
Compensation" which also will be effective for the Company's 1996 fiscal year.
FAS 123 allows companies which have stock-based compensation arrangements with
employees to adopt a new fair-value basis of accounting for stock options and
other equity instruments, or to continue to apply the existing accounting
rules under APB Opinion 25 "Accounting for Stock Issued to Employees" but with
additional financial statement disclosure. The Company is evaluating the
impact of both of these new standards on its financial position, results of
operations, and cash flows.
The $9.0 million special charge in the third quarter of 1995 ($17.0 million
for the nine months ended September 30, 1995) includes $5.0 million related to
the merger agreement with Roche ($13.0 million year-to-date) and $4.0 million
of charges associated with the resignation of the Company's former President
and Chief Executive Officer. The merger related charges include legal
expenses, investment banking fees, filing fees and other costs related to the
agreement, as well as charges associated with the proposed settlement of
stockholder lawsuits filed after the transaction was announced. The Company
expects to incur approximately $8.0 million in additional merger-related
special charges in the fourth quarter of 1995.
Interest expense primarily relates to the Company's 5% convertible
subordinated debentures and a $25 million long-term borrowing arrangement
which commenced in February 1995.
Page 13
<TABLE>
<CAPTION>
Quarter ended Nine months ended
September 30 September 30
--------------------- ------------------------
INCOME TAXES 1995 1994 1995 1994
- ----------------------------- -------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Income taxes $ 7.1 $ 1.4 $21.3 $ 4.4
</TABLE>
The increase in income tax expense was due to higher income before taxes and
an increase in the effective income tax rate, from 4% in 1994 to 15% in 1995.
The increase in the effective tax rate was primarily related to a higher
alternative minimum tax (AMT) in 1995, due to the complete utilization of
available AMT loss carryforwards in 1994.
<TABLE>
<CAPTION>
Quarter ended Nine months ended
September 30 September 30
---------------------- ------------------------
NET INCOME 1995 1994 % Change 1995 1994 % Change
- ----------------------------- ------ ------ -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C>
Net income $40.2 $33.6 20% $120.8 $105.8 14%
Earnings per share .33 .28 1.00 .89
</TABLE>
Net income increased in 1995 due to overall higher revenues from all sources,
partially offset by increases in research and development, the special charge
and income taxes.
LIQUIDITY AND CAPITAL
RESOURCES September 30, 1995 December 31, 1994
- ----------------------------- -------------------- -------------------
Cash, cash equivalents,
short-term investments
and long-term marketable
securities $ 1,080.2 $ 920.9
Working capital 902.6 776.6
LIQUIDITY AND CAPITAL RESOURCES
Cash generated from operations, maturities of investments, stock issuances and
long-term borrowings, was used to make investments in marketable securities,
other assets and capital additions. Cash and cash equivalents at September
30, 1995 increased $117.8 million compared to December 31, 1994. Working
capital increased $126.0 million. The Company believes that its cash, cash
equivalents, and short-term and long-term investments, together with funds
provided by operations and leasing arrangements, will be sufficient to meet
its cash requirements.
Capital expenditures totaled $38.3 million in the first nine months of 1995
compared to $58.9 million in the same period in 1994. The decrease was due to
the construction in 1994 of a central process utility plant and additional
manufacturing facilities, and the 1994 purchase of land for building
expansion.
Page 14
Accounts receivable increased $30.0 million or 20% from December 1994 to
September 1995. The change is due to: a $9.6 million increase in receivables
due from Roche, including amounts receivable for Pulmozyme shipments to the
European collaboration, contract payments and other items; a $12.2 million
increase in receivables for reimbursements related to construction of a new
process science facility and development of the Company's second manufacturing
site; and $8.2 million in increases in receivables for product sales and
contract revenue. Other assets increased $30.7 million in the same period
primarily attributable to the 1995 $25.0 million repurchase from a licensee of
the right to sell Activase in Canada. The asset is being amortized over ten
years, and is expected to be recovered through royalties received from Roche
on product sales in Canada.
Page 15
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors and Stockholders
Genentech, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Genentech, Inc. as of September 30, 1995, and the related condensed
consolidated statements of income for the three-month and nine-month periods
ended September 30, 1995 and 1994, and the condensed consolidated statements
of cash flows for the nine-month periods ended September 30, 1995 and 1994.
These financial statements are the responsibility of the Company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data, and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, which will
be performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
referred to above for them to be in conformity with generally accepted
accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Genentech, Inc. as of December
31, 1994, 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 January 17, 1995, we expressed an unqualified opinion on
those consolidated financial statements. In our opinion, the information set
forth in the accompanying condensed consolidated balance sheet as of December
31, 1994, is fairly stated, in all material respects, in relation to the
consolidated balance sheet from which it has been derived.
ERNST & YOUNG LLP
San Jose, California
October 10, 1995
Page 16
GENENTECH, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In May 1995, the Company, its directors, two former directors and Roche were
named as defendants in a number of suits filed in the Court of Chancery,
County of New Castle, Delaware, which have been consolidated in a single
action, by certain individual stockholders purporting to represent
stockholders as a class alleging, in general, breach of their fiduciary duties
to the Company in connection with the proposed extension of Roche's option to
cause the Company to redeem the outstanding non-Roche owned common stock and
transactions related thereto (the Proposed Transactions). As relief, the
suits seek, among other things, a preliminary and permanent injunction against
the vote held at the Special Meeting of the stockholders of the Company held
in connection with the Proposed Transactions; a preliminary and permanent
injunction against consummation of the Proposed Transactions; an order voiding
the Proposed Transactions in the event they are approved by the vote of the
stockholders; and damages in an unspecified amount. The Company, Roche and
the attorneys representing the plaintiff stockholders have entered into a
memorandum of understanding settling all claims against the defendants in
these actions. In connection with the settlement, if approved by the court,
Roche would increase the prices at which it could cause Genentech to redeem
the non-Roche owned common stock by $0.50 per share per quarter, to a final
price of $82.50 in the quarter ending June 30, 1999, and Genentech would agree
to pay the plaintiffs' attorneys up to $3.5 million in attorney fees if the
fees are approved by the Court. In addition, Genentech will absorb the
termination costs of six Europe-based Genentech employees.
See also Note 2 "Transaction with Roche Holdings, Inc." and Note 4 "Legal
Proceedings", each in Part I "Notes to Condensed Consolidated Financial
Statements."
ITEM 5. OTHER INFORMATION
At a special meeting of stockholders held on October 25, 1995, the Company's
stockholders voted upon and approved an Agreement and Plan of Merger, dated as
of May 23, 1995, as amended and restated (the "Merger Agreement"), among the
Company, Roche Holdings, Inc., a Delaware corporation ("Roche") and HLR (U.S.)
II, Inc., a Delaware corporation and a wholly owned subsidiary of Roche
("Merger Sub"). Pursuant to the Merger Agreement, among other things, the
Merger Sub was merged (the "Merger") with and into the Company, and each share
of the Company's common stock (other than shares of common stock held by Roche
and its affiliates) was converted into one share of the Company's special
common stock. The Merger became effective on October 25, 1995. Additional
information concerning the Merger and the transactions related thereto may be
found in certain Securities and Exchange Commission filings relating to the
Company, including a Schedule 13E-3, dated June 2, 1995, as amended September
8, 1995, September 18, 1995 and November 3, 1995, filed by the Company and
Roche, which is hereby incorporated herein by reference.
See also Note 2 "Transaction with Roche Holdings, Inc." in Part I "Notes to
Condensed Consolidated Financial Statements."
Page 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
15.1 Letter re: Unaudited Interim Financial Information
27.1 Financial Data Schedule
(b) Reports on Form 8-K
In a report filed on Form 8-K dated July 10, 1995, the Company reported the
issuance of a press release on July 7, 1995 related to the resignation of its
former President and Chief Executive Officer.
In a report filed on Form 8-K dated July 18, 1995, the Company reported the
issuance of a press release on July 18, 1995 related to its earnings for the
period ended June 30, 1995, which was filed because it made reference to
matters relating to the then-pending merger agreement with Roche, at that time
the subject of preliminary proxy materials filed with the Securities and
Exchange Commission.
Page 18
GENENTECH, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 14, 1995 GENENTECH, INC.
/S/ARTHUR D. LEVINSON /S/LOUIS J. LAVIGNE, JR.
------------------------------------- -----------------------------
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr.
President and Chief Executive Officer Senior Vice President and
Chief Financial Officer
/S/BRADFORD S. GOODWIN
-----------------------------
Bradford S. Goodwin
Vice President and Controller
Page 19
Exhibit 15.1
November 14, 1995
Securities and Exchange Commission
Washington, DC 20549
We are aware of the incorporation by reference in the Registration
Statements pertaining to the 1994 Stock Option Plan, the 1991 Employee
Stock Plan, the 1990 Stock Option/Stock Incentive Plan, the 1984 Incentive
Stock Option Plan and the 1984 Non-Qualified Stock Option Plan, the shares
issuable to certain warrant holders, the shares issuable to certain
convertible subordinated debenture holders, the Genentech, Inc. Tax
Reduction Investment Plan and in the related prospectuses, as applicable,
contained in such Registration Statements of our report dated October 10,
1995 relating to the unaudited condensed consolidated interim financial
statements of Genentech, Inc. which are included in its Form 10-Q for the
quarter and nine months ended September 30, 1995.
Pursuant to Rule 436(c) of the Securities Act of 1933 our report is not a
part of the registration statement prepared or certified by accountants
within the meaning of Section 7 or 11 of the Securities Act of 1933.
Very truly yours,
ERNST & YOUNG LLP
Page 20
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS, CONSOLIDATED STATEMENTS OF INCOME AND CONSOLIDATED
STATEMENTS OF CASH FLOWS INCLUDED IN THE COMPANY'S FORM 10-Q FOR THE PERIOD
ENDED SEPTEMBER 30, 1995, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS AND THE NOTES THERETO.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> SEP-30-1995
<CASH> 184,535
<SECURITIES> 895,692
<RECEIVABLES> 181,543
<ALLOWANCES> 5,294
<INVENTORY> 92,700
<CURRENT-ASSETS> 1,132,950
<PP&E> 743,522
<DEPRECIATION> 257,978
<TOTAL-ASSETS> 1,965,577
<CURRENT-LIABILITIES> 230,393
<BONDS> 176,082
<COMMON> 2,376
0
0
<OTHER-SE> 1,530,211
<TOTAL-LIABILITY-AND-EQUITY> 1,965,577
<SALES> 481,781
<TOTAL-REVENUES> 695,931
<CGS> 75,431
<TOTAL-COSTS> 75,431
<OTHER-EXPENSES> 268,097
<LOSS-PROVISION> 7,455
<INTEREST-EXPENSE> 5,904
<INCOME-PRETAX> 142,113
<INCOME-TAX> 21,317
<INCOME-CONTINUING> 120,796
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 120,796
<EPS-PRIMARY> 1.00
<EPS-DILUTED> 0
</TABLE>
