UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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.
A Delaware Corporation 94-2347624
(I.R.S. employer identification number)
1 DNA Way
South San Francisco, California 94080-4990
(650) 225-1000
Securities registered pursuant to Section 12(b) of the Act:
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Title of Each Class Name of Each Exchange on Which Registered
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Common Stock $.02 par value New York Stock Exchange
Callable Putable Common Stock Pacific Exchange
$.02 par value
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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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The approximate aggregate market value of voting stock held by nonaffiliates
of the registrant is $2,143,366,690 as of February 13, 1998. (A)
Number of shares of Common Stock outstanding as of February 13, 1998:
76,621,009
Number of shares of Callable Putable Common Stock outstanding as of
February 13, 1998: 48,148,527
Documents incorporated by reference:
PARTS INCORPORATED
DOCUMENT BY REFERENCE
(1) Annual Report to stockholders for the year ended II
December 31, 1997 (specified portions)
(2) Definitive Proxy Statement with respect to the 1998 III
Annual Meeting of Stockholders filed by Genentech, Inc.
(SEC file No. 1-9813) with the Securities and Exchange
Commission (hereinafter referred to as "Proxy Statement")
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(A) Excludes 92,386,281 shares of Common Stock and Callable Putable Common
Stock held by Directors, Officers and stockholders whose ownership exceeds
five percent of either the Common Stock or Callable Putable Common Stock
outstanding at February 13, 1998 (the holdings of FMR Corp., Goldman Sachs &
Co. and The Goldman Sachs Group, L.P. were calculated based on their holdings
as of December 31, 1997). Exclusion of shares held by any person should not
be construed to indicate that such person possesses the power, direct or
indirect, to direct or cause the direction of the management or policies of
the registrant, or that such person is controlled by or under common control
with the registrant
PART I
ITEM 1. BUSINESS
Genentech, Inc. (the Company) is a biotechnology company that discovers,
develops, manufactures and markets human pharmaceuticals produced by
recombinant DNA technology for significant unmet medical needs. The Company
manufactures and markets seven products directly in the United States (U.S.)
and sells these products to F. Hoffmann-La Roche Ltd (HLR) for HLR to sell
outside of the U.S. Of these seven products, HLR has the right to sell six in
Canada and two in a number of countries. In addition, the Company receives
royalties from HLR's sales of these products, and receives royalties from HLR
and other licensees from sales of five other products which originated from
the Company's technology.
Relationship with Roche Holdings, Inc.
On October 25, 1995, the Company and Roche Holdings, Inc. (Roche) entered into
a new agreement (the Agreement) to extend until June 30, 1999, Roche's option
to cause the Company to redeem (call) the outstanding callable putable common
stock (special common stock) of the Company at predetermined prices. Should
the call be exercised, Roche will concurrently purchase from the Company a
like number of shares of common stock for a price equal to the Company's cost
to redeem the special common stock. If Roche does not cause the redemption as
of June 30, 1999, the Company's stockholders will have the option to cause the
Company to redeem none, some, or all of their shares of special common stock
(and Roche will concurrently provide the necessary redemption funds to the
Company by purchasing a like number of shares of common stock) within thirty
business days commencing July 1, 1999. See the Relationship with Roche
Holdings, Inc. note in the Notes to Consolidated Financial Statements in the
Company's 1997 Annual Report to Stockholders (Part II, Item 8 of this Form 10-
K) for further information.
In conjunction with the Agreement, HLR was granted an option for ten years for
licenses to use and sell certain of the Company's products in non-U.S.
markets. See below and in the Relationship with Roche Holdings, Inc. note in
the Notes to Consolidated Financial Statements in the Company's 1997 Annual
Report to Stockholders (Part II, Item 8 of this Form 10-K) for further
information.
Products
The Company has developed six products, co-developed one product and currently
manufactures and markets all seven products in the U.S.: Activase, registered
trademark, (Alteplase, recombinant) recombinant tissue plasminogen activator;
Protropin, registered trademark, (somatrem for injection) recombinant growth
hormone; Nutropin, registered trademark, [somatropin (rDNA origin) for
injection] human growth hormone; Nutropin AQ, registered trademark,
[somatropin (rDNA origin) injection] liquid formulation human growth hormone;
Pulmozyme, registered trademark, (dornase alfa) inhalation solution;
Actimmune, registered trademark, (Interferon gamma-1b) recombinant interferon
gamma and Rituxan, trademark, (Rituximab, C2B8) a monoclonal antibody which
was co-developed with IDEC Pharmaceuticals Corporation (IDEC).
Pursuant to the Agreement with Roche, the Company granted exclusive rights to
HLR to sell Activase, Protropin, Nutropin and Pulmozyme in Canada and
Pulmozyme in Europe and the Company began receiving a royalty on such sales.
HLR has the right to sell Nutropin AQ in Canada from which the Company will
receive a royalty on such sales. In addition, HLR has exclusive rights to
sell Rituxan in all countries, excluding the U.S. and Japan, and the Company
will receive a royalty on such sales.
Activase: Tissue plasminogen activator (t-PA) is an enzyme that is produced
naturally by the body to dissolve blood clots. However, when a blood clot
obstructs blood flow in the coronary artery and causes a heart attack, the
body is unable to produce enough t-PA to dissolve the clot rapidly enough to
prevent damage to the heart. Through recombinant DNA technology, Genentech
produces Activase, a recombinant form of t-PA, in sufficient quantity for
therapeutic use. The U.S. Food and Drug Administration (FDA) approved
Activase for marketing in the U.S. in 1987 for the treatment of acute
myocardial infarction (AMI or heart attack); in 1990 for use in the treatment
of acute pulmonary embolism (blood clots in the lungs); and in June 1996 for
the treatment of acute ischemic stroke or brain attack (blood clots in the
brain) within three hours of symptom onset.
In exchange for royalty payments, the Company has licensed marketing rights to
a recombinant t-PA in Japan to Kyowa Hakko Kogyo, Ltd. (Kyowa) and Mitsubishi
Kasei Corporation (Mitsubishi). Kyowa and Mitsubishi are marketing forms of a
recombinant t-PA under the trademarks Activacin, registered trademark, and
GRTPA, registered trademark, respectively. In a number of countries outside
of the U.S., Canada and Japan, the Company has licensed t-PA marketing and
manufacturing rights to Boehringer Ingelheim International GmbH (Boehringer).
The Company has also licensed certain rights to Boehringer regarding future
sales of a second generation t-PA, which is currently under development.
Boehringer markets a recombinant t-PA under the trademark Actilyse, registered
trademark.
Protropin: Human growth hormone is a naturally occurring human protein
produced in the pituitary gland that regulates metabolism and is responsible
for growth in children. A recombinant growth hormone product developed by the
Company, Protropin, was approved by the FDA in 1985 for marketing in the U.S.
for the treatment of growth hormone inadequacy in children.
In exchange for royalty payments, the Company licensed rights to recombinant
growth hormone outside the U.S. and Canada to Pharmacia & Upjohn(P&U), which
manufactures and markets recombinant growth hormone under the trademarks
Somatonorm, registered trademark, and Genotropin, registered trademark. Under
the terms of the agreement with P&U, effective in late 1995, the Company has
the right to sell growth hormone in most European countries and Japan and P&U
has the right to sell their own growth hormone in the U.S. and Canada.
Nutropin: Nutropin is a human growth hormone similar to Protropin; however,
it does not have the additional amino acid, methionine, found in the Protropin
chemical structure. Nutropin was approved in November 1993 and launched in
January 1994 for marketing in the U.S. for the treatment of growth hormone
inadequacy in children due to chronic renal insufficiency (CRI). CRI causes
irreversible damage to the kidneys and a variety of other medical problems,
including growth hormone inadequacy. The condition affects an estimated 3,000
children in the U.S. Nutropin has been designated as a U.S. Orphan Drug for
treatment of growth hormone inadequacy in children with CRI. Nutropin was
approved by the FDA in March 1994 for marketing for the treatment of growth
hormone inadequacy in children. In December 1996, the FDA approved Nutropin
for the treatment of short stature associated with Turner syndrome. In
December 1997, the Company received FDA approval to market Nutropin for the
treatment of growth hormone deficiency in adults.
Nutropin AQ: In December 1995, the Company received regulatory approval to
market Nutropin AQ, a liquid formulation of Nutropin, aimed at providing
improved convenience in administration. Nutropin AQ is the first and only
liquid (aqueous) recombinant human growth hormone product available. Nutropin
AQ was approved for the treatment of growth hormone inadequacy in children,
growth hormone inadequacy in children due to CRI and short stature associated
with Turner syndrome. In December 1997, the Company received FDA approval to
market Nutropin AQ for the treatment of growth hormone deficiency in adults.
As part of the strategic alliance formed with Sumitomo Pharmaceuticals Co.,
Ltd. (Sumitomo) in December 1997, the Company has agreed to provide Sumitomo
exclusive rights to develop, import and distribute in Japan, Nutropin AQ and
ProLease, registered trademark, sustained release growth hormone (see below in
Products in Development).
Pulmozyme: Pulmozyme is marketed in the U.S. for the management of cystic
fibrosis (CF), for which it has U.S. Orphan Drug designation. There are an
estimated 22,000 patients with CF in the U.S., a significant portion of whom
are expected to be candidates for treatment. In November 1996, Pulmozyme was
cleared for marketing by the FDA for the management of CF patients with
advanced disease.
Rituxan: Rituxan is marketed in the U.S. for the treatment of relapsed or
refractory low-grade or follicular, CD20-positive B-cell non-Hodgkin's
lymphoma (B-cell NHL), a cancer of the immune system. In November 1997,
Rituxan was cleared for marketing in the U.S. by the FDA. B-cell NHL affects
approximately 250,000 people in the U.S. of which one-half are follicular or
low-grade lymphoma patients. A portion of these patients will have multiple
relapses and may be eligible for Rituxan therapy. Rituxan was co-developed by
the Company and IDEC, from whom the Company licenses Rituxan, and is the first
monoclonal antibody approved to treat cancer. IDEC and the Company are
jointly promoting Rituxan in the U.S. and share responsibility for the
manufacturing of the product.
Actimmune: Actimmune is approved in the U.S. for the treatment of chronic
granulomatous disease (CGD), a rare, inherited disorder of the immune system
which affects an estimated 250 to 400 Americans. Actimmune received
designation by the FDA in 1990 as a U.S. Orphan Drug for the treatment of CGD.
The Company receives royalty payments from Boehringer from the sale of
interferon gamma in certain countries outside of the U.S., Canada and Japan.
Licensed Products:
In addition to the royalties mentioned above, the Company also receives
royalties on the following products:
Product Trademark Company
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Recombinant human insulin Humulin Eli Lilly and Company (Lilly)
Human growth hormone Humatrope Lilly
Recombinant interferon alpha Roferon-A HLR
Hepatitis B vaccine Recombivax Merck and Company, Inc.
Hepatitis B vaccine Engerix-B Smith-Kline Beecham
Pharmaceuticals
Factor VIII Kogenate Bayer Corporation
Bovine growth hormone Posilac Monsanto Corporation
Under the December 1994 settlement agreement with Lilly regarding certain of
the Company's patents, royalties of $30.0 million per year are payable,
subject to possible offsets and contingent upon Humulin, registered trademark,
continuing to be marketed in the U.S., to the Company through 1998. Under a
prior license agreement with Lilly, the Company receives royalties from
Lilly's sales of Humulin. These royalty payments on Humulin sales will expire
in August 1998.
Through its January 1997 agreement with Roche Laboratories, Inc., a New Jersey
corporation, the Company has the exclusive right to market and promote Roche's
Roferon-A, registered trademark, in the U.S. for ten years for its approved
oncology indications. On April 1, 1998, the Company will return to Roche its
rights to market and promote Roferon-A. In consideration, the Company will
receive $5.0 million plus royalties for sales of alpha interferon under a
prior Roche agreement (the 1980 Roche Agreement).
Products in Development:
As part of the Company's program of research and development (R&D), a number
of other products are in various stages of development. Product development
efforts cover a wide range of disorders or medical conditions, including
cancer, respiratory disorders, cardiovascular diseases, endocrine disorders,
inflammatory and immune problems, and neurological disorders.
Below is a summary of products in clinical development:
<TABLE>
<CAPTION>
Product Description
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<S> <C>
Phase III
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Activase (Alteplase, recombinant) Activase currently has marketing clearance
for the treatment of acute ischemic stroke
(AIS) within three hours of symptom onset.
The Company is conducting a Phase III
clinical trial to determine if Activase
can benefit patients with AIS if
administered within three to five hours of
symptom onset.
Anti-IgE Antibody A humanized IgE monoclonal antibody
designed to interfere early in the process
that leads to symptoms of allergic asthma
(being developed in collaboration with
Tanox Biosystems, Inc. and Novartis
Pharmaceuticals Corporation).
Herceptin, trademark, A humanized monoclonal antibody targeted
(Anti-HER2 Humanized Monoclonal against a protein receptor, which may be
Antibody) useful in the treatment of certain types
of breast cancer. The Company is
currently preparing FDA regulatory
filings.
Nerve Growth Factor A protein that may aid the treatment of
diabetic peripheral neuropathy (HLR has
exercised its option for this product
outside of the U.S.). The Company is
currently conducting Phase III clinical
trials.
pimagedine A compound being developed to inhibit or
block abnormal glucose/protein complexes,
advanced glycosylation end-products (AGE),
that lead to diabetic complications such
as kidney disease (being developed under a
collaboration and license agreement
between the Company and Alteon Inc.).
Alteon is conducting Phase III clinical
trials in end-stage renal disease and in
overt nephropathy in Type I and Type II
diabetes patients.
ProLease hGH Encapsulated A sustained release version of human
Sustained-Release Growth Hormone growth hormone designed to reduce the need
for daily injections (being developed in
collaboration with Alkermes, Inc.).
Pulmozyme Inhalation Solution An approved treatment for the management
of CF in patients from age five with mild,
moderate or severe disease. The Company is
conducting a trial to determine the
effect of Pulmozyme on pulmonary functions
in patients with early stage CF.
TNK-tPA A second generation t-PA that is a
selectively mutated version of natural
t-PA. The Company is conducting Phase III
clinical trials in AMI patients (being
developed in collaboration with Boehringer.)
Xubix, trademark, (Sibrafiban) An inhibitor of platelet aggregation that
oral IIb/IIIa antibody may be useful in the prevention of
unwanted clotting in certain
cardiovascular conditions (HLR is
conducting global development of this
molecule, and the Company retains opt-in
rights).
Phase II
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Anti-CD11a antibody An antibody designed to block the immune
cells that are over-active in psoriasis
(being developed in collaboration with
Xoma Corporation).
Anti-CD18 antibody An antibody designed to address problems
related to loss of blood flow, as in
trauma. HLR began Phase II clinical trials
for the treatment of shock and burns, and
the Company began planning Phase II
clinical trials for the treatment of
AMI. In January 1998, HLR notified the
Company that it was going to discontinue
the shock and burns clinical trials.
Anti-IgE antibody A humanized IgE monoclonal antibody
designed to interfere early in the process
that leads to symptoms of allergic
rhinitis (being developed in collaboration
with Tanox Biosystems, Inc. and Novartis
Pharmaceuticals Corporation).
Thrombopoietin (TPO) A protein that is being studied for
treatment of thrombocytopenia, a reduction
in clot-inducing platelets, in cancer
patients treated with chemotherapy. This
molecule has been exclusively licensed to,
and is being co-developed for one
indication with, P&U.
Vascular Endothelial Growth A protein that ischemic tissues (tissues
Factor (VEGF) antibody lacking in oxygen) secrete. It binds to
receptors on nearby blood vessels and
causes angiogenesis, the formation of new
blood vessels. The Company is currently
investigating the use of VEGF for the
treatment of coronary ischemia. The
Company is currently preparing for Phase
II clinical trials.
Phase I
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Anti-VEGF An antibody developed to treat several
types of cancer. In preclinical studies,
the anti-VEGF antibody resulted in
decreased vascularization and a decline in
growth and metastasis of a variety of
tumors. The Company has filed with the
FDA an investigational new drug
application (IND) to investigate its
anti-VEGF antibody in Phase I clinical
trials as a potential therapy against
solid tumors.
LDP-02 A humanized monoclonal antibody for the
treatment of inflammatory bowel diseases
(licensed from and being developed in
collaboration with
LeukoSite, Inc.).
</TABLE>
In conjunction with the Agreement, HLR was granted an option for ten years for
licenses to use and sell certain of the Company's products in non-U.S. markets
(the license agreement). In the second quarter of 1997, the Company and HLR
agreed in principle to changes to the license agreement. Key changes to the
license agreement are summarized as follows: (1) For future products, HLR may
choose to exercise its option either when the Company determines to move a
product into development, or at the end of Phase II clinical trials (as in the
1995 agreement). U.S. and European development costs will be shared
(discontinuing the distinction regarding location or purpose of studies). (2)
If HLR exercises its option at the development determination point, U.S. and
European development costs will be shared 50/50. (3) If HLR exercises its
option at the end of Phase II clinical trials, HLR will reimburse the Company
for 50 percent of any development costs incurred, and subsequent U.S. and
European development costs will be shared 75/25, HLR/Genentech. (4) For nerve
growth factor (NGF), which HLR has already exercised its option to develop,
prospective U.S. and European development costs will be shared 60/40,
HLR/Genentech. (5) HLR will assume development of Xubix globally on its own.
The Company will provide clinical and scientific input for the Xubix program
and may subsequently opt-in and join development at any time up to the New
Drug Application (NDA) filing with the FDA for the first indication. If the
Company chooses to opt-in, it will reimburse HLR for 50 percent of the U.S.
and European Xubix development costs incurred after the Company's opt-out
decision through the subsequent opt-in date. In the event that the Company
opts-in, HLR and Genentech will co-promote Xubix in the U.S. with a 60/40,
Genentech/HLR, profit-sharing if the NDA filing for the first indication is
for acute therapy or a 50/50 profit-sharing if the NDA filing for the first
indication is for chronic therapy. If the Company does not opt-in, it will
receive from HLR a 6.0% royalty on worldwide sales of Xubix.
In general, with respect to the Company's products, HLR pays a royalty of
12.5% until a product reaches $100.0 million in aggregate sales outside of the
U.S. on a country-by-country basis, at which time the royalty rate on all
sales increases to 15%. In addition, HLR has rights to, and pays the Company
20% royalties on, Canadian sales of the Company's existing products, except
Rituxan, and European sales of Pulmozyme and Rituxan. In the fourth quarter
of 1995, the Company transferred to HLR the rights to sell Pulmozyme
exclusively in Canada and Europe and commenced recording royalty revenue from
HLR on such sales. The Company supplies its products to HLR, and has agreed
to supply its products for which HLR has exercised its option, for sales
outside of the U.S. at cost plus 20%.
The Company and CuraGen Corporation entered into a research collaborative
agreement in November 1997, whereby the Company will invest $5 million in
equity of CuraGen and provide a convertible loan to CuraGen of up to $26
million. The Company has exclusive rights for specified periods to evaluate
discoveries arising from the collaboration and to license them for an
additional fee. After the end of the first year, the drawn-down portion of
the loan is convertible into stock.
In December 1997, the Company and Alteon Inc. entered into a collaborative
agreement to develop and market pimagedine, an AGE formation inhibitor which
Alteon currently has in Phase III clinical trials to treat certain types of
kidney disease in diabetic patients. Under the terms of the agreement, the
Company licensed pimagedine from Alteon and made an initial equity investment
in Alteon stock of $15 million and will make additional equity investments of
up to $48 million to fund development costs for pimagedine. A $16 million
equity investment is scheduled for the first quarter of 1998.
Also, in December 1997, the Company and LeukoSite Inc. entered into a
collaboration agreement to develop and commercialize LeukoSite's LDP-02, a
humanized monoclonal antibody for the potential treatment of inflammatory
bowel diseases. Under the terms of the agreement, the Company made a $4
million equity investment in LeukoSite and will provide a convertible loan for
approximately $15 million to fund Phase II development costs. Upon successful
completion of Phase II, if LeukoSite agrees to fund 25% of Phase III
development costs, the Company will provide a second loan to LeukoSite for
such funding.
Distribution
The Company has a U.S.-based pharmaceutical marketing, sales and distribution
organization for its human pharmaceuticals. The Company's sales efforts are
focused on specialist physicians based at major medical centers in the U.S.
In general, products are sold to distributors or directly to hospital
pharmacies or medical centers. The Company utilizes common pharmaceutical
company marketing techniques, including advertisements, professional symposia,
direct mail, public relations and other methods.
The Company's products are available at no charge to qualified patients under
the Company's uninsured patient programs in the U.S. The Company has
established the Genentech Endowment for Cystic Fibrosis so qualified CF
patients in the U.S. who need Pulmozyme can gain assistance in obtaining it.
During 1997, the Company provided certain marketing programs relating to
Activase, including a comprehensive wastage replacement program for Activase
which, subject to specific conditions, provides customers the right to return
Activase to the Company for replacement related to both patient related
product wastage and product expiration. The Company maintains the right to
renew, modify or discontinue the above program.
As discussed in the Notes to Consolidated Financial Statements in the
Company's 1997 Annual Report to Stockholders (Part II, Item 8 of this Form
10-K), the Company had three customers, including HLR, who provided over 10%
of total revenues. Also discussed in the note are revenues from foreign
customers in 1997, 1996 and 1995.
Raw Materials
Raw materials and supplies required for the production of the Company's
principal products are generally available in quantities adequate to meet the
Company's needs.
Proprietary Technology - Patents and Trade Secrets
The Company has a policy of seeking patents on inventions arising from its
ongoing R&D activities. Patents issued or applied for cover inventions
ranging from basic recombinant DNA techniques to processes relating to
specific products and to the products themselves. The Company has either been
granted patents or has patent applications pending which relate to a number of
current and potential products including products licensed to others. The
Company considers that in the aggregate its patent applications, patents and
licenses under patents owned by third-parties are of material importance to
its operations. Important legal issues remain to be resolved as to the extent
and scope of available patent protection for biotechnology products and
processes in the U.S. and other important markets outside of the U.S. The
Company expects that litigation will likely be necessary to determine the
validity and scope of certain of its proprietary rights. The Company is
currently involved in a number of patent lawsuits, as either a plaintiff or
defendant, and administrative proceedings relating to the scope of protection
of its patents and those of others. These lawsuits and proceedings may result
in a significant commitment of Company resources in the future. There can be
no assurance that the patents the Company obtains or the unpatented
proprietary technology it holds will afford the Company significant commercial
protection.
In general, the Company has obtained licenses from various parties which it
deems to be necessary or desirable for the manufacture, use or sale of its
products. These licenses (both exclusive and non-exclusive) generally require
the Company to pay royalties to the parties on product sales.
The Company's trademarks, ACTIVASE, PROTROPIN, NUTROPIN, NUTROPIN AQ,
PULMOZYME and ACTIMMUNE in the aggregate are considered to be of material
importance and are registered in the U.S. Patent and Trademark Office and in
other countries throughout the world.
Royalty income recognized by the Company during 1997, 1996 and 1995 for patent
licenses, know-how and other related rights amounted to $241.1 million, $214.7
million and $190.8 million, respectively. In 1997, 1996 and 1995 the Company
incurred royalty expenses amounting to $58.9 million, $58.9 million and $54.8
million, respectively, under licenses from others.
Competition
The Company faces competition, and believes significant long-term competition
can be expected, from large pharmaceutical companies and pharmaceutical
divisions of chemical companies as well as biotechnology companies. This
competition can be expected to become more intense as commercial applications
for biotechnology products increase. Some competitors, primarily large
pharmaceutical companies, have greater clinical, regulatory and marketing
resources and experience than the Company. Many of these companies have
commercial arrangements with other companies in the biotechnology industry to
supplement their own research capabilities.
The introduction of new products or the development of new processes by
competitors or new information about existing products may result in price
reductions or product replacements, even for products protected by patents.
However, the Company believes its competitive position is enhanced by its
commitment to research leading to the discovery and development of new
products and manufacturing methods. Other factors which should help the
Company meet competition include ancillary services provided to support its
products, customer service, and dissemination of technical information to
prescribers of its products and to the health care community including payers.
Over the longer term, the Company's (and its partners') ability to
successfully market current products, expand their usage and bring new
products to the marketplace will depend on many factors, including but not
limited to the effectiveness and safety of the products, FDA and foreign
regulatory agencies' approvals for new indications, the degree of patent
protection afforded to particular products, and the effect of managed care as
an important purchaser of pharmaceutical products.
Activase: Activase's market share at the end of 1997 decreased to
approximately 71% in the U.S. for the treatment of AMI as compared to
approximately 80% at the end of 1996. The decrease was primarily due to a new
competitive thrombolytic agent, Retavase, registered trademark. Retavase
received FDA approval in October 1996 for the treatment of acute myocardial
infarction (AMI). The Company believes Retavase infringes on its patents and
has filed a patent infringement action against Boehringer Mannheim (BM) which
manufactures and markets Retavase. Recently, Centocor, Inc. (Centocor)
announced that it had agreed to purchase the U.S. and Canadian rights to
Retavase from BM. In addition, there is an increasing use of angioplasty in
lieu of thrombolytic therapy for the treatment of AMI. In April 1995, the FDA
approved for marketing an accelerated dosage of Activase. In June 1996, the
Company received clearance from the FDA to market Activase for the treatment
of acute ischemic stroke or brain attack. Activase is the first therapy to be
indicated for the acute treatment of stroke. In addition, the Company is
conducting Phase III clinical trials on a second generation of t-PA.
Genentech is aware of other companies actively pursuing the development for
the U.S. market of nonrecombinant or recombinant t-PA or t-PA variants, and
additional companies or combinations of companies pursuing the development of
other types of potentially competitive thrombolytic agents.
Protropin, Nutropin and Nutropin AQ: Lilly received FDA approval in 1987 to
market its growth hormone product for treatment of growth hormone inadequacy
in children. Three other companies - BioTechnology General (BTG), Novo
Nordisk A/S (Novo) and P&U - received FDA approval in 1995 to market their
growth hormone products for the treatment of growth hormone inadequacy in
children, although BTG has been preliminarily enjoined from selling its
product. A fifth competitor, Serono Laboratories, Inc. (Serono), received FDA
approval in October 1996 to market its growth hormone product. In the first
quarter of 1997, Serono, Novo and P&U began selling their growth hormone
products in the U.S. market. In addition, three of the Company's competitors
have received approval to market their existing human growth hormone products
for additional indications.
Pulmozyme: Sales of Pulmozyme for the management of CF in the U.S., Canada
and some countries in Europe began in early 1994. In November 1996, Pulmozyme
was cleared for marketing by the FDA for the management of CF patients with
advanced disease; a condition that affects approximately 500 patients in the
U.S. In accordance with the Agreement with Roche, in the fourth quarter of
1995, HLR obtained exclusive rights to sell Pulmozyme outside of the U.S., and
the Company receives a royalty on such sales.
Rituxan: Rituxan received designation as a U.S. Orphan Drug by the FDA in 1994
for the treatment of B-cell NHL.
Actimmune: Actimmune received designation as a U.S. Orphan Drug by the FDA in
1990 for the treatment of CGD.
Forward-Looking Statements
The following section contains forward-looking statements that are based on
the Company's current expectations. Because the Company's actual results may
differ materially from these and any other forward-looking statements made by
or on behalf of the Company, this section also includes a discussion of
important factors that could affect the Company's actual future results,
including its product sales, royalties, contract revenues, expenses and net
income.
Product Sales: The Company's product sales may vary from period to period for
several reasons including, but not limited to: the overall competitive
environment for the Company's products, the amount of sales to customers in
the U.S., the amount and timing of the Company's sales to HLR, the timing and
volume of bulk shipments to licensees, the availability of third-party
reimbursements for the cost of therapy, the effectiveness and safety of the
products, the rate of adoption and use of the Company's products for approved
indications and additional indications and the potential introduction of
additional new products and indications for existing products in 1998 and
beyond.
Competition: The Company faces growing competition in two of its therapeutic
markets. Activase lost market share and is expected to lose additional market
share in the thrombolytic market to Retavase and such adverse effect on sales
could be material. Recently, Centocor announced that it was purchasing the
U.S. and Canadian rights to Retavase from BM and will promote and sell the
product in the U.S. In addition, the increasing use of angioplasty in lieu of
thrombolytic therapy for the treatment of AMI is expected to continue. In the
growth hormone market, the Company continues to face increased competition
from five other companies with growth hormone products. Three of these
competitors have also received approval to market their existing human growth
hormone products for additional indications. The Company expects such
competition to have an adverse effect on its sales of Protropin, Nutropin and
Nutropin AQ and such effect could be material.
Other competitive factors affecting the Company's product sales include, but
are not limited to: the timing of FDA approval, if any, of additional
competitive products, pricing decisions made by the Company, the degree of
patent protection afforded to particular products, the outcome of litigation
involving the Company's patents and patents of competing companies for
products and processes related to production and formulation of those
products, the increasing use and development of alternate therapies, and the
rate of market penetration by competing products.
Royalty and Contract Revenues: Royalty and contract revenues in future
periods could vary significantly from 1997 levels. Major factors affecting
these revenues include, but are not limited to: HLR's decisions to exercise
or not to exercise its option to develop and sell the Company's future
products in non-U.S. markets and the timing and amount of related development
cost reimbursement, if any; variations in HLR's sales and other licensees'
sales of licensed products; the expiration of royalties from Lilly in 1998 for
its sales of insulin which contribute substantially to current royalty
revenues; fluctuations in foreign currency exchange rates; the initiation of
other new contractual arrangements with other companies; the timing of non-
U.S. approvals, if any, for products licensed to HLR; whether and when
contract benchmarks are achieved and the conclusion of existing arrangements
with other companies and HLR.
R&D: The Company intends to continue to develop new products and is committed
to aggressive R&D investment. Successful pharmaceutical product development
is highly uncertain and is dependent on numerous factors, many of which are
beyond the Company's control. Products that appear promising in the early
phases of development may fail to reach the market for numerous reasons: they
may be found to be ineffective or to have harmful side effects in preclinical
or clinical testing; they may fail to receive necessary regulatory approvals;
they may turn out to be uneconomical because of manufacturing costs or other
factors; or they may be precluded from commercialization by the proprietary
rights of others or by competing products or technologies for the same
indication. Success in preclinical and early clinical trials does not ensure
that large scale clinical trials will be successful. Clinical results are
frequently susceptible to varying interpretations which may delay, limit or
prevent regulatory approvals. The length of time necessary to complete
clinical trials and to submit an application for marketing approval for a
final decision by a regulatory authority varies significantly and may be
difficult to predict.
The Company currently has several products in late-stage clinical testing and
anticipates that its R&D expenses will continue at a high percentage of
revenues over the short-term. Over the long-term, however, as revenues
increase, R&D as a percent of revenues should decrease to the 20 to 25% range.
Factors affecting the Company's R&D expenses include, but are not limited to:
the outcome of clinical trials currently being conducted, the number of
products entering into development from late-stage research, in-licensing
activities, including the timing and amount of related development funding or
milestone payments, and future levels of revenues.
As part of the Company and HLR's agreed upon changes to the license agreement,
HLR has assumed development of Xubix on its own. As a result, the Company
will not be incurring future Xubix related R&D costs unless it decides to opt-
in on the development of this product. Such costs, net of amounts reimbursed
by HLR, were approximately $4.6 million for 1997.
In September 1997, the Company decided to discontinue development of IGF-I in
Type I and Type II diabetes mellitus. As a result, the Company will not be
incurring future IGF-I related R&D costs, net of amounts reimbursed by HLR,
which were approximately $16.1 million for 1997.
In addition, the Company announced in early October 1997 that it opted-out of
development and returned to IDEC the Company's marketing rights for IDEC-Y2B8,
a radioimmunotherapy under investigation for the treatment of relapsed or
refractory B-cell NHL. As a result, the Company discontinued its R&D funding
to IDEC for the development of IDEC-Y2B8. Such funding for 1997 was
immaterial.
Income Tax Provision: The Company expects its effective tax rate to increase
from the current rate of 24% to approximately 28% in 1998 and continue at or
near 35% for the next several years dependent upon several factors. These
factors include, but are not limited to, changes in tax laws and rates, future
levels of R&D spending, the outcome of clinical trials of certain development
products, the Company's success in commercializing such products, and
potential competition regarding the products.
Uncertainties Surrounding Proprietary Rights: The patent positions of
pharmaceutical and biotechnology companies can be highly uncertain and involve
complex legal and factual questions. Accordingly, the breadth of claims
allowed in such companies' patents cannot be predicted. Patent disputes are
frequent and can preclude commercialization of products. The Company has in
the past, is currently and may in the future be involved in material patent
litigation. Such litigation is costly in its own right and could subject the
Company to significant liabilities to third-parties and, if decided adversely,
the Company may need to obtain third-party licenses at a material cost or
cease using the technology or product in dispute. The presence of patents or
other proprietary rights belonging to other parties may lead to the
termination of R&D of a particular product. The Company believes it has
strong patent protection or the potential for strong patent protection for a
number of its products that generate sales and royalty revenue or that the
Company is developing; however, the courts will determine the ultimate
strength of patent protection of the Company's products and those on which the
Company earns royalties.
Year 2000: Some of the Company's older computer software programs were
written using two digit fields rather than four digit fields to define the
applicable year (i.e., "98" in the computer code refers to the year "1998").
As a result, time-sensitive functions of those software programs may
misinterpret dates after January 1, 2000, to refer to the twentieth century
rather than the twenty-first century (i.e., "02" could be interpreted as
"1902" rather than "2002"). This could cause system failures or
miscalculations resulting in inaccuracies in computer output or disruptions of
operations, including, among other things, inaccurate processing of financial
information and/or temporary inability's to process transactions, manufacture
products, or engage in similar normal business activities.
The Company has developed plans to address the potential exposures related to
the impact on its computer systems for the Year 2000 and beyond. An
assessment of key financial, informational and operational systems to
determine if they are Year 2000 compliant has been completed. Detailed plans
and timelines for implementation and testing of modifications and corrections
to the computer systems have been or are in process of being developed to
address computer systems problems as required by December 31, 1999. The
Company believes that with these detailed plans and completed modifications,
the Year 2000 issue will not pose significant operational problems for its
computer systems. However, if such modifications and conversions are not
made, or are not completed in a timely fashion, the Year 2000 issue could have
a material impact on the operations of the Company.
The total cost of the Year 2000 systems assessments and conversions is
funded through operating cash flows and the Company is expensing these costs.
The financial impact of making the required systems changes can not be known
precisely at this time, but is not expected to be material to the Company's
financial position, results of operations or cash flows.
Liquidity: The Company believes that its cash, cash equivalents, and short-
term investments, together with funds provided by operations and leasing
arrangements, will be sufficient to meet its foreseeable operating cash
requirements. In addition, the Company believes it could access additional
funds from the capital and debt markets. Factors affecting the Company's cash
position include, but are not limited to, future levels of the Company's
product sales, royalty and contract revenues, expenses, in-licensing
activities, including timing and amount of related development funding or
milestone payments and capital expenditures.
Roche Holdings, Inc.: At December 31, 1997, Roche held approximately 66.9% of
the Company's outstanding common equity. The Company expects to continue to
have material transactions with Roche, including royalty and contract
revenues, product sales and joint product development costs.
Market Risk: The Company is exposed to market risk, including changes to
interest rates, foreign currency exchange rates and equity investments prices.
To reduce the volatility relating to these exposures, the Company enters into
various derivative transactions pursuant to the Company's investment and risk
management policies and procedures in areas such as hedging and counterparty
exposure practices. The Company does not use derivatives for speculative
purposes.
A discussion of the Company's accounting policies for financial instruments
and further disclosures relating to financial instruments is included in the
Financial Review and Description of Business and Significant Accounting
Policies and Financial Instruments notes in the Notes to Consolidated
Financial Statements in the Company's 1997 Annual Report to Stockholders (Part
II, Item 8 of this Form 10K).
Credit Risk of Counterparties: The Company could be exposed to losses related
to the above financial instruments should one of its counterparties default.
This risk is mitigated through credit monitoring procedures.
Legal Proceedings: The Company is a party to various legal proceedings
including patent infringement cases and various cases involving product
liability and other matters. See Item 3. Legal Proceedings and the Leases,
Commitments and Contingencies note in the Notes to Consolidated Financial
Statements in the Company's 1997 Annual Report to Stockholders (Part II, Item
8 of this Form 10-K) for further information.
Government Regulation
The pharmaceutical industry is subject to stringent regulation with respect to
product safety and efficacy by various federal, state and local authorities.
Of particular significance are the FDA's requirements covering research and
development, testing, manufacturing, quality control, labeling and promotion
of drugs for human use. A pharmaceutical product cannot be marketed in the
U.S. until it has been approved by the FDA, and then can only be marketed for
the indications and claims approved by the FDA. As a result of these
requirements, the length of time, the level of expenditures and the laboratory
and clinical information required for approval of an NDA, a PLA (Product
License Application), a BLA (Biologics License Application) or an ELA
(Establishment License Application) are substantial and can require a number
of years, although recently revised regulations are designed to reduce
somewhat the time for approval of new products.
Although it is difficult to predict the ultimate effect, if any, these matters
or any other pending or future legislation, regulations or government actions
may have on its business, the Company believes that the development of new and
improved products which address unmet medical needs should enable it to
compete effectively within this environment.
Research and Development
A major portion of the Company's operating expenses to date have been related
to the R&D of products either on its own behalf or under contracts. During
1997, 1996 and 1995 the Company's research and development expenses were
$470.9 million, $471.1 million and $363.0 million, respectively. The Company
has sponsored approximately 86%, 89% and 95% of its research and development
for the years 1997, 1996 and 1995, respectively.
The Company's research efforts have been the primary source of the Company's
products. The Company intends to maintain its strong commitment to research
as an essential component of its product development effort. Licensed
technology developed by outside parties is an additional source of potential
products.
Human Resources
As of December 31, 1997, the Company had 3,242 employees.
Environment
The Company seeks to comply with all applicable statutory and administrative
requirements concerning environmental quality. The Company has made, and will
continue to make, the necessary expenditures for environmental compliance and
protection. Expenditures for compliance with environmental laws have not had
and are not expected to have a material effect on the Company's capital
expenditures, results of operation, financial position or competitive
position.
ITEM 2. PROPERTIES
The Company's primary facilities are located in a research and industrial park
in South San Francisco, California in both leased and owned properties. The
Company currently occupies twenty-two buildings for its research and
development, manufacturing, marketing and administrative activities. Fourteen
of the buildings are owned property and eight are leased. The Company has
made and continues to make improvements to these properties to accommodate its
growth. In addition, the Company owns approximately 17 acres adjacent to its
current facilities that may be used for future expansion. In 1995, the
Company began development of a new manufacturing facility of approximately
309.2 thousand square feet in Vacaville, California under an operating lease
arrangement. Completion of the project is expected in 1998. The Company also
has leases for certain additional office facilities in several locations in
the U.S.
The Company believes its facilities are in good operating condition and that
the real property owned or leased, combined with the new Vacaville site under
construction, are adequate for all present and foreseeable future uses. The
Company believes any additional facilities could be obtained or constructed
with the Company's capital resources.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to various legal proceedings including patent
infringement cases involving human growth hormone products and Activase,
registered trademark, product liability cases involving Protropin, registered
trademark, and other matters. In addition, in July 1997, an action was filed
in the United States (U.S.) District Court for the Northern District of
California alleging that the Company's manufacture, use and sale of its
Nutropin, registered trademark, human growth hormone products infringed a
patent (the Goodman Patent) owned by the Regents of the University of
California (UC). This action is substantially the same as a previous action
filed in 1990 against the Company by UC alleging that the Company's
manufacture, use and sale of its Protropin human growth hormone products
infringed the Goodman Patent and it has been consolidated with that prior
case. The case is expected to commence trial on June 22, 1998. In October
1997, the Company was named, along with several other pharmaceutical
companies, in a lawsuit brought by Novo Nordisk A/S (Novo) in the U.S.
District Court for the District of New Jersey alleging infringement of a
patent held by Novo relating to the Company's manufacture, use and sale of its
Nutropin human growth hormone products. Novo seeks to permanently enjoin the
Company from the alleged patent infringement and also seeks compensatory and
enhanced damages from the Company. In February 1997 and February 1998, the
Company received grand jury document subpoenas from the U.S. District Court
for the Northern District of California for documents relating to the
Company's past clinical, sales and marketing activities associated with human
growth hormone. The government is investigating this matter, and the Company
believes that it is a subject of that investigation.
Based upon the nature of the claims made and the investigations completed to
date by the Company and its counsel, the Company believes that the outcome of
these cases will not have a material adverse effect on the financial position,
results of operations or cash flows of the Company. However, were an
unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the net income of that period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
<TABLE>
<CAPTION>
GENENTECH, INC.
EXECUTIVE OFFICERS
The executive officers of the Company and their respective ages (ages as of
December 31, 1997) and positions with the Company are as follows:
<S> <C> <C>
Name Age Position
Arthur D. Levinson, Ph.D. 47 President and Chief Executive Officer
William D. Young 53 Chief Operating Officer
Louis J. Lavigne, Jr. 49 Executive Vice President and Chief
Financial Officer
Susan D. Hellmann, M.D., M.P.H. 40 Senior Vice President - Development and
Chief Medical Officer
Judy Heyboer 48 Senior Vice President, Human Resources
Robert Arathoon, Ph.D. 45 Vice President - Process Sciences
Gregory Baird 47 Vice President - Corporate Communications
Joffre Baker, Ph.D. 50 Vice President - Research Discovery
Lars Barfod 38 Vice President - Marketing
David W. Beier 49 Vice President - Government Affairs
John Curd, M.D. 52 Vice President - Clinical Development
Robert Garnick, Ph.D. 48 Vice President - Regulatory Affairs
Bradford S. Goodwin 43 Vice President - Finance
Dennis J. Henner, Ph.D. 46 Vice President - Research
Paul F. Hohenschuh 54 Vice President - Operations Planning
Logistics
Paula Jardieu, Ph.D. 47 Vice President - Pharmacological Sciences
Edmon R. Jennings 50 Vice President - Corporate Development
Stephen G. Juelsgaard 49 Vice President, General Counsel and
Secretary
Cynthia J. Ladd 42 Vice President - Corporate Law and
Assistant Secretary
Polly Moore, Ph.D. 50 Vice President - Information Resources
James P. Panek 44 Vice President - Manufacturing,
Engineering and Facilities
Kim Popovits 39 Vice President - Sales
Nicholas J. Simon 43 Vice President - Business and Corporate
Development
David Stump, M.D. 48 Vice President - Clinical Research and
Genentech Fellow
John M. Whiting 42 Controller and Chief Accounting Officer
</TABLE>
All officers are elected annually by the Board of Directors. There is no
family relationship among any of the officers or directors.
Business Experience
Dr. Levinson was appointed President and Chief Executive Officer of the
Company in July 1995. He had previously served as Senior Vice President of
the Company since January 1993. Dr. Levinson has held a number of other
positions, including Vice President, Research, Vice President, Research
Technology, Director, Cell Genetics Department and Staff Scientist subsequent
to joining the Company in May 1980 as a Senior Scientist.
Mr. Young was appointed Chief Operating Officer of the Company in April 1997.
He previously served as Executive Vice President of the Company from January
1996 to April 1997, as Senior Vice President from September 1988 to January
1996 and as Vice President, Manufacturing and Process Sciences from April 1983
to September 1988. Mr. Young joined the Company in September 1980 as
Director, Manufacturing from Eli Lilly and Company.
Mr. Lavigne was appointed Executive Vice President of the Company in March
1997 and Chief Financial Officer in August 1988. He previously served as
Senior Vice President from July 1994 to March 1997 and as Vice President from
July 1986 to July 1994. Mr. Lavigne joined the Company in July 1982 from
Pennwalt Corporation and became Controller in May 1983 and an officer of the
Company in February 1984.
Dr. Hellmann was appointed Senior Vice President, Development in December 1997
and Chief Medical Officer in December 1996. She joined the Company in March
1995 as Clinical Scientist and subsequently held the positions of Associate
Director from August 1995 to January 1996, Senior Director from January 1996
to March 1996 and Vice President, Medical Affairs from March 1996 to November
1997. Prior to joining the Company, she held the positions of Associate
Director at Bristol-Myers Squibb from February 1993 to February 1995 and
Medical Oncologist at Lexington Oncology Associates from June 1992 to February
1993.
Ms. Heyboer joined the Company as Senior Vice President, Human Resources in
August 1996. Prior to joining the Company, she held the positions of Vice
President, Employee Relations and later Senior Vice President at Acuson
Corporation from October 1983 to July 1996.
Dr. Arathoon was appointed Vice President, Process Sciences in April 1996.
Since joining the Company in 1983 from Wellcome Foundation, Dr. Arathoon has
held a series of positions of increasing responsibility, most recently as
Senior Director, Process Sciences from November 1994 to April 1996.
Mr. Baird joined the Company in February 1992 as Vice President, Corporate
Communications. Prior to joining the Company, Mr. Baird was employed by G.D.
Searle & Co. for five years as Vice President, Corporate Communications (G.D.
Searle & Co. is a wholly-owned subsidiary of Monsanto Company).
Dr. Baker was appointed Vice President, Research Discovery in February 1997.
He previously held the positions of Senior Director, Research Discovery from
March 1993 to February 1997 and Director, Cardiovascular Research Development
from September 1990 to September 1993. He has also been a member of the
Research Review Committee (RRC) since March 1993.
Mr. Barfod joined the Company in May 1997 as Vice President, Marketing. He
was previously employed by Novo Nordisk Pharmaceuticals, Inc. (Novo). While
at Novo, he held the positions of Vice President, Marketing & Business
Development, U.S. and Acting Vice President, Sales, U.S. from 1995 to 1997,
Vice President, Business Development, U.S. from 1994 to 1995 and Marketing
Director, Japan from 1991 to 1994.
Mr. Beier joined the Company in March 1989 as Vice President, Government
Affairs. Prior to joining the Company, Mr. Beier spent 10 years as Counsel to
the Committee on the Judiciary of the U.S. House of Representatives where he
was responsible for intellectual property and international trade issues.
Dr. Curd was appointed Vice President, Clinical Development in October 1997.
He previously held the positions of Senior Director, Medical Affairs from
January 1996 to October 1997 and Director, Oncology, Immunology and Infectious
Diseases from December 1991 to January 1996.
Dr. Garnick was appointed Vice President, Regulatory Affairs in February 1998.
He had previously served as Vice President, Quality since April 1994 and was
Senior Director, Quality Control from 1990 to 1994 and Director, Quality
Control from 1988 to 1990. Dr. Garnick joined the Company in August 1984 from
Armour Pharmaceutical.
Mr. Goodwin was appointed Vice President, Finance in October 1997. He had
served as Vice President, Finance and Controller since December 1996. He has
been a Vice President of the Company since July 1993 and served as Controller
from June 1989 to October 1997. He has also held the positions of Director,
Financial Planning and Analysis, the Assistant Controller and the General
Auditor. Before joining the Company in April 1987, Mr. Goodwin worked for
Price Waterhouse, a public accounting firm.
Dr. Henner was appointed Vice President, Research in April 1996. He had
served as Vice President, Research Technology from July 1994 to April 1996,
and as Senior Director, Research Technology from December 1990 to July 1994.
From May 1990 to December 1990, Dr. Henner was Director and Senior Scientist,
Cell Genetics Department. Dr. Henner joined the Company in 1981 as a
Scientist in Research. Prior to joining the Company, he was at the Scripps
Clinic and Research Foundation.
Mr. Hohenschuh was appointed Vice President, Operations Planning Logistics in
January 1998. Previously, he had served as Vice President, Manufacturing
since September 1989, Vice President, Biochemical Manufacturing from July 1986
to September 1989 and Senior Director, Biochemical Manufacturing from June
1985 to June 1986. Mr. Hohenschuh joined the Company in October 1982 as
Director, Biochemical Manufacturing.
Dr. Jardieu was appointed Vice President, Pharmacological Sciences in February
1997. She previously held the positions of Senior Director, Pharmacological
Sciences from 1996 to February 1997, Staff Scientist from 1992 to 1996, Senior
Scientist from 1989 to 1992 and Scientist from 1986 to 1989.
Mr. Jennings was appointed Vice President, Corporate Development in December
1995. He was Vice President, Sales and Marketing from January 1994 to
December 1995, and had served as Vice President, Sales since January 1991. He
joined the Company in September 1985 as Western Area Sales Manager. Prior to
joining the Company, Mr. Jennings was Western Region Sales Manager of Bristol-
Myers' Oncology Division.
Mr. Juelsgaard was appointed Vice President and General Counsel in July 1994
and Secretary in April 1997. He joined the Company in July 1985 as Corporate
Counsel and subsequently served as Senior Corporate Counsel from 1988 to 1990,
Chief Corporate Counsel from 1990 to 1993, Vice President, Corporate Law from
1993 to 1994, and Assistant Secretary from 1994 to 1997.
Ms. Ladd was appointed Vice President, Corporate Law in February 1996 and
Assistant Secretary in April 1997. She joined the Company in 1989 as
Corporate Counsel and subsequently held the positions of Senior Corporate
Counsel from November 1990 to June 1993 and Chief Corporate Counsel from June
1993 to February 1996.
Dr. Moore was elected Vice President, Information Resources in April 1994.
She was Senior Director, Information Resources from July 1992 to April 1994
and Director, Computer Resources from November 1987 to July 1992. Dr. Moore
joined the Company in August 1982 as a Senior Systems Analyst in Scientific
Computing.
Mr. Panek was appointed Vice President, Manufacturing, Engineering and
Facilities in July 1997. He joined the Company in September 1982 and
subsequently held the positions of Director, Engineering and Facilities since
May 1988, Senior Director, Engineering and Facilities since July 1991, and
Vice President, Engineering and Facilities since July 1993.
Ms. Popovits was elected Vice President, Sales in October 1994. She was
Director, Field Sales from January 1993 to October 1994 and Regional Manager,
Northeast Region from October 1989 to January 1993. Ms. Popovits was at
American Critical Care, a Division of American Hospital Supply Corporation,
for six years prior to joining the Company in November 1987 as Division
Manager, Southeast Region.
Mr. Simon was appointed Vice President, Business and Corporate Development in
December 1995. He had been Vice President, Business Development since
December 1994. He was Senior Director, Business Development from December
1993 to December 1994. Mr. Simon joined the Company as a Director in Business
Development in December 1989 from Xoma Corporation.
Dr. Stump was appointed Genentech Fellow in January 1996, in addition to his
responsibilities as Vice President, Clinical Research, a position he has held
since July 1995. He joined the Company in July 1989 as Director, Clinical
Research and was appointed Senior Director, Clinical Research in August 1991.
Prior to joining the Company, Dr. Stump was Associate Professor of Medicine
and Biochemistry at the University of Vermont.
Mr. Whiting was appointed Controller and Chief Accounting Officer in October
1997. He previously held the positions of Director, Financial Planning and
Analysis from January 1997 to October 1997, Director, Operations, Financial
Planning and Analysis from December 1996 to January 1997, Associate Director,
Operations, Financial Planning and Analysis from March 1996 to December 1996,
Plant Controller from April 1993 to March 1996, and Group Controller from July
1991 to April 1993.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The section labeled "Common Stock, Special Common Stock and Redeemable Common
Stock Information," and footnotes labeled "Relationship with Roche Holdings,
Inc." and "Capital Stock" in the Notes to Consolidated Financial Statements,
appearing on pages 64, 57 and 58 through 60, respectively, of the Company's
1997 Annual Report to Stockholders are incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The section labeled "11-Year Financial Summary" appearing on pages 62 and 63
of the Company's 1997 Annual Report to Stockholders is incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
The section labeled "Financial Review" appearing on pages 31 through 40 of the
Company's 1997 Annual Report to Stockholders is incorporated herein by
reference.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and Notes to Consolidated Financial
Statements appearing on pages 42 through 60, the Report of Ernst & Young LLP,
Independent Auditors, appearing on page 61 and the section labeled "Quarterly
Financial Data (unaudited)" appearing on page 61 of the Company's 1997 Annual
Report to Stockholders are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) The sections labeled "Nominees" and "Section 16 (a) Beneficial Ownership
Reporting Compliance" of the Company's Proxy Statement in connection with the
1998 Annual Meeting of Stockholders are incorporated herein by reference.
(b) Information concerning the Company's Executive Officers is set forth in
Part I of the Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The sections labeled "Executive Compensation," "Compensation of Directors,"
"Compensation of Executive Officers," "Summary of Compensation," "Summary
Compensation Table," "Stock Option Grants and Exercises," "Option Grants in
Last Fiscal Year," "Aggregated Option Exercises in Last Fiscal Year and FY-End
Option Values," "Long-Term Incentive Plans," "Long-Term Incentive Plans -
Awards in Last Fiscal Year," "Loans and Other Compensation" and "Compensation
Committee Interlocks and Insider Participation" of the Company's Proxy
Statement in connection with the 1998 Annual Meeting of Stockholders are
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The sections labeled "Merger with Roche Holdings, Inc.," "Security Ownership
of Certain Beneficial Owners," "Security Ownership of Management" and "Amount
and Nature of Beneficial Ownership" of the Company's Proxy Statement in
connection with the 1998 Annual Meeting of Stockholders are incorporated
herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section labeled "Certain Relationships and Related Transactions" of the
Company's Proxy Statement in connection with the 1998 Annual Meeting of
Stockholders is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Index to Financial Statements
The following Financial Statements and supplementary data are included in
the Company's 1997 Annual Report to Stockholders and are incorporated herein
by reference pursuant to Item 8 of this Form 10-K.
Page(s) in
1997 Annual
Report to Stockholders
----------------------
Consolidated Statements of Income for each
of the three years in the period ended
December 31, 1997 42
Consolidated Statements of Cash Flows for each
of the three years in the period ended
December 31, 1997 43
Consolidated Balance Sheets at December 31,
1997 and 1996 44
Consolidated Statements of Stockholders' Equity
for each of the three years in the period ended
December 31, 1997 45
Notes to Consolidated Financial Statements 46-60
Report of Ernst & Young LLP, Independent Auditors 61
Quarterly Financial Data (unaudited) 61
2. Financial Statement Schedule
The following schedule is filed as part of this Form 10-K:
Schedule II- Valuation and Qualifying Accounts for each of the three years in
the period ended December 31, 1997.
All other schedules are omitted because they are not applicable, or not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
3. Exhibits
Exhibit No. Description
----------- -----------
3.1 Certificate of Incorporation.(1)
3.2 Amended Certificate of Incorporation.(5)
3.3 Restated By-Laws.(3)
4.1 Indenture, dated March 27, 1987 ("Indenture") for U.S. $150,000,000
5% Convertible Subordinated Debentures due 2002.(2)
4.2 First Supplemental to Indenture, dated August 17, 1990.(3)
4.3 Second Supplemental to Indenture, dated October 18, 1995. (7)
10.1 Patent License Agreement with Columbia University dated October 12,
1988.(2)
10.2 Amended and Restated Contract for the Sale and Distribution of
Protropin dated as of March 1, 1991.(4)
10.3 Agreement and Plan of Merger, dated as of May 23, 1995, as amended
and restated, among the Company, Roche Holdings, Inc. and HLR
(U.S.) II, Inc. with exhibits.(5)
10.4 Amended and Restated Governance Agreement, dated October 25, 1995,
between the Company and Roche Holdings, Inc.(5)
10.5 Agreement between Genentech and F. Hoffman-La Roche Ltd
regarding commercialization of Genentech's products outside the
United States dated as of October 25, 1995.(5)
10.6 Guaranty Agreement between Genentech and Roche Holding, Ltd dated
as of October 25, 1995.(5)
10.7 Guiding Principles for the Genentech/Roche Relationship.(8)
13.1 1997 Annual Report to Stockholders.(11)
23.1 Consent of Ernst & Young LLP, Independent Auditors.(11)
27.1 Financial Data Schedule.(11)
28.1 Description of the Company's capital stock.(1)
99.1* 1984 Incentive Stock Option Plan, as amended and restated as of
October 16, 1996.(8)
99.2* 1984 Non-Qualified Stock Option Plan, as amended and restated
as of October 16, 1996.(8)
99.3* Restated Relocation Loan Program.(4)
99.4* Restated 401(k) Plan.(7)
99.5* 1990 Stock Option/Stock Incentive Plan, as amended and restated
as of October 16, 1996.(8)
99.6* Supplemental Plan.(4)
99.7* 1994 Stock Option Plan, as amended and restated as of October 16,
1996.(8)
99.8* 1996 Stock Option/Stock Incentive Plan, as amended and restated
as of October 16, 1996.(8)
99.9* Deferred Compensation Plan.(8)
99.10* 1991 Employee Stock Plan, as amended April 10, 1997.(9)
99.11* Incentive Units Plan.(10)
* As required by Item 14(a)(3) of Form 10-K, the Company identifies this
Exhibit as a management contract or compensatory plan or arrangement of the
Company.
- --------------------
(1) Filed as an exhibit to Annual Report on Form 10-K for the year ended
December 31, 1986 and incorporated herein by reference.
(2) Filed as an exhibit to Annual Report on Form 10-K for the year ended
December 31, 1987 and incorporated herein by reference.
(3) Filed as an exhibit to Annual Report on Form 10-K for the year ended
December 31, 1990 and incorporated herein by reference.
(4) Filed as an exhibit to Annual Report on Form 10-K for the year ended
December 31, 1991 and incorporated herein by reference.
(5) Filed as an exhibit to Form S-4 dated October 25, 1995 (registration
statement no. 33-59949) and incorporated herein by reference.
(6) Filed as an exhibit to Form S-8 dated October 25, 1995 (registration
statement no. 33-59949-01) and incorporated herein by reference.
(7) Filed as an exhibit to Annual Report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.
(8) Filed as an exhibit to Annual Report on Form 10-K for the year
ended December 31, 1996 and incorporated herein by reference.
(9) Filed as an exhibit to the Quarterly Report on Form 10-Q filed for the
quarterly period ended March 31, 1997.
(10) Filed as an exhibit to the Quarterly report on Form 10-Q filed for the
quarterly period ended June 30, 1997
(11) Filed with this document.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed for the quarter ended December 31,
1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Registrant
Date: March 3, 1998
By: /S/JOHN M. WHITING
----------------------------------
John M. Whiting
Controller and Chief Accounting
Officer
(Principal Accounting Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Louis J. Lavigne, Jr., Executive Vice President
and Chief Financial Officer, and John M. Whiting, Controller and Chief
Accounting Officer, his attorney-in-fact, with the full power of substitution,
for him in any and all capacities, to sign any amendments to this report, and
to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorney-in-fact, or his substitute or substitutes,
may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
Principal Executive Officer:
/S/ARTHUR D. LEVINSON President, Chief Executive March 3, 1998
- --------------------------- Officer and Director
Arthur D. Levinson
Principal Financial Officer:
/S/LOUIS J. LAVIGNE, JR. Executive Vice President March 3, 1998
- --------------------------- and Chief Financial Officer
Louis J. Lavigne, Jr.
Director:
/S/HERBERT W. BOYER Director March 3, 1998
- ---------------------------
Herbert W. Boyer
/S/JONATHAN K.C. KNOWLES Director March 3, 1998
- ---------------------------
Jonathan K.C. Knowles
/S/FRANZ B. HUMER Director March 3, 1998
- ---------------------------
Franz B. Humer
/S/LINDA F. LEVINSON Director March 3, 1998
- ---------------------------
Linda F. Levinson
/S/J. RICHARD MUNRO Director March 3, 1998
- ---------------------------
J. Richard Munro
/S/DONALD L. MURFIN Director March 3, 1998
- ---------------------------
Donald L. Murfin
/S/JOHN T. POTTS, JR. Director March 3, 1998
- ---------------------------
John T. Potts, Jr.
/S/C. THOMAS SMITH, JR. Director March 3, 1998
- ---------------------------
C. Thomas Smith, Jr.
/S/DAVID S. TAPPAN, JR. Director March 3, 1998
- ---------------------------
David S. Tappan, Jr.
<TABLE>
SCHEDULE II
GENENTECH, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1997, 1996 and 1995
(in thousands)
<CAPTION>
Additions
Balance at Charged to Balance at
Beginning of Costs and End of
Period Expenses Deductions(1) Period
---------- ---------- ---------- ----------
Allowance for doubtful accounts
and returns:
<S> <C> <C> <C> <C>
Year Ended December 31, 1997: $ 7,869 $ 13,976 $ (7,310) $ 14,535
========== ========== ========== ==========
Year Ended December 31, 1996: $ 6,672 $ 12,320 $ (11,123) $ 7,869
========== ========== ========== ==========
Year Ended December 31, 1995: $ 4,422 $ 10,972 $ (8,722) $ 6,672
========== ========== ========== ==========
Inventory reserves:
Year Ended December 31, 1997: $ 9,279 $ 5,901 $ (3,125) $ 12,055
========== ========== ========== ==========
Year Ended December 31, 1996: $ 6,909 $ 4,950 $ (2,580) $ 9,279
========== ========== ========== ==========
Year Ended December 31, 1995: $ 13,008 $ 3,690 $ (9,789) $ 6,909
========== ========== ========== ==========
Reserve for non-marketable
equity securities:
Year Ended December 31, 1997: $ 4,990 $ 500 $ - $ 5,490
========== ========== ========== ==========
Year Ended December 31, 1996: $ 5,092 $ - $ (102) $ 4,990
========== ========== ========== ==========
Year Ended December 31, 1995: $ 4,623 $ 469 $ - $ 5,092
========== ========== ========== ==========
<FN>
(1) Represents amounts written off or returned against the allowance or reserves.
</TABLE>
<TABLE>
INDEX OF EXHIBITS FILED WITH FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
<CAPTION>
Exhibit No. Description
- ----------- -----------
<S> <C>
13.1 1997 Annual Report to Stockholders
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
</TABLE>
2
2
FINANCIAL REVIEW
(dollars in millions, except per share amounts)
RELATIONSHIP WITH ROCHE HOLDINGS, INC.
On October 25, 1995, Genentech, Inc. (the Company) and Roche Holdings, Inc.
(Roche) entered into a new agreement (the Agreement) to extend until June 30,
1999, Roche's option to cause the Company to redeem (call) the outstanding
callable putable common stock (special common stock) of the Company at
predetermined prices. Should the call be exercised, Roche will concurrently
purchase from the Company a like number of shares of common stock for a price
equal to the Company's cost to redeem the special common stock. If Roche does
not cause the redemption as of June 30, 1999, the Company's stockholders will
have the option to cause the Company to redeem none, some, or all of their
shares of special common stock (and Roche will concurrently provide the
necessary redemption funds to the Company by purchasing a like number of
shares of common stock) within thirty business days commencing July 1, 1999.
In conjunction with the Agreement, F. Hoffmann-La Roche Ltd (HLR) was
granted an option for ten years for licenses to use and sell certain of the
Company's products in non-United States markets (the license agreement). In
the second quarter of 1997, the Company and HLR agreed in principle to
changes to the license agreement. In general, these changes allow for the
sharing of United States (U.S.) and European development costs regardless of
location or purpose of studies. Under the license agreement, as revised,
HLR may exercise its option either when the Company determines to move a
product into development or at the end of Phase II clinical trials. In
addition, HLR has assumed development of Xubix, trademark, (the oral
IIb/IIIa antagonist) globally on its own. See the Relationship with Roche
Holdings, Inc. note in the Notes to Consolidated Financial Statements for
further information.
As a result of the license agreement which transferred the Company's
Canadian and European operations to Roche, in 1996 the Company's total
product sales decreased compared to 1995, while contract and royalty revenue
increased. Cost of sales as a percentage of product sales also increased
due to the license agreement. See below for further discussion.
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Annual % Change
1997 1996 1995 97/96 96/95
- ------------------------------------------------------------------------------
Revenues $1,016.7 $ 968.7 $ 917.8 5% 6%
Revenues for 1997 increased in all areas, but primarily from royalties and
contract revenues. The increase in 1996 resulted primarily from higher
contract and royalty revenue partly offset by lower product sales. Product
sales to HLR in conjunction with the license agreement were $17.4 million in
1997, $13.2 million in 1996 and $1.8 million in 1995.
Annual % Change
Product Sales 1997 1996 1995* 97/96 96/95
- ------------------------------------------------------------------------------
Activase $ 260.7 $ 284.1 $ 301.0 (8)% (6)%
Protropin, Nutropin
and Nutropin AQ 223.6 218.2 219.4 2 (1)
Pulmozyme 91.6 76.0 111.3 21 (32)
Rituxan 5.5 - - - -
Actimmune 3.5 4.5 3.6 (22) 25
----------------------------------------------------------
- -
Total product
sales $ 584.9 $ 582.8 $ 635.3 0% (8)%
% of revenues 58% 60% 69%
Total product sales increased slightly in 1997 over 1996 due to increases in
Pulmozyme, registered trademark, growth hormone sales and new sales from the
introduction of Rituxan, trademark. This increase was offset by a decrease in
Activase, registered trademark, sales. The decrease in total product sales in
1996 compared to 1995 primarily resulted from the license agreement with
Roche.* On a pro forma basis that includes sales to HLR in 1996 and the
fourth quarter of 1995, and excludes Canadian and European customer sales in
1995, sales increased to $582.8 million in 1996 from $578.7 million in 1995.
Activase: Total net sales of Activase in 1997 decreased primarily due to a
new competitive thrombolytic agent, Retavase, registered trademark.
Activase's market share fell to approximately 71% at the end of 1997 from
approximately 80% at the end of 1996 and from approximately 75% at the end of
1995. Activase sales decreased in 1996 compared to 1995 primarily due to the
impact of not having Canadian customer sales in 1996 as a result of the
license agreement with Roche and the decline in the overall size of the U.S.
thrombolytic market. Activase sales to Canadian customers were $12.7 million
in 1995. The market size decrease was approximately 6% in 1996. This decline
in the market size was the result of the increasing use of angioplasty rather
than thrombolytic therapy, as well as from patients receiving therapy through
ongoing clinical trials. On a pro forma basis, Activase sales were $284.1
million in 1996 versus $288.3 million in 1995, with the slight decrease due
to lower U.S. sales and lower bulk product sales to Japan licensees. In
March 1997, results from the GUSTO III clinical trial, which involved a head-
to-head comparison of Activase to Retavase, failed to demonstrate that
Retavase was superior over Activase, which was the endpoint that the trial
was designed to assess. In June 1996, the Company received clearance from
the U.S. Food and Drug Administration (FDA) to market Activase for the
treatment of acute ischemic stroke or brain attack (blood clots in the
brain). Activase is the first therapy to be indicated for the acute
treatment of stroke.
Protropin, Nutropin and Nutropin AQ: Net sales of the Company's three growth
hormone products - Protropin, registered trademark, (somatrem for injection),
Nutropin, registered trademark, [somatropin (rDNA origin) for injection] and
Nutropin AQ, registered trademark, [somatropin (rDNA origin) injection] liquid
formulation - increased slightly in 1997 compared to 1996 and were essentially
flat in 1996 compared to 1995. On a pro forma basis, growth hormone sales in
1996 were $218.2 million compared to $216.7 million in 1995. The Company
continues to face increased competition in the growth hormone market for
treatment of children with growth hormone inadequacy. In the growth hormone
market, three companies received FDA approval in 1995, and a fourth company
received FDA approval in October 1996 to market their growth hormone products
for treatment of growth hormone inadequacy in children; although one of those
companies has been preliminarily enjoined from selling its products. In the
first quarter of 1997, three of those companies, Serono Laboratories, Inc.,
Novo Nordisk A/S (Novo) and Pharmacia & Upjohn (P&U) began selling their
growth hormone products in the U.S. market. In addition, three of the
Company's competitors have received approval to market their existing human
growth hormone products for additional indications. In December 1997, the
Company received clearance to market Nutropin and Nutropin AQ for the
treatment of growth hormone inadequacy in adults. In December 1996 and
January 1997, the Company received clearance from the FDA to market Nutropin
and Nutropin AQ, respectively, for the treatment of growth inadequacy
associated with Turner syndrome.
Pulmozyme: Net sales of Pulmozyme were higher in 1997 primarily due to
continued penetration in the moderate and early cystic fibrosis (CF) patient
populations as well as from variations in customer ordering patterns for
U.S. sales. The decrease in 1996 compared to 1995 occurred primarily as a
result of the license agreement with Roche. Pulmozyme sales to customers in
Europe and Canada totaled $41.3 million in 1995. In 1996, sales in these
territories were made by Roche for the full year, and the Company received
royalties on Roche's sales. On a pro forma basis, Pulmozyme sales were
$76.0 million in 1996 compared to $70.0 million in 1995. In November 1996,
Pulmozyme was cleared for marketing by the FDA for the management of CF
patients with advanced disease, a condition that affects approximately 500
patients in the U.S.
Rituxan: Rituxan is marketed in the U.S. for the treatment of relapsed or
refractory low-grade or follicular, CD20-positive B-cell non-Hodgkin's
lymphoma (B-cell NHL), a cancer of the immune system. In late November 1997,
Rituxan was cleared for marketing in the U.S. by the FDA. B-cell NHL affects
approximately 250,000 people in the U.S. of which one-half are follicular or
low-grade lymphoma patients. A portion of these patients will have multiple
relapses and may be eligible for Rituxan therapy. The Company launched
Rituxan on December 16, 1997, and recorded initial sales of $5.5 million.
However, not enough time has passed for these figures to be indicative of the
future trend of Rituxan sales. Rituxan was co-developed by the Company and
IDEC Pharmaceuticals Corporation (IDEC), from whom the Company licenses
Rituxan, and is the first monoclonal antibody approved to treat cancer. IDEC
and the Company are jointly promoting Rituxan in the U.S. and share
responsibility for the manufacturing of the product. HLR is responsible for
marketing Rituxan in the rest of the world, excluding Japan.
Actimmune: Actimmune, registered trademark, is approved in the U.S. for the
treatment of chronic granulomatous disease, a rare, inherited disorder of the
immune system which affects an estimated 250 to 400 Americans.
Royalties, Contract and Other, Annual %
Change
and Interest Income 1997 1996 1995 97/96 96/95
- ------------------------------------------------------------------------------
- -
Royalties $ 241.1 $ 214.7 $ 190.8 12%
13%
Contract and other 121.6 107.0 31.2 14 243
Interest income 69.1 64.2 60.5 8 6
The Company receives royalty payments from HLR from its sales of the Company's
products outside of the U.S. under the license agreement, and receives
royalties from other licensees and HLR from the sales of various other health
care products. Total royalties in 1997 increased over 1996 primarily due to
increased licensee sales from various licensees. Royalties in 1996 increased
over 1995 primarily due to new royalties from HLR in conjunction with the
license agreement, as well as higher income from existing licensees due to
increased licensee sales. Royalty revenue under the license agreement was
$17.0 million in 1996 and $1.9 million in 1995. All other royalty revenue
from HLR in 1996 and 1995, totaled $9.2 million and $10.6 million,
respectively. Royalties in 1995 include $30.0 million of royalty revenue
related to the December 1994 settlement with Eli Lilly and Company (Lilly)
regarding certain of the Company's patents. Under the December 1994 settlement
agreement with Lilly, royalties of $30.0 million per year are payable, subject
to possible offsets and contingent upon Humulin, registered trademark,
continuing to be marketed in the U.S., to the Company through 1998, at which
time such royalty obligations expire. Under a prior license agreement with
Lilly, the Company receives royalties from Lilly's sales of its human insulin
product. These royalty obligations expire in August of 1998. Cash flows from
royalty income include non-dollar denominated revenues. The Company currently
purchases simple foreign currency put option contracts (options) to hedge
these royalty cash flows. All options expire within the next three years.
See below for discussion of market risks related to these financial
instruments.
Contract and other revenues were higher in 1997 compared to 1996 primarily due
to $30.9 million from Sumitomo Pharmaceuticals Co., Ltd. (Sumitomo) and P&U
for strategic alliances and $11.7 million of gains from the sale of
biotechnology equity securities in 1997. These increases were partly offset
by higher revenues from HLR in 1996. As part of the strategic alliance with
Sumitomo, the Company has agreed to provide Sumitomo exclusive rights to
develop, import and distribute in Japan, Nutropin AQ and ProLease, registered
trademark, sustained release growth hormone. In its alliance with P&U, in
exchange for development costs, fees and, upon regulatory approval, royalties,
the Company agreed to provide P&U exclusive worldwide rights for
thrombopoietin (TPO) which is in Phase II trials for potential use in treating
patients with complications of cancer chemotherapy. P&U and the Company will
jointly develop TPO for one indication; however, the Company has no marketing
rights for this indication. Contract and other revenues increased in 1996
from 1995 due to contract revenue from HLR for the exercises of their options
under the license agreement with respect to the development of three projects
- - Rituxan, insulin-like growth factor (IGF-I) and nerve growth factor (NGF).
Development of IGF-I was subsequently terminated. The Company recorded non-
recurring contract revenues of $44.7 million relating to these option
exercises in 1996. All other contract revenue from HLR, including
reimbursement for ongoing development expenses after the option exercise date,
totaled $67.6 million in 1997, $50.6 million in 1996 and $13.4 million in
1995.
Interest income increased in 1997 from last year primarily due to an increase
in the average yield on the investment portfolio and a larger investment
portfolio. The increase in 1996 compared to 1995 was due to a larger
investment portfolio. The Company enters into interest rate swaps (swaps) as
part of its overall strategy of managing the duration of its investment
portfolio. See below for discussion of market risks related to these swaps and
also the Financial Instruments note in the Notes to Consolidated Financial
Statements.
Annual % Change
Costs and Expenses 1997 1996 1995 97/96 96/95
- -------------------------------------------------------------------------------
Cost of sales $ 102.5 $104.5 $ 97.9 (2)% 7%
Research and
development 470.9 471.1 363.0 0 30
Marketing, general and
administrative 269.9 240.1 251.7 12 (5)
Special charge - - 25.0 - -
Interest expense 3.6 5.1 8.0 (29) (36)
----------------------------------------------------------
Total costs
and expenses $ 846.9 $820.8 $ 745.6 3% 10%
% of revenues 83% 85% 81%
Cost of sales as % of
product sales 18% 18% 15%
R&D as % of revenues 46 49 40
MG&A as % of revenues 27 25 27
Cost of Sales: Cost of sales as a percent of product sales was 18% in 1997
which was comparable to 1996, but increased in 1996 compared to 1995 primarily
due to the impact of lower margin sales to HLR in 1996. The economic benefits
from sales to HLR are also reflected in royalties as discussed above. In 1996
and 1995, reserves of $3.6 million and $3.7 million, respectively, included in
cost of sales, were provided for expected expirations of certain inventories.
In 1997, such reserves were immaterial.
Research and Development: Research and Development (R&D) expenses in 1997
were flat compared to 1996. R&D as a percentage of revenues decreased to 46%
in 1997 from 49% in 1996. This percentage decrease from 1996 reflects
increases in revenues and continuing efforts towards disciplined spending in
R&D. R&D expenses increased 30% in 1996 compared to 1995 due to continued
late-stage clinical testing of products and new development projects.
To gain additional access to potential new products and technologies,
including acquiring the equity and convertible debt of, and to utilize other
companies to help develop the Company's potential new products, the Company
has established strategic alliances with companies developing technologies
that fall outside the Company's research focus and with companies having the
potential to generate new products through technology exchanges and
investments. The Company has also entered into product-specific
collaborations to acquire development and marketing rights for products.
Marketing, General and Administrative: Marketing, general and administrative
(MG&A) expenses increased in 1997 primarily due to increased marketing and
sales (M&S) expenses in the oncology area, defending Activase against new
competition and launching a new indication, growth hormone deficiency in
adults, for Nutropin and Nutropin AQ. In addition, there was an increase in
general and administrative expenses due to higher royalty expense. MG&A
expenses in 1996 decreased from 1995 primarily due to the closure of the
Company's European and Canadian operations in conjunction with the license
agreement.
Special Charge: The Company recorded a special charge of $25.0 million in
1995, which included $21.0 million related to the Agreement with Roche and
$4.0 million associated with the resignation of the Company's former President
and Chief Executive Officer. The merger expenses included investment banking
fees, legal expenses, filing fees and other costs related to the Agreement, as
well as charges associated with the settlement of stockholder lawsuits filed
after the transaction was announced.
Interest Expense: Interest expense declined in 1997 over 1996 due to higher
capitalized interest resulting from an increase in construction projects.
Interest expense in 1997, 1996 and 1995, net of amounts capitalized, relates
primarily to interest on the Company's 5% convertible subordinated debentures.
In 1995, it also included interest on a $25.0 million borrowing arrangement
which commenced in February 1995 and was paid in December of that year.
Income Before Taxes and Income Taxes 1997 1996 1995
- -----------------------------------------------------------------------------
Income before taxes $ 169.8 $ 147.9 $ 172.2
Income tax provision 40.8 29.6 25.8
Effective tax rate 24% 20% 15%
Increases in the effective tax rate for 1997 over 1996 and 1996 over 1995 are
attributable to proportionally decreased realization of previously reserved
deferred tax assets. The valuation allowance for deferred tax assets was
fully realized in 1996, with the exception of the portion attributable to the
realization of tax benefits on stock option deductions which will be credited
to additional paid-in-capital when realized.
Annual % Change
Net Income 1997 1996 1995 97/96 96/95
- ------------------------------------------------------------------------------
Net income $ 129.0 $ 118.3 $ 146.4 9% (19)%
Earnings per share:
Basic $ 1.05 $ 0.98 $ 1.24
Diluted $ 1.02 $ 0.95 $ 1.20
Net income in 1997 increased over 1996 primarily due to higher royalties and
contract and other revenues partly offset by higher MG&A expenses. Net income
in 1996 decreased compared to 1995 primarily due to higher R&D expenses and
lower product sales, partly offset by increased contract and royalty revenue.
LIQUIDITY AND CAPITAL RESOURCES 1997 1996 1995
- ------------------------------------------------------------------------------
Cash, cash equivalents, short-term investments
and long-term marketable debt and equity
securities $1,286.5 $1,159.1 $1,096.8
Working capital 904.4 705.1 812.0
Cash provided by (used in):
Operating activities 118.3 139.7 133.9
Investing activities (168.4) (141.7)
(117.7)
Financing activities 87.3 72.2 54.1
Capital expenditures
(included in investing activities above) (154.9) (141.8)
(70.2)
Current ratio 4.1:1 3.8:1 4.5:1
Cash generated from operations, income from investments and proceeds from
stock issuances were used to purchase marketable securities and make capital
additions in 1997.
Capital expenditures in 1997 primarily included building improvements to
existing manufacturing and office facilities and production systems. In 1996,
capital expenditures primarily included building and land purchases and
improvements to existing manufacturing and office facilities. In 1995, the
Company entered into an arrangement with a lessor, which qualifies as an
operating lease, for a new manufacturing facility that is expected to become
operational in 1998.
FORWARD-LOOKING STATEMENTS
The following section contains forward-looking statements that are based on
the Company's current expectations. Because the Company's actual results may
differ materially from these and any other forward-looking statements made by
or on behalf of the Company, this section also includes a discussion of
important factors that could affect the Company's actual future results,
including its product sales, royalties, contract revenues, expenses and net
income.
Product Sales: The Company's product sales may vary from period to period for
several reasons including, but not limited to: the overall competitive
environment for the Company's products, the amount of sales to customers in
the U.S., the amount and timing of the Company's sales to HLR, the timing and
volume of bulk shipments to licensees, the availability of third-party
reimbursements for the cost of therapy, the effectiveness and safety of the
products, the rate of adoption and use of the Company's products for approved
indications and additional indications, and the potential introduction of
additional new products and indications for existing products in 1998 and
beyond.
Competition: The Company faces growing competition in two of its therapeutic
markets. Activase lost market share and is expected to lose additional market
share in the thrombolytic market to Retavase and such adverse effect on sales
could be material. Boehringer Mannheim (BM) manufactures and markets Retavase.
Recently, Centocor, Inc. announced that it was purchasing the U.S. and
Canadian rights to Retavase from BM and will promote and sell the product in
the U.S. Retavase received FDA approval in October 1996 for the treatment of
acute myocardial infarction (AMI). In addition, there is an increasing use of
angioplasty in lieu of thrombolytic therapy for the treatment of AMI which is
expected to continue. In the growth hormone market, the Company continues to
face increased competition from five other companies with growth hormone
products. Three of these competitors have also received approval to market
their existing human growth hormone products for additional indications. The
Company expects such competition to have an adverse effect on its sales of
Protropin, Nutropin and Nutropin AQ and such effect could be material.
Other competitive factors affecting the Company's product sales include, but
are not limited to: the timing of FDA approval, if any, of additional
competitive products, pricing decisions made by the Company, the degree of
patent protection afforded to particular products, the outcome of litigation
involving the Company's patents and patents of competing companies for
products and processes related to production and formulation of those
products, the increasing use and development of alternate therapies, and the
rate of market penetration by competing products.
Royalty and Contract Revenues: Royalty and contract revenues in future
periods could vary significantly from 1997 levels. Major factors affecting
these revenues include, but are not limited to: HLR's decisions to exercise
or not to exercise its option to develop and sell the Company's future
products in non-U.S. markets and the timing and amount of related development
cost reimbursement, if any; variations in HLR's sales and other licensees'
sales of licensed products; the expiration of royalties from Lilly in 1998 for
its sales of insulin which contribute substantially to current royalty
revenues; fluctuations in foreign currency exchange rates; the initiation of
other new contractual arrangements with other companies; the timing of non-
U.S. approvals, if any, for products licensed to HLR; whether and when
contract benchmarks are achieved; and the conclusion of existing arrangements
with other companies and HLR.
R&D: The Company intends to continue to develop new products and is
committed to aggressive R&D investment. Successful pharmaceutical product
development is highly uncertain and is dependent on numerous factors, many
of which are beyond the Company's control. Products that appear promising in
the early phases of development may fail to reach the market for numerous
reasons: they may be found to be ineffective or to have harmful side effects
in preclinical or clinical testing; they may fail to receive necessary
regulatory approvals; they may turn out to be uneconomical because of
manufacturing costs or other factors; or they may be precluded from
commercialization by the proprietary rights of others or by competing
products or technologies for the same indication. Success in preclinical
and early clinical trials does not ensure that large scale clinical trials
will be successful. Clinical results are frequently susceptible to varying
interpretations which may delay, limit or prevent regulatory approvals. The
length of time necessary to complete clinical trials and to submit an
application for marketing approval for a final decision by a regulatory
authority varies significantly and may be difficult to predict.
The Company currently has several products in late-stage clinical testing
and anticipates that its R&D expenses will continue at a high percentage of
revenues over the short-term. Over the long-term, however, as revenues
increase, R&D as a percent of revenues should decrease to the 20 to 25%
range. Factors affecting the Company's R&D expenses include, but are not
limited to: the outcome of clinical trials currently being conducted, the
number of products entering into development from late-stage research, in-
licensing activities, including the timing and amount of related development
funding or milestone payments, and future levels of revenues.
As part of the Company and HLR's agreed upon changes to the license
agreement, HLR has assumed development of Xubix on its own. As a result,
the Company will not be incurring future Xubix related R&D costs unless it
decides to opt-in on the development of this product. Such costs, net of
amounts reimbursed by HLR, were approximately $4.6 million for 1997.
In September 1997, the Company decided to discontinue development of IGF-I
in Type I and Type II diabetes mellitus. As a result, the Company will not
be incurring future IGF-I related R&D costs, net of amounts reimbursed by
HLR, which were approximately $16.1 million for 1997.
In addition, the Company announced in early October 1997 that it opted-out
of development and returned to IDEC the Company's marketing rights for IDEC-
Y2B8, a radioimmunotherapy under investigation for the treatment of relapsed
or refractory B-cell NHL. As a result, the Company discontinued its R&D
funding to IDEC for the development of IDEC-Y2B8. Such funding for 1997 was
immaterial.
Income Tax Provision: The Company expects its effective tax rate to
increase from the current rate of 24% to approximately 28% in 1998 and
continue at or near 35% for the next several years dependent upon several
factors. These factors include, but are not limited to, changes in tax laws
and rates, future levels of R&D spending, the outcome of clinical trials of
certain development products, the Company's success in commercializing such
products, and potential competition regarding the products.
Uncertainties Surrounding Proprietary Rights: The patent positions of
pharmaceutical and biotechnology companies can be highly uncertain and involve
complex legal and factual questions. Accordingly, the breadth of claims
allowed in such companies' patents cannot be predicted. Patent disputes are
frequent and can preclude commercialization of products. The Company has in
the past, is currently and may in the future, be involved in material patent
litigation. Such litigation is costly in its own right and could subject the
Company to significant liabilities to third-parties and, if decided adversely,
the Company may need to obtain third-party licenses at a material cost or
cease using the technology or product in dispute. The presence of patents or
other proprietary rights belonging to other parties may lead to the
termination of R&D of a particular product. The Company believes it has
strong patent protection or the potential for strong patent protection for a
number of its products that generate sales and royalty revenue or that the
Company is developing; however, the courts will determine the ultimate
strength of patent protection of the Company's products and those on which the
Company earns royalties.
Year 2000: Some of the Company's older computer software programs were
written using two digit fields rather than four digit fields to define the
applicable year (i.e., "98" in the computer code refers to the year "1998").
As a result, time-sensitive functions of those software programs may
misinterpret dates after January 1, 2000, to refer to the twentieth century
rather than the twenty-first century (i.e., "02" could be interpreted as
"1902" rather than "2002"). This could cause system failures or
miscalculations resulting in inaccuracies in computer output or disruptions of
operations, including, among other things, inaccurate processing of financial
information and/or temporary inabilities to process transactions, manufacture
products, or engage in similar normal business activities.
The Company has developed plans to address the potential exposures related to
the impact on its computer systems for the Year 2000 and beyond. An
assessment of key financial, informational and operational systems to
determine if they are Year 2000 compliant has been completed. Detailed plans
and timelines for implementation and testing of modifications and corrections
to the computer systems have been or are in process of being developed to
address computer systems problems as required by December 31, 1999. The
Company believes that with these detailed plans and completed modifications,
the Year 2000 issue will not pose significant operational problems for its
computer systems. However, if such modifications and conversions are not
made, or are not completed in a timely fashion, the Year 2000 issue could have
a material impact on the operations of the Company.
The total cost of the Year 2000 systems assessments and conversions is funded
through operating cash flows and the Company is expensing these costs. The
financial impact of making the required systems changes can not be known
precisely at this time, but is not expected to be material to the Company's
financial position, results of operations or cash flows.
Liquidity: The Company believes that its cash, cash equivalents, and short-
term investments, together with funds provided by operations and leasing
arrangements, will be sufficient to meet its foreseeable operating cash
requirements. In addition, the Company believes it could access additional
funds from the capital and debt markets. Factors affecting the Company's cash
position include, but are not limited to, future levels of the Company's
product sales, royalty and contract revenues, expenses, in-licensing
activities, including the timing and amount of related development funding or
milestone payments, and capital expenditures.
Roche Holdings, Inc.: At December 31, 1997, Roche held approximately 66.9% of
the Company's outstanding common equity. The Company expects to continue to
have material transactions with Roche, including royalty and contract
revenues, product sales and joint product development costs.
Market Risk: The Company is exposed to market risk, including changes to
interest rates, foreign currency exchange rates and equity investment prices.
To reduce the volatility relating to these exposures, the Company enters into
various derivative transactions pursuant to the Company's investment and risk
management policies and procedures in areas such as hedging and counterparty
exposure practices. The Company does not use derivatives for speculative
purposes.
A discussion of the Company's accounting policies for financial instruments
and further disclosures relating to financial instruments is included in the
Description of Business and Significant Accounting Policies and the Financial
Instruments notes in the Notes to Consolidated Financial Statements.
The Company maintains risk management control systems to monitor the risks
associated with interest rates, foreign currency exchange rates and equity
investment price changes, and its derivative and financial instrument
positions. The risk management control systems use analytical techniques,
including sensitivity analysis, and market values. Though the Company intends
for its risk management control systems to be comprehensive, there are
inherent risks which may only be partially offset by the Company's hedging
programs should there be unfavorable movements in interest rates, foreign
currency exchange rates or equity investment prices.
The estimated exposures discussed below are intended to measure the maximum
amount the Company could lose from adverse market movements in interest rates,
foreign currency exchange rates and equity investment prices, given a
specified confidence level, over a given period of time. Loss is defined in
the value at risk estimation as fair market value loss. The exposures to
interest rate, foreign currency exchange rate and equity investment price
changes are calculated based on proprietary modeling techniques from a Monte
Carlo simulation value at risk model (value at risk model) using a 30-day
holding period and a 95% confidence level. The value at risk model assumes
non-linear financial returns and generates potential paths various market
prices could take and tracks the hypothetical performance of a portfolio under
each scenario to approximate its financial return. The value at risk model
takes into account correlations and diversification across market factors,
including interest rates, foreign currencies and equity prices. Market
volatilities and correlations are based on JP Morgan Riskmetrics, trademark,
dataset as of December 31, 1997.
Interest Rates - The Company's interest income is sensitive to changes
in the general level of U.S. interest rates. In this regard, changes in U.S.
interest rates affect the interest earned on the Company's cash equivalents,
short-term investments, convertible equity loans and long-term investments. To
mitigate the impact of fluctuations in U.S. interest rates, the Company may
enter into swap transactions which involve the receipt of fixed rate interest
and the payment of floating rate interest without the exchange of the
underlying principal. By investing the Company's cash in an amount equal to
the notional amount of the swap contract, with a maturity date equal to the
maturity date of the floating rate obligation, the Company hedges itself from
any potential earnings impact due to changes in interest rates.
Based on the Company's overall interest rate exposure at December 31, 1997,
including derivative and other interest rate sensitive instruments, a near-
term change in interest rates, within a 95% confidence level based on
historical interest rate movements, would not materially affect the fair value
of interest rate sensitive instruments.
Foreign Currency Exchange Rates - The Company receives royalty revenues
from licensees selling products in countries throughout the world. As a
result, the Company's financial results could be significantly affected by
factors such as changes in foreign currency exchange rates or weak economic
conditions in the foreign markets in which the Company's licensed products are
sold. The Company is exposed to changes in exchange rates in Europe, Asia and
Canada. The Company's exposure to foreign exchange rates primarily exists
with the German Mark. When the U.S. dollar strengthens against the currencies
in these countries, the U.S. dollar value of non-U.S. dollar-based revenue
decreases; when the U.S. dollar weakens, the U.S. dollar value of the non-U.S.
dollar-based revenues increases. Accordingly, changes in exchange rates, and
in particular a strengthening of the U.S. dollar, may adversely affect the
Company's royalty revenues as expressed in U.S. dollars. In addition, as part
of its overall investment strategy, the Company has three portfolios that are
managed by external money managers and these portfolios consist primarily of
non-dollar denominated investments. As a result, the Company is exposed to
changes in the exchanges rates of the countries in which these non-dollar
denominated investments are made.
To mitigate this risk, the Company hedges certain of its anticipated revenues
by purchasing option contracts with expiration dates and amounts of currency
that are based on 40%-90% of probable future revenues so that the potential
adverse impact of movements in currency exchange rates on the non-dollar
denominated revenues will be at least partly offset by an associated increase
in the value of the option. The duration of these options is generally one to
four years. The Company may also enter into foreign currency forward
contracts (forward contracts) to lock in the dollar value of a portion of
these anticipated revenues. The duration of these forward contracts is
generally less than one year. Also, to hedge the non-dollar denominated
investments in the externally managed portfolios, the external money managers
also enter into forward contracts.
Based on the Company's overall currency rate exposure at December 31, 1997,
including derivative and other foreign currency sensitive instruments, a near-
term change in currency rates within a 95% confidence level based on
historical currency rate movements, would not materially affect the fair value
of foreign currency sensitive instruments.
Equity Investment Securities - As part of its strategic alliance
efforts, the Company invests in equity instruments of biotechnology companies
that are subject to fluctuations from market value changes in stock prices.
To mitigate this risk, certain equity securities are hedged with costless
collars. A costless collar is a purchased put option and a written call
option in which the cost of the purchased put and the proceeds of the written
call offset each other; therefore, there is no initial cost or cash outflow
for these instruments at the time of purchase. The purchased put protects the
Company from a decline in the market value of the security below a certain
minimum level (the put "strike" level); while the call effectively limits the
Company's potential to benefit from an increase in the market value of the
security above a certain maximum level (the call "strike" level). In
addition, as part of its strategic alliance efforts, the Company has issued
interest bearing convertible equity loans.
Based on the Company's overall exposure to fluctuations from market value
changes in equity prices at December 31, 1997, a near-term change in equity
prices within a 95% confidence level based on historic volatilities could
result in a potential loss in fair value of the equity securities portfolio of
$11.3 million.
Credit Risk of Counterparties: The Company could be exposed to losses related
to the above financial instruments should one of its counterparties default.
This risk is mitigated through credit monitoring procedures.
Legal Proceedings: The Company is a party to various legal proceedings
including patent infringement cases and various cases involving product
liability and other matters. See the Leases, Commitments and Contingencies
note in the Notes to Consolidated Financial Statements for further
information.
REPORT OF MANAGEMENT
Genentech, Inc. is responsible for the preparation, integrity and fair
presentation of its published financial statements. The Company has prepared
the financial statements, presented on pages 42 to 60, in accordance with
generally accepted accounting principles. As such, the statements include
amounts based on judgments and estimates made by management. The Company also
prepared the other information included in the annual report and is
responsible for its accuracy and consistency with the financial statements.
The financial statements have been audited by the independent auditing firm,
Ernst & Young LLP, which was given unrestricted access to all financial
records and related data, including minutes of all meetings of stockholders,
the Board of Directors and committees of the Board. The Company believes that
all representations made to the independent auditors during their audit were
valid and appropriate. Ernst & Young LLP's audit report appears on page 61.
Systems of internal accounting controls, applied by operating and financial
management, are designed to provide reasonable assurance as to the integrity
and reliability of the financial statements and reasonable, but not absolute,
assurance that assets are safeguarded from unauthorized use or disposition,
and that transactions are recorded according to management's policies and
procedures. The Company continually reviews and modifies these systems, where
appropriate, to maintain such assurance. Through the Company's general audit
activities, the adequacy and effectiveness of the systems and controls are
reviewed and the resultant findings are communicated to management and the
Audit Committee of the Board of Directors.
The selection of Ernst & Young LLP as the Company's independent auditors has
been approved by the Company's Board of Directors and ratified by the
stockholders. The Audit Committee of the Board of Directors is composed of
four non-management directors who meet regularly with management and the
independent auditors and the general auditor, jointly and separately, to
review the adequacy of internal accounting controls and auditing and financial
reporting matters to ascertain that each is properly discharging its
responsibilities.
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr. Bradford S. Goodwin
President and Executive Vice President Vice President - Finance
Chief Executive Officer and Chief Financial Officer
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
(thousands, except per share amounts)
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31 1997 1996 1995
- ---------------------------------------------------------------------------------
Revenues
Product sales (including amounts from
related parties: 1997-$17,396;
1996-$13,216; 1995-$1,776) $ 584,889 $ 582,829 $ 635,263
Royalties (including amounts
from related parties: 1997-$25,362;
1996-$26,240; 1995-$12,492) 241,112 214,702 190,811
Contract and other (including amounts
from related parties: 1997-$67,596;
1996-$95,299; 1995-$13,448) 121,587 107,037 31,209
Interest 69,160 64,110 60,562
------------------------------------
Total revenues 1,016,748 968,678 917,845
Costs and expenses
Cost of sales (including amounts from
related parties: 1997-$14,348;
1996-$10,900; 1995-$6,963) 102,536 104,527 97,930
Research and development (including
contract related: 1997-$67,596;
1996-$50,586; 1995-$17,124) 470,923 471,143 363,049
Marketing, general and administrative 269,852 240,063 251,653
Special charge (primarily merger related) -- -- 25,000
Interest 3,642 5,010 7,940
-------------------------------------
Total costs and expenses 846,953 820,743 745,572
Income before taxes 169,795 147,935 172,273
Income tax provision 40,751 29,587 25,841
-------------------------------------
Net income $ 129,044 $ 118,348 $ 146,432
=====================================
Earnings per share:
Basic $ 1.05 $ 0.98 $ 1.24
Diluted $ 1.02 $ 0.95 $ 1.20
=====================================
Weighted average shares used to compute
diluted earnings per share: 126,397 123,969 121,748
=====================================
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
Increase in Cash and
Cash Equivalents
YEAR ENDED DECEMBER 31 1997 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 129,044 $ 118,348 $ 146,432
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 65,533 62,124 58,421
Deferred income taxes 19,660 (34,021) (22,655)
Gain on sales of securities available-for-sale (13,203) (1,010) (7,589)
Loss on sales of securities available-for-sale 2,096 663 157
Writedown of securities available-for-sale 4,000 - 6,609
Loss on fixed asset dispositions
(including merger-related in 1995) 318 5,309 1,032
Other - - (234)
Changes in assets and liabilities:
Net cash flow from trading securities (109,132) (8,184) (50,014)
Receivables and other current assets 11,194 (30,416) (28,446)
Inventories (24,083) 1,705 9,552
Accounts payable, other current
liabilities and other long-term
liabilities 32,897 25,153 20,682
----------------------------------
Net cash provided by operating activities 118,324 139,671 133,947
Cash flows from investing activities:
Purchases of securities held-to-maturity (304,932) (634,124) (682,396)
Proceeds from maturities of securities
held-to-maturity 455,317 772,922 924,345
Purchases of securities available-for-sale (512,727) (304,806) (353,118)
Proceeds from sales of securities available-
for-sale 410,395 182,564 101,591
Purchases of nonmarketable equity securities - (9,323) -
Capital expenditures (154,902) (141,837) (70,166)
Change in other assets (61,529) (7,046) (37,948)
-----------------------------------
Net cash used in investing activities (168,378) (141,650) (117,692)
Cash flows from financing activities:
Stock issuances 87,259 72,558 54,946
Reduction in long-term debt,
including current portion - (358) (871)
-----------------------------------
Net cash provided by financing activities 87,259 72,200 54,075
-----------------------------------
Increase in cash and cash equivalents 37,205 70,221 70,330
Cash and cash equivalents at beginning of year 207,264 137,043 66,713
-----------------------------------
Cash and cash equivalents at end of year $ 244,469 $ 207,264 $ 137,043
===================================
Supplemental cash flow data:
Cash paid during the year for:
Interest, net of portion capitalized $ 3,642 $ 5,010 $ 7,917
Income taxes 15,474 52,243 44,699
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except par value)
DECEMBER 31 1997 1996
- --------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 244,469 $ 207,264
Short-term investments 588,853 415,900
Accounts receivable - trade (net of
allowances of: 1997-$8,826; 1996-$4,110) 71,415 77,785
Accounts receivable - other (net of
allowances of: 1997-$5,709; 1996-$3,759) 73,444 86,450
Accounts receivable - related party 44,386 33,377
Inventories 116,026 91,943
Prepaid expenses and other current assets 55,325 42,365
------------------------------
Total current assets 1,193,918 955,084
Long-term marketable securities 453,188 535,916
Property, plant and equipment, net 683,304 586,167
Other assets 177,202 149,205
------------------------------
Total assets $ 2,507,612 $ 2,226,372
==============================
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 48,992 $ 45,501
Income taxes payable 40,293 18,530
Accrued liabilities - related party 15,427 9,908
Other accrued liabilities 184,845 176,012
------------------------------
Total current liabilities 289,557 249,951
Long-term debt 150,000 150,000
Other long-term liabilities 36,830 25,362
------------------------------
Total liabilities 476,387 425,313
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.02 par value; authorized:
100,000,000 shares; none issued - -
Special common stock, $0.02 par value;
authorized: 100,000,000 shares; outstanding:
1997-47,606,785; 1996-44,805,755 952 896
Common stock, $0.02 par value;
authorized: 200,000,000 shares;
outstanding: 1997-76,621,009;
1996-76,621,009 1,532 1,532
Additional paid-in capital 1,463,768 1,362,585
Retained earnings (since October 1, 1987
quasi-reorganization) 511,141 382,097
Net unrealized gain on securities
available-for-sale 53,832 53,949
-------------------------------
Total stockholders' equity 2,031,225 1,801,059
-------------------------------
Total liabilities and stockholders' equity $ 2,507,612 $ 2,226,372
===============================
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
<CAPITON>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands)
1997 1996 1995
Year ended December 31 ------------------- ------------------- -------------------
Shares Amount Shares Amount Shares Amount
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Special common stock
Beginning balance 44,806 $ 896 42,647 $ 853 - -
Issuance of stock upon exercise
of options and warrants 2,801 56 2,159 43 298 $ 6
Conversion of common stock
to special common stock - - - - 42,349 847
---------------------------------------------------------------
Ending balance 47,607 952 44,806 896 42,647 853
---------------------------------------------------------------
Redeemable common stock
Beginning balance - - - - 50,106 1,002
Issuance of stock upon exercise
of options and warrants - - - - 679 14
Issuance of stock under
employee stock plan - - - - 322 6
Conversion of redeemable
common stock to common stock - - - - (51,107) (1,022)
---------------------------------------------------------------
Ending balance - - - - - -
---------------------------------------------------------------
Common stock
Beginning balance 76,621 1,532 76,621 1,532 67,133 1,343
Issuance of stock upon exercise
of options and warrants - - - - 512 10
Issuance of stock under
employee stock plan - - - - 218 4
Conversion of redeemable
common stock to common stock - - - - 51,107 1,022
Conversion of common stock
to special common stock - - - - (42,349) (847)
---------------------------------------------------------------
Ending balance 76,621 1,532 76,621 1,532 76,621 1,532
---------------------------------------------------------------
Additional paid-in capital
Beginning balance 1,362,585 1,281,640 1,207,720
Issuance of stock upon exercise
of options and warrants 68,346 55,103 37,087
Issuance of stock under
employee stock plan 18,857 17,412 17,819
Income tax benefits
realized from employee
stock option exercises 13,980 8,430 7,204
Tax benefits arising prior
to quasi-reorganization - - 11,810
---------- ---------- -----------
Ending balance 1,463,768 1,362,585 1,281,640
---------- ---------- -----------
Retained earnings
Beginning balance 382,097 263,749 129,127
Net income 129,044 118,348 146,432
Tax benefits arising prior
to quasi-reorganization - - (11,810)
---------- ---------- -----------
Ending balance 511,141 382,097 263,749
---------- ---------- -----------
Net unrealized gain on securities
Beginning balance 53,949 54,273 9,592
Net unrealized (loss) gain on
securities available-for-sale (117) (324) 44,681
---------- ---------- ----------
Ending balance 53,832 53,949 54,273
---------- ---------- ----------
Total stockholders' equity $2,031,225 $1,801,059 $1,602,047
========== ========== ==========
<FN>
See Notes to Consolidated Financial Statements.
</TABLE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of Business: Genentech, Inc. (the Company) is a biotechnology
company that discovers, develops, manufactures and markets human
pharmaceuticals produced by recombinant DNA technology for significant unmet
medical needs. The Company manufactures and markets seven products directly
in the United States (U.S.) and sells these products to F. Hoffmann-La Roche
Ltd (HLR) for HLR to sell outside of the U.S. Of these seven products, HLR
has the right to sell six in Canada and two in a number of countries. In
addition, the Company receives royalties from HLR's sales of these products,
and receives royalties from HLR and other licensees from sales of five other
products which originated from the Company's technology.
Principles of Consolidation: The consolidated financial statements include
the
accounts of the Company and all significant subsidiaries. Material
intercompany balances and transactions are eliminated.
Use of Estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
Cash and Cash Equivalents: The Company considers all highly liquid debt
instruments purchased with an original maturity of three months or less to be
cash equivalents.
Short-term Investments and Long-term Marketable Securities: The Company
invests its excess cash balances in short-term and long-term marketable
securities, primarily corporate notes, certificates of deposit and treasury
notes. As part of its strategic alliance efforts, the Company also invests in
equity securities and interest bearing convertible debt of other biotechnology
companies. Marketable equity securities are accounted for as available-for-
sale investment securities as described below. Nonmarketable equity
securities and convertible debt are carried at cost. At December 31, 1997 and
1996, the Company had investments of $55.2 million and $15.7 million,
respectively, in convertible debt of various biotechnology companies.
Investment securities are classified into one of three categories: held-to-
maturity, available-for-sale, or trading. Securities are considered held-to-
maturity when the Company has the positive intent and ability to hold the
securities to maturity. These securities are recorded as either short-term
investments or long-term marketable securities on the balance sheet depending
upon their contractual maturity dates. Held-to-maturity securities are stated
at amortized cost, including adjustments for amortization of premiums and
accretion of discounts. Securities are considered trading when bought
principally for the purpose of selling in the near term. These securities are
recorded as short-term investments and are carried at market value.
Unrealized holding gains and losses on trading securities are included in
interest income. Securities not classified as held-to-maturity or as trading
are considered available-for-sale. These securities are recorded as either
short-term investments or long-term marketable securities and are carried at
market value with unrealized gains and losses included in stockholders'
equity. If a decline in fair value below cost is considered other than
temporary, such securities are written down to estimated fair value with a
charge to marketing, general and administrative expenses. The cost of all
securities sold is based on the specific identification method.
Property, Plant and Equipment: The costs of buildings and equipment are
depreciated using the straight-line method over the following estimated useful
lives of the assets: buildings - 25 years; certain manufacturing equipment -
15 years; other equipment - 4 or 8 years; leasehold improvements - length of
applicable lease. The costs of repairs and maintenance are expensed as
incurred. Repairs and maintenance expenses for the years ended December 31,
1997, 1996 and 1995 were $32.9 million, $28.8 million and $22.1 million,
respectively. Capitalized interest on construction-in-progress of $3.9
million in 1997, $2.5 million in 1996 and $1.5 million in 1995 is included in
property, plant and equipment.
Property, plant and equipment balances at December 31 are summarized below
(in thousands):
1997 1996
-------------------------------------------------------------------------
At cost:
Land $ 69,010 $ 67,619
Buildings 339,708 297,888
Equipment 494,874 428,738
Leasehold improvements 3,270 12,314
Construction in progress 152,533 99,708
----------------------------
1,059,395 906,267
Less: accumulated depreciation 376,091 320,100
----------------------------
Net property, plant and equipment $ 683,304 $ 586,167
=============================
Patents and Other Intangible Assets: As a result of its research and
development (R&D) programs, the Company owns or is in the process of applying
for patents in the U.S. and other countries which relate to products and
processes of significant importance to the Company. Costs of patents and
patent applications are capitalized and amortized on a straight-line basis
over their estimated useful lives of approximately 12 years. Intangible
assets are generally amortized on a straight-line basis over their estimated
useful lives.
Contract Revenue: Contract revenue for R&D is recorded as earned based on the
performance requirements of the contract. In return for contract payments,
contract partners may receive certain marketing and manufacturing rights,
products for clinical use and testing, or R&D services.
Royalty Expenses: Royalty expenses directly related to product sales are
classified in cost of sales. Other royalty expenses, relating to royalty
revenue, totaled $39.8 million, $36.0 million, and $30.2 million in 1997,
1996, and 1995, respectively, and are classified in marketing, general and
administrative expenses.
Advertising Expenses: The Company expenses the costs of advertising, which
also includes promotional expenses, as incurred. Advertising expenses for the
years ended December 31, 1997, 1996, and 1995, were $41.8 million, $28.0
million, and $29.2 million, respectively.
Income Taxes: The Company accounts for income taxes by the asset and
liability approach for financial accounting and reporting of income taxes.
The Company's method of accounting for operating loss and tax credit
carryforwards arising prior to the date of the Company's quasi-reorganization
in 1987 is described in the Quasi-Reorganization note.
Earnings Per Share: Basic earnings per share is computed based on the
weighted average number of shares of the Company's special common stock and
common stock. Diluted earnings per share is computed based on the weighted
average number of shares of the Company's special common stock, common stock
and common stock equivalents, if dilutive. See also the New Accounting
Standards section below.
Financial Instruments: The Company uses external money managers to manage
part of its investment portfolio that is held for trading purposes. This
externally managed investment portfolio consists entirely of debt securities.
When the money managers purchase securities denominated in a foreign currency,
they enter into foreign currency forward contracts which are recorded at fair
value with the related gain or loss recorded in interest income.
The Company purchases simple foreign currency put options (options) with
expiration dates and amounts of currency that are based on a portion of
probable non-dollar revenues so that the potential adverse impact of movements
in currency exchange rates on the non-dollar denominated revenues will be at
least partially offset by an associated increase in the value of the options.
See the Financial Instruments note for further discussion. At the time the
options are purchased they have little or no intrinsic value. Realized and
unrealized gains related to the options are deferred until the designated
hedged revenues are recorded. The associated costs, which are deferred and
classified as other current assets, are amortized over the term of the options
and recorded as a reduction of the hedged revenues. Realized gains and losses
are recorded in the income statement with the related hedged revenues.
Options are generally terminated, or offsetting contracts are entered into,
upon determination that purchased options no longer qualify as a hedge or are
determined to exceed probable anticipated net foreign revenues. The realized
gains and losses are recorded as a component of other revenues. For early
termination of options that qualify as hedges, the gain or loss on termination
will be deferred through the original term of the option and then recognized
as a component of the hedged revenues. Changes in the fair value of hedging
instruments that qualify as a hedge are not recognized and changes in the fair
value of instruments that do not qualify as a hedge would be recognized in
other revenues.
The Company may also enter into foreign currency forward contracts (forward
contracts) as hedging instruments. Forward contracts are recorded at fair
value, and any gains and losses from these forward contracts are recorded in
the income statement with the related hedged revenues. Financial instruments,
such as forward contracts, not qualifying as hedges under generally accepted
accounting principles are marked to market with gains or losses recorded in
other revenues if they occur.
Interest rate swaps (swaps) have been used and may be used in the future to
adjust the duration of the investment portfolio in order to meet duration
targets. Interest rate swaps are contracts in which two parties agree to swap
future streams of payments over a specified period. See the Financial
Instruments note for further discussion. The accrued net settlement amounts on
swaps are reflected on the balance sheet as other accounts receivable or other
accrued liabilities. Net payments made or received on swaps are included in
interest income as adjustments to the interest received on invested cash.
Amounts deferred on terminated swaps are classified as other assets and are
amortized to interest income over the original contractual term of the swaps
by a method that approximates the level-yield method. For early termination
of swaps where the underlying asset is not sold, the amount of the terminated
swap is deferred and amortized over the remaining life of the original swap.
For early termination of swaps with the corresponding termination or sale of
the underlying asset, the amounts are recognized through interest income.
Changes in the fair value of swap hedging instruments that qualify as a hedge
are not recognized and changes in the fair value of swap instruments that do
not qualify as a hedge would be recognized in other income.
The Company's marketable equity portfolio consists primarily of biotechnology
companies whose risk of market fluctuations is greater than the stock market
in general. To manage this risk, the Company enters into certain costless
collar instruments to hedge certain equity securities against changes in
market value. See the Financial Instruments note for further discussion.
Gains and losses on these instruments are recorded as an adjustment to
unrealized gains and losses on marketable securities with a corresponding
receivable or payable recorded in short-term or long-term other assets or
liabilities. Equity collar instruments that do not qualify for hedge
accounting and early termination of these instruments with the sale of the
underlying security would be recognized through earnings. For early
termination of these instruments without the sale of the underlying security,
the time value would be recognized through earnings and the intrinsic value
will adjust the cost basis of the underlying security.
401(k) Plan: The Company's 401(k) Plan (Plan) covers substantially all of its
employees. Under the Plan, eligible employees may contribute up to 15% of
their eligible compensation, subject to certain Internal Revenue Service
restrictions. The Company matches a portion of employee contributions, up to a
maximum of 4% of each employee's eligible compensation. The match is effective
December 31 of each year and is fully vested when made. During 1997, 1996, and
1995, the Company provided $6.7 million, $6.1 million, and $5.6 million,
respectively, for the Company match under the Plan.
New Accounting Standards: On December 31, 1997, the Company adopted Statement
of Financial Accounting Standards (FAS) 128, "Earnings per Share." As a
result, the Company has changed the method used to compute earnings per share
(EPS) and has restated all prior periods as required by FAS 128. The adoption
of FAS 128 did not have a material impact on the Company's results of
operations. The following is a reconciliation of the numerator and
denominators of the basic and diluted EPS computations for the years ended
December 31, 1997, 1996 and 1995 (in thousands).
1997 1996 1995
-------------------------------------
Numerator:
Net income - numerator for
basic and diluted EPS: $ 129,044 $ 118,348 $ 146,432
--------- --------- ---------
Denominator:
Denominator for basic EPS--
weighted-average shares 123,042 120,623 118,271
Effect of dilutive securities:
Stock options 3,355 3,325 3,440
Warrants - 21 37
--------- --------- ---------
Denominator for diluted EPS
--adjusted weighted-average
shares and assumed conversions 126,397 123,969 121,748
========= ========= ==========
Options to purchase 103,700 shares of common stock at $59.00 per share,
5,251,665 shares of common stock at $54.25 per share and 17,500 shares of
common stock at $51.63 per share were outstanding during 1997, 1996 and 1995,
respectively, but were not included in the computation of diluted earnings per
share because the options' exercise price was greater than the average market
price of the common shares and therefore, the effect would be anti-dilutive.
See Capital Stock note for information on option expiration dates.
During 1997, 1996 and 1995, the Company had convertible subordinated
debentures which are convertible to 1,013,514 shares of common stock, but were
not included in the computation of diluted earnings per share because they
were anti-dilutive. See the Long-Term Debt note for additional information
on the convertible subordinated debentures.
The Financial Accounting Standards Board also issued FAS 130, Reporting
Comprehensive Income, and FAS 131, Disclosures about Segments of an Enterprise
and Related Information, in June 1997, which requires additional disclosures
to be adopted on December 31, 1998. Under FAS 130, the Company is required to
display comprehensive income and its components as part of the Company's full
set of financial statements. FAS 131 requires that the Company report
financial and descriptive information about its reportable operating segments.
The Company is evaluating the impact on its disclosures, if any.
Inventories: Inventories are stated at the lower of cost or market. Cost is
determined using a weighted-average approach which approximates the first-in
first-out method. Inventories at December 31, 1997 and 1996 are summarized
below (in thousands):
1997 1996
------------------------------------------------------------------
Raw materials and supplies $ 17,544 $ 17,971
Work in process 84,831 61,368
Finished goods 13,651 12,604
----------------------
Total $116,026 $ 91,943
======================
Reclassifications: Certain reclassifications of prior year amounts have been
made to conform with the current year presentation.
SIGNIFICANT CUSTOMER AND GEOGRAPHIC INFORMATION
HLR contributed approximately 11% of the Company's total revenues in 1997, 14%
in 1996, and less than 10% in 1995. See the Related Party Transactions note
below for further information. Two major customers, Caremark, Inc. and Bergen
Brunswig, contributed 10% or more of the Company's total revenues in each of
the last three years. Caremark, Inc., which accounted for 14%, 15% and 18% of
total revenues in 1997, 1996 and 1995, respectively, distributes Protropin,
registered trademark, Nutropin, registered trademark, Nutropin AQ, registered
trademark, Pulmozyme, registered trademark, and Actimmune, registered
trademark, through its extensive branch network and is then reimbursed through
a variety of sources. Bergen Brunswig, a wholesale distributor of all of the
Company's products, contributed 10% in 1997 and 1996 and 11% in 1995.
Approximate foreign sources of revenues were as follows (in millions):
1997 1996 1995
- ----------------------------------------------------
Europe $139.5 $146.4 $112.0
Asia 34.2 17.8 23.6
Canada 11.7 11.1 25.0
The Company currently sells primarily to distributors and hospitals throughout
the U.S., performs ongoing credit evaluations of its customers' financial
condition and extends credit without collateral. In 1997, 1996 and 1995, the
Company did not record any material additions to, or losses against, its
provision for doubtful accounts.
RESEARCH AND DEVELOPMENT ARRANGEMENTS
To gain access to potential new products and technologies and to utilize other
companies to help develop the Company's potential new products, the Company
has
established strategic alliances with, including the acquisition of both
marketable and non-marketable equity investments and convertible debt in
companies developing technologies that fall outside the Company's research
focus and with companies having the potential to generate new products through
technology exchanges and investments. Potential future payments may be due to
certain collaborative partners achieving certain benchmarks as defined in the
collaborative agreements. The Company has also entered into product-specific
collaborations to acquire development and marketing rights for products.
SPECIAL CHARGE
The $25.0 million special charge in 1995 includes $21.0 million related to the
merger agreement (the Agreement) with Roche Holdings, Inc. (Roche), discussed
in the Relationship with Roche Holdings, Inc. note, and $4.0 million of
charges associated with the resignation of the Company's former President and
Chief Executive Officer. The merger expenses include legal expenses,
investment banking fees, filing fees and other costs related to the Agreement
with Roche, as well as charges associated with the settlement of stockholder
lawsuits filed after the transaction was announced.
INCOME TAXES
The income tax provision consists of the following amounts (in thousands):
1997 1996 1995
- --------------------------------------------------------------
Current:
Federal $ 30,617 $ 61,502 $ 43,997
State 432 2,104 4,467
Foreign 2 2 32
----------------------------------
Total current 31,051 63,608 48,496
----------------------------------
Deferred:
Federal 23,799 (34,021) (12,319)
State (14,099) - (10,336)
----------------------------------
Total deferred 9,700 (34,021) (22,655)
----------------------------------
Total income tax provision $ 40,751 $ 29,587 $ 25,841
==================================
Actual current tax liabilities are lower than reflected above by $14.0
million, $8.4 million and $7.2 million in 1997, 1996 and 1995, respectively,
due to employee stock option related tax benefits which were credited to
stockholders' equity. The deferred provision excludes activity in the net
deferred tax assets relating to appreciation in securities available-for-sale
in the amount of $10.0 million.
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate follows:
<TABLE>
<CAPTION>
Tax Rate
1997 Amount ---------------------------
(thousands) 1997 1996 1995
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tax at U.S. statutory rate $ 59,428 35.0% 35.0% 5.0%
R&D credits realized (19,298) (11.4) (3.0) (15.9)
Tax benefit of realized gains on
securities available-for-sale (6,517) (3.8) - -
Adjustment of deferred tax assets
valuation allowance - - (15.3) (13.1)
Foreign losses (benefited) not benefited - - (3.4) 2.8
State taxes 3,871 2.3 2.3 2.6
Other 3,267 1.9 4.4 3.6
-----------------------------------------
Income tax provision $ 40,751 24.0% 20.0% 15.0%
=========================================
</TABLE>
The components of deferred taxes consist of the following at December 31
(in thousands):
1997 1996
- ------------------------------------------------------------------------------
Deferred tax liabilities:
Depreciation $ 55,137 $ 58,842
Unrealized gain on sale of securities
available-for-sale 25,086 21,017
Other 2,173 10,543
--------------------------
Total deferred tax liabilities 82,396 90,402
Deferred tax assets:
Capitalized R&D costs 33,950 34,280
Federal credit carryforwards 100,400 111,400
Expenses not currently deductible 35,000 38,368
State credit carryforwards 28,365 26,710
Other 4,398 6,340
--------------------------
Total deferred tax assets 202,113 217,098
Valuation allowance (48,508) (35,827)
--------------------------
Total net deferred tax assets 153,605 181,271
--------------------------
Total net deferred taxes $ 71,209 $ 90,869
==========================
Total tax credit carryforwards of $128.8 million expire in the years 1998
through 2012, except for $43.0 million of alternative minimum tax credits
which have no expiration date. The valuation allowance at December 31, 1997,
reflected above relates to the tax benefits of stock option deductions which
will be credited to additional paid-in capital when realized.
The valuation allowance increased by $12.7 million in 1997, decreased by $17.0
million in 1996 and decreased by $31.6 million in 1995. Realization of net
deferred taxes depends on future earnings from existing and new products and
new indications for existing products. The timing and amount of future
earnings will depend on continued success in marketing and sales of the
Company's current products, as well as the scientific success, results of
clinical trials and regulatory approval of products under development.
INVESTMENT SECURITIES
Securities classified as trading, available-for-sale and held-to-maturity at
December 31, 1997 and 1996 are summarized below. Estimated fair value is based
on quoted market prices for these or similar investments.
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1997 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $ 256,428 $ 686 $ (4,487) $ 252,627
==============================================
SECURITIES AVAILABLE-FOR-SALE
(carried at estimated
fair value):
Equity securities $ 46,262 $ 75,796 $ (2,147) $ 119,911
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing:
between 5-10 years 38,330 577 (3) 38,904
Corporate debt securities
maturing:
within 1 year 98,073 51 (8) 98,116
between 1-5 years 98,283 770 (103) 98,950
between 5-10 years 146,921 4,053 - 150,974
Other debt securities
maturing:
within 1 year 40,314 - (578) 39,736
between 1-5 years 40,323 - (2,008) 38,315
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 508,506 $ 81,247 $ (4,847) $ 584,906
==============================================
SECURITIES HELD-TO-MATURITY
(carried at amortized cost):
Corporate debt securities
maturing:
within 1 year $ 193,295 $ 19 - $ 193,314
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 193,295 $ 19 - $ 193,314
==============================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1996 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $ 144,460 $ 1,932 $ (2,897) $ 143,495
==============================================
SECURITIES AVAILABLE-FOR-SALE
(carried at estimated
fair value):
Equity securities $ 42,773 $ 56,347 $ (1,376) $ 97,744
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing:
within 1 year 51,179 - (71) 51,108
between 1-5 years 103,057 1,299 (209) 104,147
between 5-10 years 113,176 1,001 (2,114) 112,063
Other debt securities
maturing:
within 1 year 46,583 27 - 46,610
between 1-5 years 43,954 185 (94) 44,045
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 400,722 $ 58,859 $ (3,864) $ 455,717
==============================================
SECURITIES HELD-TO-MATURITY*
(carried at amortized cost):
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing:
within 1 year $ 76,718 $ 31 - $ 76,749
between 5-10 years 30,155 - $ (777) 29,378
Other debt securities
maturing:
within 1 year 91,664 4 (35) 91,633
between 1-5 years 141,553 576 (27) 142,102
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 340,090 $ 611 $ (839) $ 339,862
==============================================
* Interest rate swap arrangements are used to modify the duration of certain
held-to-maturity securities. The average effective maturity of the
portfolio was 2.5 years at December 31, 1996.
The carrying value of all investment securities held at December 31, 1997 and
1996 is summarized below (in thousands):
Security 1997 1996
- ------------------------------------------------------------------------------
Trading securities $252,627 $143,495
Securities available-for-sale maturing within one year 137,852 97,718
Securities held-to-maturity maturing within one year 193,295 68,382
Accrued interest 5,079 6,305
-------- --------
Total short-term investments $588,853 $415,900
======== ========
Securities available-for-sale maturing between
1-10 years, including equity securities $447,054 $357,999
Securities held-to-maturity maturing between 1-10 years - 171,708
Accrued interest 6,134 6,209
-------- --------
Total long-term marketable securities $453,188 $535,916
======== ========
In 1997, proceeds from the sales of available-for-sale securities totaled
$410.4 million; gross realized gains totaled $13.2 million and gross realized
losses totaled $2.1 million. In 1996, proceeds from sales of available-for-
sale securities totaled $182.6 million; gross realized gains totaled $1.0
million and gross realized losses totaled $0.7 million. In 1995, proceeds
from sales of available-for-sale securities totaled $101.6 million; gross
realized gains totaled $7.6 million and gross realized losses totaled $0.2
million. The Company recorded charges in 1997 and 1995 of $4.0 million and
$6.6 million, respectively, to write down certain available-for-sale
biotechnology equity securities for which the decline in fair value below cost
was other than temporary. In 1996, there were no such write downs.
During the year ended December 31, 1997 and 1996, net unrealized holding
losses on trading securities included in net income totaled $3.8 million and
$1.0 million, respectively. In 1995, such losses were not material.
Marketable debt securities held by the Company are issued by a diversified
selection of corporate and financial institutions with strong credit ratings.
The Company's investment policy limits the amount of credit exposure with any
one institution. These debt securities are generally not collateralized. The
Company has not experienced any material losses due to credit impairment on
its investments in marketable debt securities in the years 1997, 1996 and
1995.
FINANCIAL INSTRUMENTS
Foreign Currency Instruments: Certain of the Company's revenues are earned
outside of the U.S. Moreover, the Company's foreign currency denominated
revenues exceed its foreign currency denominated expenses; therefore, risk
exists that net income may be impacted by changes in the exchange rates
between the U.S. dollar and foreign currencies. To hedge anticipated non-
dollar denominated net revenues, the Company currently purchases options and
enters into forward contracts. At December 31, 1997, the Company had hedged
approximately 75% of probable net foreign revenues anticipated within 12
months and between 40% and 75% of its probable net foreign revenues through
the year 2000. At December 31, 1997 and 1996, the notional amount of the
options totaled $122.9 million and $100.3 million, respectively, and consisted
of the following currencies: Australian dollars, Canadian dollars, German
marks, Spanish pesetas, French francs, British pounds, Italian lire, Japanese
yen and Swedish krona. All option contracts mature within the next three
years. The fair value of the options is based on exchange rates and market
conditions at December 31, 1997 and 1996. At December 31, 1996, the U.S.
dollar equivalent of the notional amount of the forward sell contracts was
$34.3 million and the forward buy contracts totaled $0.4 million,
respectively. All forward contracts were closed out at the end of December
31, 1997.
Credit exposure is limited to the unrealized gains on these contracts. All
agreements are with a diversified selection of institutions with strong credit
ratings which minimizes risk of loss due to nonpayment from the counterparty.
The Company has not experienced any material losses due to credit impairment
of its foreign currency instruments.
Interest Rate Swaps: Interest income is subject to fluctuations as U.S.
interest rates change. To manage this risk, the Company periodically
establishes duration targets for its investment portfolio that reflect its
anticipated use of cash and fluctuations in market rates of interest. The
Company enters into swaps as part of its overall strategy of managing the
duration of its cash portfolio. For each swap, the Company receives interest
based on fixed rates and pays interest to counterparties based on floating
rates [three- or six-month London Inter-Bank Offered Rate (LIBOR)] on a
notional principal amount. By designating a swap with a pool of short-term
securities equal in size to the notional amount of the swap, an instrument
with an effective interest rate and maturity equal to the term of the swap is
created. Increases (decreases) in swap variable payments caused by rising
(falling) interest rates will be essentially offset by increased (reduced)
interest income on the related short-term investments, while the fixed rate
payments received from the swap counterparty establish the Company's interest
income. LIBOR payments received on swaps are highly correlated to interest
collections on short-term investments. The use of swaps in this manner
generates net interest income on the swap and the associated pool of short-
term securities equivalent to interest income that would be earned from a
high-grade corporate security of the same maturity as the swap, while reducing
credit risk (there is no principal invested in a swap). The Company's credit
exposure on swaps is limited to the value of the interest rate swaps that have
become favorable to the Company and any net interest earned but not yet
received. The Company's swap counterparties have strong credit ratings which
minimize the risk of non-performance on the swaps. The Company has not
experienced any material losses due to credit impairment. The Company's
credit exposure on swaps as of December 31, 1997 and 1996, was $3.7 million
and $6.8 million, respectively. The net carrying amount of the swaps, which
reflects the net interest accrued for such swaps, totaled $2.0 million and
$2.1 million at December 31, 1997 and 1996, respectively, and is included in
accounts receivable.
The Company targets the average maturity of its investment portfolio
(including cash, cash equivalents, short-term and long-term investments, swaps
and excluding equity securities) based on its anticipated use of cash and
fluctuations in the market rates of interest. The maturity of the investment
portfolio (including swaps) ranges from overnight funds used for near-term
working capital purposes to investments maturing within the next one to ten
years for future working capital, capital expenditures, strategic investments
and debt repayment.
The notional amount of each swap is equal to the amount of designated high-
quality short-term investments which are expected to be invested in during the
life of the swap. The anticipated investments include U.S. Treasury
securities, U.S. government agency securities, commercial paper and corporate
debt obligations. Swaps are used to extend the maturity of the investment
portfolio.
For the years ended December 31, 1997, 1996 and 1995, the weighted average
rate received on swaps was 7.57%, 6.71% and 7.29%, respectively, and the
weighted average rate paid on swaps was 5.38%, 5.68% and 6.56%, respectively.
Net interest income (loss) from swaps, including amortization of net losses on
terminated swaps, totaled $3.6 million in 1997, $2.5 million in 1996 and
($0.7) million in 1995.
Equity Collar Instruments: To hedge against fluctuations in the market value
of a portion of the marketable equity portfolio, the Company has entered into
costless collar instruments, a form of equity collar instrument, that expire
in 1998 and 1999 and will require settlement in equity securities or cash. A
costless collar instrument is a purchased put option and a written call option
on a specific equity security such that the cost of the purchased put and the
proceeds of the written call offset each other; therefore, there is no initial
cost or cash outflow for these instruments. The fair value of the purchased
puts and the written calls were determined based on quoted market prices at
year end. At December 31, 1997, the notional amount of the put and call
options were $33.7 million and $50.1 million, respectively. At December 31,
1996, the notional amount of the put and call options were $17.2 million and
$27.5 million, respectively.
The tables below outline specific information for the swaps outstanding at
December 31, 1997 and 1996. The fair value is based on market prices of
similar agreements. Dollars are in millions.
<TABLE>
<CAPTION>
Interest Rate Swaps Short-term Investments
--------------------------- ------------------------------
Fixed Average
Rates Variable Effective
Notional To Be Rates To Carrying Average Interest
December 31, 1997: Amounts Received Be Paid* Value Maturity** Rate
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Swaps matched
to investments
to meet maturity
target comparable
to outstanding debt 3- or 6-
[Maturing on: 7.68%- month
1/2/02] $ 150 7.71% LIBOR $ 150 9 days 5.65%
Other short-term
investments - 439
-------- --------
Total $ 150 $ 589
======== ========
December 31, 1996:
- ------------------
Swaps matched
to investments
to meet maturity
target comparable
to outstanding debt 3- or 6-
[Maturing on: 7.68%- month
1/2/02] $ 150 7.71% LIBOR $ 150 13 days 5.66%
Swaps matched to
other investments
to meet specific
maturity targets 3- or 6-
[Ending dates: 4.97%- month
10/27/97-9/20/99] 60 7.20% LIBOR 60 32 days 5.47%
Other short-term
investments - 206
-------- ---------
Total $ 210 $ 416
======== =========
<FN>
* 3- and 6-month LIBOR rates are reset every 3 or 6 months. At December 31,
1997, the 3-month LIBOR rate and the 6-month LIBOR rate were 5.8%. At December
31, 1996, the 3-month LIBOR rate and the 6-month LIBOR rate were 5.6%.
** Average maturity reflects either the maturity date or, for a floating
investment, the next reset date.
</TABLE>
Financial Instruments Held for Trading Purposes: As part of its overall
investment strategy, the Company has contracted with three external money
managers in 1997 and two external money managers in 1996 to manage part of its
investment portfolio. Three portfolios in 1997, which had a combined carrying
value of $145.1 million at December 31, 1997, and one portfolio in 1996, which
had a carrying value of $37.2 million at December 31, 1996, consisted of
primarily non-dollar denominated investments. To hedge the non-dollar
denominated investments, the money managers enter into forward contracts. The
notional amounts of the forward contracts at December 31, 1997 and 1996, were
$209.3 million and $41.7 million, respectively. The fair value at December
31, 1997 and 1996, of the forward contracts, totaled $3.3 million and $0.8
million, respectively. The average fair value during 1997 and 1996 totaled
$2.1 million and $0.3 million, respectively. Net realized and unrealized
trading gains on the portfolio totaled approximately $9.1 million in 1997 and
$2.4 million in 1996, respectively, and are included in interest income.
Counterparties have strong credit ratings which minimize the risk of non-
performance from the counterparties.
Summary of Fair Values: The table below summarizes the carrying value and
fair value at December 31, 1997 and 1996, of the Company's financial
instruments. The fair value of the long-term debt was estimated based on the
quoted market price at year end (in thousands):
1997 1996
------------------ -------------------
Carrying Fair Carrying Fair
Financial Instrument Value Value Value Value
- ------------------------------------------------------------------------------
Assets:
Investment securities
(including accrued interest
and traded forward contracts) $1,042,041 $1,042,060 $951,816 $951,588
Convertible equity loans 55,248 55,248 15,668 15,668
Purchased foreign exchange put
options 3,891 14,468 4,616 7,273
Outstanding interest rate swaps 5,742 165,559 6,757 226,189
Liabilities:
Long-term debt 150,000 139,500 150,000 139,500
Equity collars 12,161 15,533 1,222 4,892
Outstanding interest rate swaps 3,732 153,732 4,635 214,634
OTHER ACCRUED LIABILITIES
Other accrued liabilities at December 31 are as follows (in thousands):
1997 1996
- ------------------------------------------------------------------------------
Accrued compensation $ 44,624 $ 42,716
Accrued clinical and other studies 40,269 39,981
Accrued royalties 30,905 25,098
Accrued marketing and promotion costs 13,369 11,889
Other 55,678 56,328
------------------------------
Total other accrued liabilities $184,845 $176,012
=============================
LONG-TERM DEBT
The Company's long-term debt as of December 31, 1997 and 1996 consisted of
$150.0 million of convertible subordinated debentures, with interest payable
at 5%, due in 2002. The debentures are convertible, at the option of the
holder, into shares of the Company's special common stock. Upon conversion,
the holder receives, for each $74 in principal amount of debenture converted,
one-half share of the Company's special common stock and $18 in cash. The $18
in cash is reimbursed by Roche to the Company. Generally, the Company may
redeem the debentures until maturity.
LEASES, COMMITMENTS AND CONTINGENCIES
Future minimum lease payments under operating leases, net of sublease income,
at December 31, 1997 are as follows (in thousands):
1998 1999 2000 2001 2002 Thereafter Total
- ------------------------------------------------------------------------------
$15,068 15,622 15,196 14,950 14,969 14,759 $90,564
The Company leases various real property under operating leases that generally
require the Company to pay taxes, insurance and maintenance. Rent expense was
approximately $11.7 million, $11.7 million and $9.5 million for the years
1997, 1996 and 1995, respectively. Sublease income was not material in any of
the three years presented.
Under three of the lease agreements, the Company has an option to purchase the
properties at an amount that does not constitute a bargain. Alternatively,
the Company can cause the property to be sold to a third party. The Company
is contingently liable, under residual value guarantees, for approximately
$293.7 million. The Company also is required to maintain certain financial
ratios and is limited to the amount of additional debt it can assume.
The Company and CuraGen Corporation (CuraGen) entered into a research
collaborative agreement in November 1997, whereby the Company will invest $5.0
million in equity of CuraGen and provide a convertible equity loan to CuraGen
of up to $26.0 million. As of December 31, 1997, no amounts have been funded
to CuraGen.
In December 1997, the Company and Alteon Inc. entered into a collaborative
agreement to develop and market pimagedine, an advanced glycosylation end-
product formation inhibitor which Alteon currently has in Phase III clinical
trials, to treat kidney disease in diabetic patients. Under the terms of the
agreement, the Company licensed pimagedine from Alteon and made an initial
equity investment in Alteon stock of $15.0 million and will make additional
equity investments of up to $48.0 million to fund development costs for
pimagedine. A $16.0 million investment is scheduled for the first quarter of
1998.
Also, in December 1997, the Company and LeukoSite Inc. entered into a
collaboration agreement to develop and commercialize LeukoSite's LDP-02, a
humanized monoclonal antibody for the potential treatment of inflammatory
bowel diseases. Under the terms of the agreement, the Company made a $4.0
million equity investment in LeukoSite and will provide a convertible equity
loan for approximately $15.0 million to fund Phase II development costs. Upon
successful completion of Phase II, if LeukoSite agrees to fund 25% of Phase
III development costs, the Company will provide a second loan to LeukoSite for
such funding.
In addition, the Company has entered into research collaborations with
companies whereby potential future payments may be due to selective
collaborative partners achieving certain benchmarks as defined in the
collaborative agreements. The Company may also, from time-to-time, lend
additional funds to these companies, subject to approval.
The Company is a limited partner in the Vector Later-Stage Equity Fund II,
L.P. (Vector Fund). The General Partner is Vector Fund Management II, L.L.C.,
a Delaware limited liability company. The purpose of the Vector Fund is to
invest in biotech equity and equity-related securities. Under the terms of
the Vector Fund agreement, the Company makes contributions to the capital of
the Vector Fund through installments in cash as called by the General Partner.
The Company's total commitment to the Vector Fund through September 2003 is
$25.0 million, of which $1.0 million was contributed as of December 31, 1997
and another $1.8 million was contributed in January 1998. The Vector Fund
will terminate and be dissolved in September 2007.
The Company is a party to various legal proceedings including patent
infringement cases involving human growth hormone products and Activase,
product liability cases involving Protropin and other matters. In addition,
in July 1997, an action was filed in the U.S. District Court for the Northern
District of California alleging that the Company's manufacture, use and sale
of its Nutropin human growth hormone products infringed a patent (the Goodman
Patent) owned by the Regents of the University of California (UC). This
action is substantially the same as a previous action filed in 1990 against
the Company by UC alleging that the Company's manufacture, use and sale of its
Protropin human growth hormone products infringed the Goodman Patent and it
has been consolidated with that prior case. The case is expected to commence
trial on June 22, 1998. In October 1997, the Company was named, along with
several other pharmaceutical companies, in a lawsuit brought by Novo Nordisk
A/S (Novo) in the U.S. District Court for the District of New Jersey alleging
infringement of a patent held by Novo relating to the Company's manufacture,
use and sale of its Nutropin human growth hormone products. Novo seeks to
permanently enjoin the Company from the alleged patent infringement and also
seeks compensatory and enhanced damages from the Company. In addition, in
1995 the Company received and responded to grand jury document subpoenas from
the U.S. District Court for the Northern District of California for documents
relating to the Company's past clinical, sales and marketing activities
associated with human growth hormone. In February 1997 and February 1998, the
Company received grand jury document subpoenas from the same court related to
the same subject matter. The government is investigating this matter, and the
Company believes that it is a subject of that investigation.
Based upon the nature of the claims made and the investigations completed to
date by the Company and its counsel, the Company believes the outcome of these
actions will not have a material adverse effect on the financial position,
results of operations or cash flows of the Company. However, were an
unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the net income of that period.
RELATIONSHIP WITH ROCHE HOLDINGS, INC.
On October 25, 1995, the Company and Roche entered into the Agreement. Each
share of the Company's common stock not held by Roche or its affiliates on
that date automatically converted to one share of callable putable common
stock (special common stock). The Agreement extends until June 30, 1999,
Roche's option to cause the Company to redeem (call) the outstanding special
common stock of the Company at predetermined prices. Should the call be
exercised, Roche will concurrently purchase from the Company a like number of
common shares for a price equal to the Company's cost to redeem the special
common stock. During the quarter beginning January 1, 1998, the call price is
$75.00 per share and increases by $1.50 per share each quarter through the end
of the option period on June 30, 1999, on which date the price will be $82.50
per share. If Roche does not cause the redemption as of June 30, 1999, the
Company's stockholders will have the option (the put) to cause the Company to
redeem none, some or all of their shares of special common stock at $60.00 per
share (and Roche will concurrently provide the necessary redemption funds to
the Company by purchasing a like number of shares of common stock at $60.00
per share) within thirty business days commencing July 1, 1999. Roche Holding
Ltd, a Swiss corporation, has guaranteed Roche's obligation under the put.
In the event of the put, wherein sufficient shares of the Company's special
common stock are tendered to result in Roche owning at least 85% of the total
outstanding shares of the Company's stock, the Company has in place an
Incentive Units Program (Program) which could result in amounts payable to
eligible employees. These amounts are based on specified performance
benchmarks achieved by the Company during the term of the Program. At
December 31, 1997, no such amounts were payable under the Program.
In conjunction with the Agreement, HLR was granted an option for ten years for
licenses to use and sell certain of the Company's products in non-U.S. markets
(the license agreement). In the second quarter of 1997, the Company and HLR
agreed in principle to changes to the license agreement. Key changes to the
license agreement are summarized as follows: (1) For future products, HLR may
choose to exercise its option either when the Company determines to move a
product into development, or at the end of Phase II clinical trials (as in the
1995 agreement). U.S. and European development costs will be shared
(discontinuing the distinction regarding location or purpose of studies). (2)
If HLR exercises its option at the development determination point, U.S. and
European development costs will be shared 50/50. (3) If HLR exercises its
option at the end of Phase II clinical trials, HLR will reimburse the Company
for 50 percent of any development costs incurred, and subsequent U.S. and
European development costs will be shared 75/25, HLR/Genentech. (4) For nerve
growth factor (NGF), which HLR has already exercised its option to develop,
prospective U.S. and European development costs will be shared 60/40,
HLR/Genentech. (5) HLR has assumed development of Xubix, trademark, (the oral
IIb/IIIa antagonist) globally on its own. The Company may subsequently opt-in
and join development at any time up to the New Drug Application (NDA) filing
for the first indication. If the Company does not opt-in, it will receive
from HLR a 6.0% royalty on worldwide sales of Xubix.
In general, with respect to the Company's products, HLR pays a royalty of
12.5% until a product reaches $100.0 million in aggregate sales outside of the
U.S. on a country-by-country basis, at which time the royalty rate on all
sales increases to 15%. In addition, HLR has rights to, and pays the Company
20% royalties on, Canadian sales of the Company's existing products, except
Rituxan, trademark, (the C2B8 antibody), and European sales of Pulmozyme and
Rituxan. Consequently, in the fourth quarter of 1995, the Company transferred
to HLR the rights to sell Pulmozyme exclusively in Canada and Europe and
commenced recording royalty revenue from HLR on such sales. The Company
supplies its products to HLR, and has agreed to supply its products for which
HLR has exercised its option, for sales outside of the U.S. at cost plus 20%.
Under the Agreement, independent of its right to cause the Company to redeem
the special common stock, Roche may increase its ownership of the Company up
to 79.9% by making purchases on the open market. Roche holds approximately
66.9% of the outstanding common equity of the Company as of December 31, 1997.
RELATED PARTY TRANSACTIONS
The Company has transactions with Roche, HLR (a wholly owned subsidiary of
Roche, with two officers on the Company's Board of Directors) and its
affiliates in the ordinary course of business. In 1996, HLR exercised its
option under the license agreement with respect to the development of three
projects - Rituxan, insulin-like growth factor (IGF-I) and NGF. The Company
recorded non-recurring contract revenues in 1996 of $44.7 million relating to
the option exercises. Other contract revenue from HLR, including
reimbursement for ongoing development expenses after the option exercise date
for the three projects, totaled $67.6 million in 1997, $50.6 million in 1996
and $13.4 million in 1995. All other revenue from Roche, HLR and their
affiliates, principally royalties under previous product licensing agreements,
and royalties and product sales under the license agreement, totaled $42.8
million in 1997, $39.5 million in 1996 and $14.3 million in 1995. Development
of IGF-I was discontinued in September 1997 due to the amount of additional
clinical effort and the greater period of time that would be required to
address potential concerns about retinopathy when using IGF-I in Type I and
Type II diabetes mellitus. During the three years, the Company has
collaborated with HLR on other projects.
CAPITAL STOCK
Common Stock, Special Common Stock and Redeemable Common Stock: After the
close of business on June 30, 1995, each share of the Company's redeemable
common stock automatically converted to one share of Genentech common stock,
in accordance with the terms of the redeemable common stock put in place at
the time of its issuance in 1990 and as described in Genentech's Certificate
of Incorporation. On October 25, 1995, pursuant to the Agreement with Roche,
each share of the Company's common stock not held by Roche or its affiliates
automatically converted to one share of special common stock. See the
Relationship with Roche Holdings, Inc. note above for a discussion of these
transactions.
Stock Award Plans: The Company has stock option plans adopted in 1996, 1994,
1990 and 1984, which variously allow for the granting of non-qualified stock
options, stock awards and stock appreciation rights to employees, non-employee
directors and consultants of the Company. Incentive stock options may only be
granted to employees under these plans. Generally, non-qualified options have
a maximum term of 20 years, except those granted under the 1996 Plan and
options granted prior to 1992 under the 1984 Plan, which have a term of 10
years. Incentive options have a maximum term of 10 years. In general,
options vest in increments over four years from the date of grant, although
the Company may grant options with different vesting terms from time-to-time.
No stock appreciation rights have been granted to date.
The Company adopted the 1991 Employee Stock Plan (1991 Plan) on December 4,
1990, and amended it during 1993, 1995 and 1997. The 1991 Plan allows
eligible employees to purchase special common stock at 85% of the lower of the
fair market value of the special common stock on the grant date or the fair
market value on the first business day of each calendar quarter. Purchases
are limited to 15% of each employee's eligible compensation. All full-time
employees of the Company are eligible to participate in the 1991 Plan. Of the
4,500,000 shares of special common stock reserved for issuance under the 1991
Plan, 3,316,826 shares have been issued as of December 31, 1997. During 1997,
2,624 of the eligible employees participated in the 1991 Plan.
The Company has elected to continue to follow APB 25 for accounting for its
employee stock options because the alternative fair value method of accounting
prescribed by FAS 123, Accounting for Stock-Based Compensation, requires the
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB 25, Accounting for Stock Issued to
Employees, no compensation expense is recognized because the exercise price of
the Company's employee stock options equals the market price of the underlying
stock on the date of grant.
Pro forma information regarding net income and earnings per share has been
determined as if the Company had accounted for its employee stock options and
employee stock plan under the fair value method prescribed by FAS 123 and the
earnings per share method under FAS 128. The resulting effect on pro forma
net income and earnings per share disclosed is not likely to be representative
of the effects on net income and earnings per share on a pro forma basis in
future years, due to subsequent years including additional grants and years of
vesting. The fair value of options was estimated at the date of grant using a
Black-Scholes option valuation model with the following weighted average
assumptions for 1997, 1996 and 1995, respectively: risk-free interest rates
of 6.2%, 5.8% and 6.0%; dividend yields of 0%; volatility factors of the
expected market price of the Company's common stock of 9.2%, 6.2% and 6.2%;
and a weighted-average expected life of the option of five years.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.
For purposes of pro forma disclosures, the estimated fair value of options is
amortized to pro forma expense over the options' vesting period. Pro forma
information for the years ending December 31 follows (in thousands, except per
share amounts):
1997 1996 1995
------ ------ ------
Net income - as reported $ 129,044 $ 118,348 $ 146,432
Net income - pro forma $ 111,441 104,358 142,370
Earnings per share - as reported:
Basic 1.05 0.98 1.24
Diluted 1.02 0.95 1.20
Earnings per share - pro forma:
Basic 0.91 0.87 1.20
Diluted 0.89 0.84 1.17
A summary of the Company's stock option activity and related information were
as follows:
Shares Weighted Average
Price
------------ ----------------
Options outstanding at December 31, 1994 15,980,807 $ 34.93
Grants 1,303,800 48.52
Exercises (1,472,759) 24.60
Cancellations (602,774) 42.59
------------
Options outstanding at December 31, 1995 15,209,074 36.80
Grants 6,761,545 53.99
Exercises (1,624,541) 29.39
Cancellations (743,569) 48.93
------------
Options outstanding at December 31, 1996 19,602,509 42.89
Grants 329,505 58.21
Exercises (2,443,696) 30.07
Cancellations (1,248,709) 52.35
------------
Options outstanding at December 31, 1997 16,239,609 $ 44.41
============
The following table summarizes information concerning currently outstanding
and exercisable options:
Options Outstanding Options Exercisable
----------------------------------- --------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- ----------------- ----------- ----------- -------- ----------- --------
$14.080 - $20.625 753,169 1.19 $ 17.21 753,169 $ 17.21
$21.375 - $31.000 3,064,884 11.59 26.42 3,011,197 26.42
$32.125 - $48.125 2,484,800 15.69 41.83 2,102,035 40.69
$48.250 - $59.000 9,936,756 12.44 52.68 2,677,214 52.07
----------- -----------
16,239,609 8,543,615
=========== ===========
Using the Black-Scholes option valuation model, the weighted average fair
value of options granted in 1997, 1996 and 1995, respectively was $15.37,
$13.36 and $12.27. Shares of special common stock available for future grants
under all stock option plans were 5,401,056 at December 31, 1997.
QUASI-REORGANIZATION
On October 1, 1987, the Company eliminated its accumulated deficit through an
accounting reorganization of its stockholders' equity accounts (a quasi-
reorganization) that did not involve any revaluation of assets or liabilities.
An accumulated deficit of $329.5 million was eliminated by a transfer from
additional paid-in capital in an amount equal to the accumulated deficit.
The Company has been recording, in income, the recognition of operating loss
and tax credit carryforward items arising prior to the quasi-reorganization
due to the Company's adoption of its quasi-reorganization in the context of
the accounting and quasi-reorganization literature existing at the date the
quasi-reorganization was effected. If the provisions of the subsequently
issued Staff Accounting Bulletin 86 (SAB 86) had been applied, net income in
1995 would have been reduced by $11.8 million or $0.10 per share because SAB
86 would require that the tax benefits of prior operating loss and tax credit
carryforwards be reported as a direct addition to additional paid-in capital
rather than being recorded in the income statement. The Securities and
Exchange Commission staff has indicated that it would not object to the
Company's accounting for such tax benefits. As of June 30, 1995, the
operating loss and tax credit carryforwards arising prior to the quasi-
reorganization had been fully utilized, therefore there was no impact on
earnings in 1996 and 1997.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of Genentech, Inc.
We have audited the accompanying consolidated balance sheets of Genentech,
Inc. as of December 31, 1997 and 1996, and the related consolidated statements
of income, stockholders' equity, and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Genentech, Inc.
at December 31, 1997 and 1996, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1997, in conformity with generally accepted accounting principles.
Ernst & Young LLP
San Jose, California
January 20, 199
QUARTERLY FINANCIAL DATA (UNAUDITED)
(thousands, except per share amounts)
1997 Quarter Ended
----------------------------------------------
December 31 September 30 June 30 March 31
- -------------------------------------------------------------------------------
Total revenues $277,053 $248,917 $233,493 $257,285
Product sales 143,352 142,306 145,018 154,213
Gross margin from product sales 120,633 115,741 119,451 126,528
Net income 41,529 32,122 23,794 31,599
Earnings per share:
Basic 0.34 0.26 0.19 0.26
Diluted 0.33 0.25 0.19 0.25
1996 Quarter Ended
----------------------------------------------
December 31 September 30 June 30 March 31
- -------------------------------------------------------------------------------
Total revenues $230,325 $251,707 $243,762 $242,884
Product sales 139,724 142,463 148,305 152,337
Gross margin from product sales 113,065 117,627 121,152 126,458
Net income 7,470 50,942 21,719 38,217
Earnings per share:
Basic 0.06 0.42 0.18 0.32
Diluted 0.06 0.41 0.17 0.31
<TABLE>
<CAPTION>
11-YEAR FINANCIAL SUMMARY (UNAUDITED)
(millions, except per share and employee data)
1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total revenues $1,016.7 $ 968.7 $ 917.8 $ 795.4 $ 649.7
Product sales 584.9 582.8 635.3 601.0 457.4
Royalties 241.1 214.7 190.8 126.0 112.9
Contract & other 121.6 107.0 31.2 25.6 37.9
Interest 69.1 64.2 60.5 42.8 41.5
----------------------------------------------
Total costs and expenses $ 846.9 $ 820.8 $ 745.6 $ 665.8 $ 590.8
Cost of sales 102.5 104.5 97.9 95.8 70.5
Research & development 470.9 471.1 363.0 314.3 299.4
Marketing, general & administrative 269.9 240.1 251.7 248.6 214.4
Special charge - - 25.0(1) - -
Interest 3.6 5.1 8.0 7.1 6.5
----------------------------------------------
Income data
Income (loss) before taxes $ 169.8 $ 147.9 $ 172.2 $ 129.6 $ 58.9
Income tax provision 40.8 29.6 25.8 5.2 -
Net income (loss) 129.0 118.3 146.4 124.4 58.9
Earnings (loss) per share:
Basic 1.05 0.98 1.24 1.07 0.52
Diluted 1.02 0.95 1.20 1.03 0.50
----------------------------------------------
Selected balance sheet data
Cash, short-term investments
& long-term marketable securities $1,286.5 $1,159.1 $1,096.8 $ 920.9 $ 719.8
Accounts receivable 189.2 197.6 172.2 146.3 130.5
Inventories 116.0 91.9 93.6 103.2 84.7
Property, plant & equipment, net 683.3 586.2 503.7 485.3 456.7
Other long-term assets 177.2 149.2 105.5 61.0 64.1
Total assets 2,507.6 2,226.4 2,011.0 1,745.1 1,468.8
Total current liabilities 289.6 250.0 233.4 220.5 190.7
Long-term debt 150.0 150.0 150.0 150.4 151.2
Total liabilities 476.4 425.3 408.9 396.3 352.0
Total stockholders' equity 2,031.2 1,801.1 1,602.0 1,348.8 1,116.8
----------------------------------------------
Other data
Depreciation and amortization expense $ 65.5 $ 62.1 $ 58.4 $ 53.5 $ 44.0
Capital expenditures 154.9 141.8 70.2 82.8 87.5
----------------------------------------------
Share information
Shares used to compute EPS:
Basic 123.0 120.6 118.3 116.0 113.9
Diluted 126.4 124.0 121.7 120.2 118.7
Actual year-end 124.2 121.4 119.3 117.2 114.8
----------------------------------------------
Per share data
Market price: High $ 60.63 $ 55.38 $ 53.00* $ 53.50 $ 50.50
Low $ 53.25 $ 51.38 $ 44.50* $ 41.75 $ 31.25
Book value $ 16.35 $ 14.84 $ 13.43 $ 11.50 $ 9.73
----------------------------------------------
Number of employees 3,242 3,071 2,842 2,738 2,510
----------------------------------------------
<FN>
The Company has paid no dividends.
The Financial Summary above reflects adoption of FAS 128 and 129 in 1997, FAS 121 in
1996, FAS 115 in 1994, FAS 109 in 1992 and FAS 96 in 1988.
All share and per share amounts reflect a two-for-one split in 1987.
*Special common stock began trading October 26, 1995. On October 25, 1995, pursuant
to the new Agreement with Roche, each share of the Company's common stock not held by
Roche or its affiliates automatically converted to one share of special common stock.
**Redeemable common stock began trading September 10, 1990; prior to that date
all shares were common stock. Pursuant to the merger agreement with Roche, all
shareholders as of effective date September 7, 1990, received for each common
share owned, $18 in cash from Roche and one-half share of newly issued
redeemable common stock from the Company.
(1) Charges related to 1995 merger and new Agreement with Roche ($21 million) and
resignation of the Company's former CEO ($4 million).
(2) Charges primarily related to 1990 Roche merger.
(3) Primarily inventory-related charge.
(4) Reflect amounts previously reported. Information was not available to restate
these amounts pursuant to FAS 128.
</TABLE>
1992 1991 1990 1989 1988 1987
- --------------------------------------------------------------------
$ 544.3 $ 515.9 $ 476.1 $ 400.5 $ 334.8 $ 230.5
391.0 383.3 367.2 319.1 262.5 141.4
91.7 63.4 47.6 36.7 26.7 20.1
16.7 20.4 31.9 27.5 33.5 57.1
44.9 48.8 29.4 17.2 12.1 11.9
- --------------------------------------------------------------------
$ 522.3 $ 469.8 $ 572.7 $ 352.9 $ 311.7 $ 186.6
66.8 68.4 68.3 60.6 46.9 23.8
278.6 221.3 173.1 156.9 132.7 96.5
172.5 175.3 158.1 127.9 101.9 59.5
- - 167.7(2) - 23.3(3) -
4.4 4.8 5.5 7.5 6.9 6.8
- --------------------------------------------------------------------
$ 21.9 $ 46.1 $ (96.6) $ 47.6 $ 23.1 $ 43.9
1.1 1.8 1.5 3.6 2.5 1.7
20.8 44.3 (98.0) 44.0 20.6 42.2
0.19 0.40 - - 0.25 0.54
0.18 0.39 (1.05)(4) 0.51(4) 0.24 0.50
- --------------------------------------------------------------------
$ 646.9 $ 711.4 $ 691.3 $ 205.0 $ 152.5 $ 158.3
93.9 69.0 58.8 66.8 63.9 92.2
65.3 56.2 39.6 49.3 63.4 58.0
432.5 342.5 300.2 299.1 289.4 195.7
37.1 42.7 61.7 85.0 89.7 108.7
1,305.1 1,231.4 1,157.7 711.2 662.9 619.0
133.5 118.6 101.4 75.9 95.4 82.8
152.0 152.9 153.5 154.4 155.3 168.1
297.8 281.7 264.5 242.2 263.6 263.6
1,007.3 949.7 893.2 469.0 399.3 355.4
- --------------------------------------------------------------------
$ 52.2 $ 46.9 $ 47.6 $ 44.6 $ 38.3 $ 23.5
126.0 71.3 36.0 37.2 110.9 65.3
- --------------------------------------------------------------------
111.9 111.0 - - 82.2 78.1
115.0 113.2 93.0(4) 86.0(4) 85.0 85.1
112.9 111.3 110.6 84.3 82.9 78.7
- --------------------------------------------------------------------
$ 39.50 $ 36.25 $ 30.88 $ 23.38 $ 47.50 $ 64.75
$ 27.50**
$ 25.88 $ 20.75 $ 20.13 $ 16.00 $ 14.38 $ 28.00
$ 21.75**
$ 8.92 $ 8.53 $ 8.08 $ 5.56 $ 4.82 $ 4.52
- --------------------------------------------------------------------
2,331 2,202 1,923 1,790 1,744 1,465
- --------------------------------------------------------------------
COMMON STOCK, SPECIAL COMMON STOCK AND REDEEMABLE COMMON STOCK INFORMATION
Stock Trading Symbol GNE
Stock Exchange Listings
The Company's callable putable common stock (special common stock) has traded
on the New York Stock Exchange and the Pacific Exchange under the symbol GNE
since October 26, 1995. On October 25, 1995, the Company's non-Roche
stockholders approved a new agreement (the Agreement) with Roche Holdings,
Inc. (Roche). Pursuant to the Agreement, each share of the Company's common
stock not held by Roche or its affiliates automatically converted to one share
of special common stock. From July 3, 1995 through October 25, 1995, the
Company's common stock was traded under the symbol GNE. After the close of
business on June 30, 1995, each share of the Company's redeemable common stock
automatically converted to one share of the Company's common stock. The
conversion was in accordance with the terms of the redeemable common stock put
in place at the time of its issuance on September 7, 1990, when the Company's
merger with a wholly owned subsidiary of Roche was consummated. The
redeemable common stock of the Company traded under the symbol GNE from
September 10, 1990 to June 30, 1995. The Company's common stock was traded on
the New York Stock Exchange under the symbol GNE from March 2, 1988, until
September 7, 1990, and on the Pacific Exchange under the symbol GNE from April
12, 1988, until September 7, 1990. The Company's common stock was previously
traded in the NASDAQ National Market System under the symbol GENE. No
dividends have been paid on the common stock, special common stock or
redeemable common stock. The Company currently intends to retain all future
income for use in the operation of its business and, therefore, does not
anticipate paying any cash dividends in the foreseeable future. See the
"Relationship with Roche Holdings, Inc." note in the "Notes to Consolidated
Financial Statements" for a further description of the Agreement with Roche.
Special Common Stockholders
As of December 31, 1997, there were approximately 15,122 stockholders of
record of the Company's special common stock.
Stock Prices Special Common/Redeemable Common/Common Stock
1997 1996
- --------------------------------------------------------------------------
High Low High Low
-------------------------------------------------
4th Quarter $ 60 5/8 $ 57 1/2 $ 54 3/8 $ 52 3/4
3rd Quarter 58 15/16 56 1/2 53 1/4 51 3/8
2nd Quarter 59 1/4 56 1/2 53 3/8 51 7/8
1st Quarter 58 53 1/4 55 3/8 52 1/2
Draft # 2 (3/3/98)
Exhibit 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Genentech, Inc. of our report dated January 20, 1998, included in the 1997
Annual Report to Stockholders of Genentech, Inc.
Our audits also included the financial statement schedule of Genentech, Inc.
listed in Item 14(a). This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
We also consent to the incorporation by reference in the Registration
Statements pertaining to the 1991 Employee Stock Plan, the 1996 Stock
Option/Stock Incentive Plan, the 1994 Stock Option 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 convertible
subordinated debenture holders, the Genentech, Inc. Tax Reduction Investment
Plan and in the related Prospectuses of our report dated January 20, 1998,
with respect to the consolidated financial statements incorporated herein by
reference, and our report included in the preceding paragraph with respect to
the financial statement schedule included in this Annual Report (Form 10-K)
for the year ended December 31, 1997.
Ernst & Young LLP
San Jose, California
February 27, 1998
<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-K FOR THE YEAR ENDED
DECEMBER 31, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS AND THE NOTES THERETO. ALSO, THE EPS-PRIMARY REPRESENTS
THE EPS-BASIC CALCULATED PURSUANT TO FAS 128.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 244,469
<SECURITIES> 1,042,041
<RECEIVABLES> 203,780
<ALLOWANCES> 14,535
<INVENTORY> 116,026
<CURRENT-ASSETS> 1,193,918
<PP&E> 1,059,395
<DEPRECIATION> 376,091
<TOTAL-ASSETS> 2,507,612
<CURRENT-LIABILITIES> 289,557
<BONDS> 150,000
0
0
<COMMON> 2,484
<OTHER-SE> 2,028,741
<TOTAL-LIABILITY-AND-EQUITY> 2,507,612
<SALES> 584,889
<TOTAL-REVENUES> 1,016,748
<CGS> 102,536
<TOTAL-COSTS> 102,536
<OTHER-EXPENSES> 470,923
<LOSS-PROVISION> 13,976
<INTEREST-EXPENSE> 3,642
<INCOME-PRETAX> 169,795
<INCOME-TAX> 40,751
<INCOME-CONTINUING> 129,044
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 129,044
<EPS-PRIMARY> 1.05
<EPS-DILUTED> 1.02
</TABLE>
