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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, 1998
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.
Delaware 94-2347624
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
1 DNA Way, South San Francisco, California 94080
(Address of principal executive offices and zip code)
(650) 225-1000
(Registrant's telephone number, including area code)
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
=============================================================================
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 $2,772,135,122 as of December 31, 1998. (A)
Number of shares of Common Stock outstanding as of December 31, 1998:
76,621,009
Number of shares of Callable Putable Common Stock outstanding as of
December 31, 1998: 50,493,631
Documents incorporated by reference:
PARTS INCORPORATED
DOCUMENT BY REFERENCE
(1) Annual Report to stockholders for the year ended II
December 31, 1998 (specified portions)
(2) Definitive Proxy Statement with respect to the 1999 III
Annual Meeting of Stockholders to be filed by Genentech,
Inc. with the Securities and Exchange Commission
(hereinafter referred to as "Proxy Statement")
- -----------------------------------------------------------------------------
(A) Excludes 92,327,062 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 December 31, 1998 (the holdings of FMR Corp.,
Goldman Sachs & Co., The Goldman Sachs Group, L.P. and Roche Holdings,
Inc. were calculated based on their filings as of December 31, 1998, with
the Securities and Exchange Commission pursuant to Section 13(g) of the
Securities Exchange Act of 1934. As of January 22, 1999, it is
unconfirmed whether any other person or entity holds greater than five
percent of the registrant's Common Stock and Callable Putable Common
Stock. 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.
<PAGE>
PART I
ITEM 1. BUSINESS
Genentech, Inc. (the Company) is a biotechnology company that uses human
genetic information to discover, develop, manufacture and market human
pharmaceuticals for significant unmet medical needs. Twelve of the approved
products of biotechnology stem from Genentech science. The Company
manufactures and markets eight products (see also the Actimmune section
below) directly in the United States (U.S.).
Relationship with Roche Holdings, Inc.
On October 25, 1995, the Company and Roche Holdings, Inc. (Roche) entered
into an 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 1998 Annual Report to Stockholders
(Part II, Item 8 of this Form 10-K) for further information.
In conjunction with the Agreement, F. Hoffman-La Roche Ltd (HLR), a
subsidiary of Roche, 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 1998 Annual Report to
Stockholders (Part II, Item 8 of this Form 10-K) for further information.
Products
The Company has developed seven products, co-developed one product and
manufactures and markets eight of its products (see also the Actimmune
section below) in the U.S.: Herceptin, registered trademark, (trastuzumab)
anti-HER2 antibody; Rituxan, registered trademark, (rituximab, C2B8)
monoclonal antibody, which was co-developed with IDEC Pharmaceuticals
Corporation (IDEC); Activase, registered trademark, (alteplase, recombinant)
recombinant tissue plasminogen activator (t-PA); Protropin, registered
trademark, (somatrem for injection) recombinant growth hormone; Nutropin,
registered trademark, [somatropin (rDNA origin) for injection] growth
hormone; Nutropin AQ, registered trademark, [somatropin (rDNA origin)
injection] liquid formulation of growth hormone; Pulmozyme, registered
trademark, (dornase alfa, recombinant) inhalation solution; and Actimmune,
registered trademark, (interferon gamma-1b) recombinant interferon gamma.
As part of the Agreement, the Company receives royalties on sales of its
products in Canada, on sales of Pulmozyme outside of the U.S. and on sales of
rituximab outside of the U.S. (excluding Japan) from HLR. The Company
receives royalties on sales of two of its products, growth hormone and t-PA,
outside of the U.S. and Canada through other licensees. The Company also
receives worldwide royalties on five additional licensed products, and
received royalties on one other licensed product for which those royalties
expired in August 1998, that originated from the Company's technology and are
marketed by other companies.
Herceptin: In September 1998, the Company received U.S. Food and Drug
Administration (FDA) approval to market Herceptin for use as first line
therapy in combination with paclitaxel and as a single agent in second and
third line therapy in patients with metastatic breast cancer who have tumors
that overexpress the human epidermal growth factor receptor2 (HER2) protein.
Herceptin is the first humanized monoclonal antibody for the treatment of
HER2 overexpressing metastatic breast cancer and the second U.S. approval in
this new class of monoclonal antibody biotherapeutic cancer drugs. The first
was Rituxan, which was approved in November of 1997. Pursuant to an
agreement entered into with the Company, HLR received exclusive marketing
rights to Herceptin outside of 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 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 was 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 MabThera, trademark, (rituximab) in the rest of the world,
excluding Japan.
In December 1998, a letter was sent to physicians advising them of some
deaths associated with administration of Rituxan. As a result, the Company
and IDEC have updated the Warning section of the package insert to include
information on infusion-related reactions and cardiovascular events.
Activase: 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
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 (AIS) 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, TNK,
which is currently under late stage development. Boehringer markets a
recombinant t-PA under the trademark Actilyse, registered trademark.
In July 1998, the Company discontinued development of Activase for
treating AIS in patients presenting later than three hours from symptom onset
after the termination of two clinical trials, one in AIS patients presenting
three to five hours from symptom onset, and another in AIS patients
presenting zero to six hours from symptom onset. Neither study showed
clinical benefit. Activase is approved for the treatment of AIS within three
hours of symptom onset.
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 and Genotropin. Under the terms of the agreement
with P&U, commencing 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 N-terminal 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 failure in children associated with chronic renal insufficiency (CRI)
up to the time of renal transplantation. CRI causes irreversible damage to
the kidneys and a variety of other medical problems. 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 failure 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 failure in children associated with CRI up to the
time of renal transplantation 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
a sustained release formulation of human 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. In November
1996, Pulmozyme was cleared for marketing by the FDA for the management of CF
patients with advanced disease. In February 1998, the Company received
approval from the FDA for a label extension which includes the safety and
alternative administration of Pulmozyme in children with CF under the age of
five, adding to the product's previous approvals for patients five years of
age and older.
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. During the quarter ended June 30, 1998, the Company licensed U.S.
marketing and development rights to interferon gamma, including Actimmune,
to Connetics Corporation (Connectics). Following a transition period ending
January 1999, the Company will no longer market Actimmune, and has agreed to
supply bulk materials to Connetics at cost plus a mark-up and a royalty.
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:
<TABLE>
<CAPTION>
Product Trademark Company
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<S> <C> <C>
Human growth hormone Humatrope Eli Lilly and Company (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
</TABLE>
Under a December 1994 settlement agreement with Lilly regarding certain of
the Company's patents, royalties of $30.0 million per year were payable to
the Company through 1998, subject to possible offsets and contingent upon
Humulin, registered trademark, continuing to be marketed in the U.S. These
royalty obligations have now expired. Under a prior license agreement with
Lilly, the Company received royalties from Lilly's sales of Humulin. These
royalty payments on Humulin sales expired in August 1998.
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>
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Product Description
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<S> <C>
Phase III
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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). Phase III development in both
allergic asthma and allergic rhinitis began
in 1998.
Neuleze, trademark, A protein that may aid the treatment of
(Nerve Growth Factor) diabetic peripheral neuropathy (HLR has
exercised its option for this product outside
of the U.S.). The Company is in the process
of concluding Phase III clinical trials.
Nutropin Depot, trademark, A sustained release version of human growth
(Sustained-Release Growth hormone based on Alkermes' ProLease,
Hormone) registered trademark, injectable sustained
release drug delivery system designed to
reduce the need for daily injections (being
developed in collaboration with Alkermes,
Inc.). The Company is currently preparing
FDA regulatory filings.
Pulmozyme Inhalation Solution An approved treatment for the management of
CF in patients 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.
This t-PA version may be faster acting,
easier to administer and may restore blood
flow faster. The Company has completed
enrollment in Phase III clinical trials in
AMI patients (being developed in collaboration
with Boehringer Ingelheim, GmbH.)
gp120 A recombinant form of the gp120 envelope
protein of human immunodeficiency virus (HIV-1),
which may serve as the basis for the development
of a prophylactic HIV/Acquired Immune Deficiency
Syndrome (AIDS) vaccine. Under a license
agreement entered into with VaxGen Inc. (VaxGen),
the Company is responsible for supplying
specified amounts of clinical quantities of
gp120 (and has an option to supply additional
clinical supplies); VaxGen is responsible for
conducting all clinical trials necessary for
worldwide product approvals. Currently,
VaxGen is conducting phase III trials with
gp120. The Company has separate options for
worldwide marketing rights and commercial
supply of gp120 in the event that gp120 is
approved as an AIDS vaccine.
Xubix, trademark, (Sibrafiban) An inhibitor of platelet aggregation that may
oral IIb/IIIa antagonist be useful in the prevention of unwanted
clotting in certain cardiovascular conditions
(HLR is conducting global development of this
molecule, and the Company retains certain
opt-in rights with respect to the U.S.).
Phase II
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Anti-CD11a antibody An antibody designed to block certain
immune cells as a potential treatment for
psoriasis (being developed in collaboration
with Xoma Corporation).
Anti-CD18 antibody An antibody designed to address problems
related to loss of blood flow. The Company
is conducting Phase II clinical trials aimed
at increasing blood flow in AMI patients.
Anti-VEGF antibody An antibody developed to inhibit angiogenesis
(the formation of new blood vessels) as a
potential treatment for several types of
cancer. In pre-clinical studies the anti-
VEGF antibody resulted in decreased
vascularization and a decline in growth and
metastasis of a variety of solid tumors.
Phase II studies are ongoing in prostate
cancer, breast cancer, renal cell carcinoma,
lung cancer and colorectal cancer.
Herceptin An approved treatment for metastatic breast
cancer, Herceptin will also be evaluated for
broader application in breast cancer as well
as in other tumor types. The Company is
planning to conduct Phase II studies alone or
in collaboration with HLR, the National Cancer
Institute or other clinical research groups.
Rituxan A monoclonal antibody marketed to treat
relapsed or refractory low-grade or
follicular, CD20-positive B-cell non-
Hodgkin's lymphoma, a cancer of the immune
system. The Company is in Phase II clinical
trials for the treatment of intermediate and
high-grade non-Hodgkin's lymphoma (being
developed in collaboration with IDEC).
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) 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 and is
currently in Phase II clinical trials.
Phase I
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LDP-02 A humanized monoclonal antibody for the
treatment of inflammatory bowel diseases
(licensed from and being developed in
collaboration with LeukoSite, Inc.). The
Company is currently conducting Phase I
clinical trials in Canada and the United
Kingdom.
</TABLE>
In conjunction with the Agreement and revisions agreed upon in principle in
the second quarter of 1997, 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). See the Relationship with Roche Holdings,
Inc. note in the Notes to Consolidated Financial Statements in the Company's
1998 Annual Report to Stockholders (Part II, Item 8 of this Form 10-K) for
further information.
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., 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 Activase, Protropin, Nutropin, Pulmozyme and Actimmune, sales of
Pulmozyme outside of the U.S. and sales of Rituxan outside of the U.S.,
excluding Japan. 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%.
In addition, in July 1998, the Company entered into an agreement with HLR to
provide HLR exclusive marketing rights outside of the U.S. for Herceptin.
Under the agreement, HLR paid $40.0 million and has agreed to pay cash
milestones tied to future product development activities, to contribute
equally with the Company up to a maximum of $40.0 million on global
development costs and to make royalty payments on product sales. As of
December 31, 1998, no additional amounts have been paid.
In December 1997, the Company and Alteon Inc. (Alteon) entered into a
collaborative agreement to develop and market pimagedine, an advanced
glycosylation end-product formation inhibitor to treat kidney disease in
diabetic patients. Under the terms of the agreement, the Company licensed
pimagedine and second generation compounds from Alteon and has made
investments in Alteon stock of $37.5 million. In 1998, as a result of
unsuccessful clinical trials with pimagedine and the decline in the value of
the Company's investment in Alteon, the Company wrote down $24.2 million of
its marketable and nonmarketable equity investments in Alteon. The Company
is in discussions with Alteon as to the future direction of the
collaboration.
The Company and CuraGen Corporation (CuraGen) entered into a research
collaborative agreement in November 1997, whereby the Company invested $5.0
million in equity of CuraGen and has agreed to provide a convertible equity
loan to CuraGen of up to $26.0 million. As of December 31, 1998, no loan
amounts have been funded to CuraGen.
Also, in December 1997, the Company and LeukoSite Inc. (LeukoSite) 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 has agreed to 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 has agreed to
provide a second loan to LeukoSite for such funding. As of December 31,
1998, no loan amounts have been funded to LeukoSite.
Distribution
The Company has a U.S.-based pharmaceutical marketing, sales and distribution
organization. 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 1998, the Company provided certain marketing programs relating to
Activase, including comprehensive wastage replacement and expired product
programs for Activase that, 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 programs.
As discussed in the Notes to Consolidated Financial Statements in the
Company's 1998 Annual Report to Stockholders (Part II, Item 8 of this Form
10-K), the Company had four major customers, including HLR, who provided over
10% of total revenues. Also discussed in the note are revenues from foreign
customers in 1998, 1997 and 1996.
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 that 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, HERCEPTIN 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 1998, 1997 and 1996 for
patent licenses, know-how and other related rights amounted to $229.6
million, $241.1 million and $214.7 million, respectively. Royalty expenses
for 1998, 1997 and 1996, were $66.3 million, $58.9 million and $58.9 million,
respectively.
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 collaborators' 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.
Herceptin: Herceptin is the first humanized monoclonal antibody for the
treatment of HER2 overexpressing metastatic breast cancer and the second U.S.
approval in this new class of monoclonal antibody biotherapeutic cancer
drugs. The first was Rituxan.
Rituxan: Rituxan received designation as a U.S. Orphan Drug by the FDA in
1994 for the treatment of B-cell NHL. Genentech is aware of other
potentially competitive biologic therapies in development. Coulter
Pharmaceuticals, Inc. (Coulter) recently filed for approval with the FDA with
respect to one such product for a similar indication for which Rituxan is
approved.
Activase: The Company continues to face competition from Retavase,
registered trademark, a thrombolytic agent. Retavase received FDA approval
in October 1996 for the treatment of AMI. The Company believes Retavase
infringes on its patents and has filed a patent infringement action against
Boehringer Mannheim (BM). Centocor, Inc. (Centocor) purchased the U.S. and
Canadian rights to Retavase from BM. In addition, the market for
thrombolytic therapy has declined as there is an increasing use of mechanical
reperfusion 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 AIS 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.
In March 1998, the Company received two new patents related to variant
forms of t-PA. Based on these patents, the Company filed an infringement
action against Centocor in the Northern District of California which alleges
that Centocor's sale, offer for sale, use in, and importation into, the U.S.
of Retavase (Reteplase, recombinant), a t-PA, infringes these two new patents
of the Company. The Company is seeking a permanent injunction and damages.
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, 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 February 1998, the Company received approval from
the FDA for a label extension which includes the safety and alternative
administration of Pulmozyme in children under the age of five with CF. 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.
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 new
products and additional indications for existing products in 1999 and beyond.
Competition: The Company faces growing competition in two of its
therapeutic markets and expects new competition in a third. First, Activase
lost market share and could lose additional market share in the thrombolytic
market to Centocor's Retavase and the resulting adverse effect on sales
could be material. Retavase received FDA approval in October 1996 for the
treatment of AMI. In addition, there is an increasing use of mechanical
reperfusion in lieu of thrombolytic therapy for the treatment of AMI, which
is expected to continue. Second, in the growth hormone market, the Company
continues to face increased competition from five other companies with
growth hormone products, although one company has been preliminarily
enjoined from selling its product. As a result of this competition, the
Company has experienced a loss in new patient market share. Four of these
competitors have also received approval to market their existing human
growth hormone products for additional indications. The Company expects
that such competition could have an adverse effect on its sales of
Protropin, Nutropin and Nutropin AQ and such effect could be material.
Third, in the NHL market, Coulter recently filed for approval with the FDA
with respect to a product for a similar indication for which Rituxan is
approved. Genentech is aware of other potentially competitive biologic
therapies in development.
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 1998 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 reimbursements, if any; variations in HLR's sales and other licensees'
sales of licensed products; 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 and
other licensees; whether and when contract benchmarks are achieved; and the
conclusion of existing arrangements with other companies and HLR.
R&D: The Company is committed to aggressive R&D investment to discover and
develop new products. 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, as
revenues increase, R&D as a percent of revenues should decrease to the 20% to
25% range.
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 that may delay, limit or prevent
regulatory approvals. The length of time necessary to complete clinical
trials and to submit an application for marketing approval for a final
decision by a regulatory authority varies significantly and may be difficult
to predict. Factors affecting the Company's R&D expenses include, but are
not limited to: the number of and the outcome of clinical trials currently
being conducted by the Company and/or its collaborators; 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.
Income Tax Provision: The Company expects its effective tax rate to be 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,
interpretation of existing tax laws, 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 been, 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: The Company uses and relies on a wide variety of information
technologies, computer systems and scientific and manufacturing equipment
containing computer related components (such as programmable logic
controllers and other embedded systems). Some of the Company's older
computer software programs and equipment are unable to distinguish between
the year 1900 and the year 2000. As a result, time-sensitive functions of
those software programs and equipment may misinterpret dates after January 1,
2000, to refer to the twentieth century rather than the twenty-first century.
This could cause system or equipment shutdowns, 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 a Year 2000 Project (Y2K Project) in place to address
the potential exposures related to the impact on its computer systems and
scientific and manufacturing equipment containing computer related components
for the Year 2000 and beyond. Approximately half of the Company's Year 2000
(Y2K) scheduled work is complete. The remaining work is scheduled to be
completed by the end of the third quarter of 1999. The Y2K Project phases
include: (1) inventorying and prioritizing business critical systems; (2)
Y2K compliance analysis; (3) remediation activities including repairing or
replacing identified systems; (4) testing; and (5) developing contingency
plans.
An inventory of business critical financial, informational and
operational systems, including manufacturing control systems, has been
completed. Compliance analysis is approximately 80% complete for these
systems. Remediation activities vary by department, however, on the average,
remediation activities are approximately 50% complete. Testing of the
Company's information technology infrastructure is 60% complete. Testing of
business critical application programs began in the third quarter of 1998,
and is scheduled to be complete by the third quarter of 1999. Contingency
planning will begin in the first quarter of 1999. The Company believes that
with the completed modifications, the Y2K issue will not pose significant
operational problems for its computer systems and equipment. 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 precise degree of which cannot be known at
this time.
In addition to risks associated with the Company's own computer systems
and equipment, the Company has relationships with, and is to varying degrees
dependent upon, a large number of third parties that provide information,
goods and services to the Company. These include financial institutions,
suppliers, vendors, research partners, governmental entities and customers.
If significant numbers of these third parties experience failures in their
computer systems or equipment due to Year 2000 non-compliance, it could
affect the Company's ability to process transactions, manufacture products,
or engage in similar normal business activities. While some of these risks
are outside the control of the Company, the Company has instituted programs,
including internal records review and use of external questionnaires, to
identify key third parties, assess their level of Year 2000 compliance,
update contracts and address any non-compliance issues.
The total cost of the Year 2000 systems assessments and conversions is
funded through operating cash flows and the Company is expensing these costs
as they are incurred. The Company has created a mechanism to trace costs
directly related to the Year 2000 issue and has budgeted funds to address the
issues of assessment and conversion. The financial impact of making the
required systems changes cannot be known precisely at this time, but it is
currently expected to be less than $10.0 million. The actual financial
impact could, however, exceed this estimate.
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, 1998, Roche held approximately 65.3%
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. See also
Relationship with Roche Holdings, Inc. note in Notes to Consolidated
Financial Statements in the Company's 1998 Annual Report to Stockholders
(Part II, Item 8 of this Form 10-K) for a discussion of the terms of the put
and call pursuant to the Agreement.
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
Financial Review Section and Description of Business and Significant
Accounting Policies and Financial Instruments notes in the Notes to
Consolidated Financial Statements in the Company's 1998 Annual Report to
Stockholders (Part II, Item 8 of this Form 10-K).
New Accounting Standard: In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards (FAS) 133,
"Accounting for Derivative Instruments and Hedging Activities," effective
beginning in the first quarter of 2000. FAS 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It
requires companies to recognize all derivatives as either assets or
liabilities on the balance sheet and measure those instruments at fair value.
Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting under FAS 133. Based on the requirements of
FAS 133, there may be changes to the balance sheet and reported assets and
liabilities. The Company is currently evaluating the impact of FAS 133 on
its financial position and results of operations.
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 other matters. See the Leases,
Commitments and Contingencies note in the Notes to Consolidated Financial
Statements in the Company's 1998 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 a NDA (New Drug
Application) or a BLA (Biologics 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
1998, 1997 and 1996 the Company's R&D expenses were $396.2 million, $470.9
million and $471.1 million, respectively. The Company has sponsored
approximately 93%, 86% and 89% of its research and development for the years
1998, 1997 and 1996, respectively.
The Company's R&D efforts have been the primary source of the Company's
products. The Company intends to maintain its strong commitment to R&D 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, 1998, the Company had 3,389 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 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. The project is expected to be operational by
the third quarter of 1999, with licensure expected thereafter. 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,
currently conducting start-up and validation checks, are adequate for all
present and near term uses although additional manufacturing capacity may be
added on the Vacaville site dependent on the success of products in clinical
trials. The Company believes any additional facilities could be obtained or
constructed with the Company's capital resources.
ITEM 3. LEGAL PROCEEDINGS
Contingencies: The Company is a party to various legal proceedings,
including patent infringement cases involving human growth hormone products
and Activase, registered trademark, and other matters.
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, 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, registered trademark,
human growth hormone products infringed the Goodman Patent. The 1997 case
has been stayed pending the conclusion of the 1990 case, which is expected to
commence trial in April 1999.
Based upon the nature of the claims made and the information available to
date to the Company and its counsel through investigations and otherwise, the
Company believes the outcome of these actions is not likely to 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.
In addition to the above, 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, February 1998 and October 1998, the Company received grand
jury document subpoenas from the same court related to the same subject
matter. The government is actively investigating this matter, and the
Company is a target of that investigation. At this time, the Company cannot
reasonably estimate a possible range of loss, if any, that may result from
this investigation due to uncertainty regarding the outcome.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
<PAGE>
GENENTECH, INC.
EXECUTIVE OFFICERS
The executive officers of the Company and their respective ages (ages as of
December 31, 1998) and positions with the Company are as follows:
<TABLE>
<CAPTION>
Name Age Position
- ------------------------------- --- ------------------------------------
<S> <C> <C>
Arthur D. Levinson, Ph.D. 48 President and Chief Executive Officer
William D. Young 54 Chief Operating Officer
Louis J. Lavigne, Jr. 50 Executive Vice President and
Chief Financial Officer
Susan D. Hellmann, M.D., M.P.H. 41 Senior Vice President - Development and
Chief Medical Officer
Dennis J. Henner, Ph.D. 47 Senior Vice President - Research
Judy Heyboer 49 Senior Vice President, Human Resources
Stephen G. Juelsgaard 50 Senior Vice President, General Counsel and
Secretary
W. Robert Arathoon, Ph.D. 46 Vice President - Process Sciences
Joffre B. Baker, Ph.D. 51 Vice President - Research Discovery
J. Joseph Barta 51 Vice President - Quality
John G. Curd, M.D. 53 Vice President - Clinical Development
Stephn Dilly, M.D., Ph.D. 39 Vice President - Medical Affairs
Robert L. Garnick, Ph.D. 49 Vice President - Regulatory Affairs
Bradford S. Goodwin 44 Vice President - Finance
Paula M. Jardieu, Ph.D. 48 Vice President - Pharmacological Sciences
Edmon R. Jennings 51 Vice President - Corporate Development
Sean A. Johnston, Ph.D. 40 Vice President - Intellectual Property
Cynthia J. Ladd 43 Vice President - Corporate Law and
Assistant Secretary
Walter Moore 47 Vice President - Government Affairs
James P. Panek 45 Vice President - Manufacturing, Engineering and
Facilities
Kimberly J. Popovits 40 Vice President - Sales
Nicholas J. Simon 44 Vice President - Business and
Corporate Development
David C. Stump, M.D. 49 Vice President - Clinical Research and
Genentech Fellow
John M. Whiting 43 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.
Dr. Henner was appointed Senior Vice President, Research in May 1998. He had
served as Vice President, Research from April 1996 to May 1998, 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.
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.
Mr. Juelsgaard was appointed Senior Vice President in April 1998, 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.
Dr. Arathoon was appointed Vice President, Process Sciences in April 1996.
Since joining the Company in 1983 from The 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.
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. Barta was appointed Vice President, Quality in October 1998. He
previously held the positions of Senior Director, Quality from March to
October 1998, Senior Director, Quality Assurance from January 1994 to
February 1998, Senior Director, Pharmaceutical Manufacturing from September
to December 1993, Director, Pharmaceutical Manufacturing from September 1989
to August 1993, and Associate Director, Validation and Technical Services
from June to September 1989. He joined the Company in March 1988 as Manager,
Validation. Prior to joining the Company, he held positions of Director,
Quality Assurance and Quality Control at Codon from May 1986 to March 1988
and Group Validation Manager at Miles Laboratories, Inc. from September 1979
to March 1986.
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. Dilly joined the company as Vice President, Medical Affairs in
December 1998. Prior to joining the company he held various positions
with SmithKline Beecham Pharmaceuticals from August 1988, including
Director and Vice President Neurosciences Therapeutic Unit from December
1996 to December 1998, Director and Vice President CardioPulmonary
Therapeutic Team from December 1994 to December 1996 and Group Director
Neurosciences Therapeutic Unit from April 1993 to December 1994.
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, where he worked from 1980. Prior to that,
he was Manager of Analytical Development at Merrell National Labs from 1977
to 1980.
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. 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.
Dr. Johnston was appointed Vice President, Intellectual Property in June
1998. He joined the Company in October 1990 as Patent Counsel and
subsequently held the positions of Senior Patent Counsel from October 1993 to
October 1995, Senior Patent Counsel and Manager of Patent Litigation from
October 1995 to April 1998, and Associate General Counsel, Patent Law from
April 1998 to June 1998. Prior to joining the Company, he served as a Law
Clerk at the U.S. District Court for the Central District of California from
September 1989 to September 1990 and was a Research Scientist at
International Genetic Engineering, Inc. from December 1984 to August 1986.
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.
Mr. Moore was appointed Vice President, Government Affairs in May 1998. He
joined the Company in September 1993 as Senior Director of Government
Affairs. Prior to joining the Company, Mr. Moore served as Manager of
Governmental Relations at Eli Lilly and Company.
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 of Business and Corporate Development
in December 1995. He had been Vice President of Business Development from
December 1994 to December 1995, and was Senior Director of Business
Development from December 1993 to December 1994. He joined the Company in
1989 as Director of Business Development 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.
<PAGE>
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 of the Company's 1998 Annual Report to Stockholders are
incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The section labeled "11-Year Financial Summary" of the Company's 1998
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" of the Company's 1998 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, the Report of Ernst & Young LLP, Independent Auditors
and the section labeled "Quarterly Financial Data (unaudited)" of the
Company's 1998 Annual Report to Stockholders are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
<PAGE>
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 1999 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 1999 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 1999 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 1999 Annual Meeting of
Stockholders is incorporated herein by reference.
<PAGE>
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 1998 Annual Report to Stockholders and are incorporated
herein by reference pursuant to Item 8 of this Form 10-K.
Consolidated Statements of Income for each of the three years in the
period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1998
Consolidated Balance Sheets at December 31, 1998 and 1997
Consolidated Statements of Stockholders' Equity for each of the three
years in the period ended December 31, 1998
Notes to Consolidated Financial Statements
Report of Ernst & Young LLP, Independent Auditors
Quarterly Financial Data (unaudited)
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, 1998.
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.
<PAGE>
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. (6)
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 Amended and Restated Lease Agreement, dated December 8, 1995,
between the Company and BNP Leasing Corporation.(6)
10.8 Amended and Restated Purchase Agreement, dated December 8,
1995, between the Company and BNP Leasing Corporation.(6)
10.9 Guiding Principles for the Genentech/Roche Relationship.(7)
13.1 1998 Annual Report to Stockholders.(9)
23.1 Consent of Ernst & Young LLP, Independent Auditors.(9)
27.1 Financial Data Schedule.(9)
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.(7)
99.2* 1984 Non-Qualified Stock Option Plan, as amended and restated
as of October 16, 1996.(7)
99.3* Restated Relocation Loan Program.(4)
99.4* Restated 401(k) Plan.(6)
99.5* 1990 Stock Option/Stock Incentive Plan, as amended and restated
as of October 16, 1996.(7)
99.6* Supplemental Plan.(4)
99.7* 1994 Stock Option Plan, as amended and restated as of October
16, 1996.(7)
99.8* 1996 Stock Option/Stock Incentive Plan, as amended and restated
as of October 16, 1996.(7)
99.9* Deferred Compensation Plan.(7)
99.10* 1991 Employee Stock Plan, as amended April 10, 1997.(8)
99.11* Incentive Units Plan, as amended on October 8, 1998.(9)
* 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 Annual Report on Form 10-K for the year
ended December 31, 1995 and incorporated herein by reference.
(7) Filed as an exhibit to Annual Report on Form 10-K for the year
ended December 31, 1996 and incorporated herein by reference.
(8) Filed as an exhibit to the Quarterly Report on Form 10-Q filed for the
quarterly period ended March 31, 1997.
(9) 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, 1998.
<PAGE>
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: January 22, 1999
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 January 22, 1999
- --------------------------- Officer and Director
Arthur D. Levinson
Principal Financial Officer:
/S/LOUIS J. LAVIGNE, JR. Executive Vice President January 22, 1999
- --------------------------- and Chief Financial Officer
Louis J. Lavigne, Jr.
Director:
/S/HERBERT W. BOYER Director January 22, 1999
- ---------------------------
Herbert W. Boyer
/S/JONATHAN K.C. KNOWLES Director January 22, 1999
- ---------------------------
Jonathan K.C. Knowles
/S/FRANZ B. HUMER Director January 22, 1999
- ---------------------------
Franz B. Humer
/S/LINDA F. LEVINSON Director January 22, 1999
- ---------------------------
Linda F. Levinson
/S/J. RICHARD MUNRO Director January 22, 1999
- ---------------------------
J. Richard Munro
/S/DONALD L. MURFIN Director January 22, 1999
- ---------------------------
Donald L. Murfin
/S/JOHN T. POTTS, JR. Director January 22, 1999
- ---------------------------
John T. Potts, Jr.
/S/C. THOMAS SMITH, JR. Director January 22, 1999
- ---------------------------
C. Thomas Smith, Jr.
/S/DAVID S. TAPPAN, JR. Director January 22, 1999
- ---------------------------
David S. Tappan, Jr.
<PAGE>
<TABLE>
<CAPTION
SCHEDULE II
GENENTECH, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1998, 1997 and 1996
(in thousands)
Additions
Balance at Charged to Balance at
Beginning of Costs and End of
Period Expenses Deductions(1) Period
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts
and returns:
Year Ended December 31, 1998: $ 14,535 $ 11,389 $ (8,506) $ 17,418
========== ========== ========== ==========
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
========== ========== ========== ==========
Inventory reserves:
Year Ended December 31, 1998: $ 12,055 $ 5,405 $ (2,556) $ 14,904
========== ========== ========== ==========
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
========== ========== ========== ==========
Reserve for nonmarketable
equity securities and
convertible debt:
Year Ended December 31, 1998: $ 5,490 $ 7,958 $ (1,305) $ 12,143
========== ========== ========== ==========
Year Ended December 31, 1997: $ 4,990 $ 500 $ - $ 5,490
========== ========== ========== ==========
Year Ended December 31, 1996: $ 5,092 $ - $ (102) $ 4,990
========== ========== ========== ==========
<FN>
(1) Represents amounts written off or returned against the allowance or reserves.
</FN>
</TABLE>
<PAGE>
INDEX OF EXHIBITS FILED WITH FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1998
Exhibit No. Description
- ----------- -----------
13.1 1998 Annual Report to Stockholders
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedule
99.11 Incentive Units Plan, as amended on October 8, 1998
Page 1
1998 FORM 10K - Draft One 01/22/99 @ 1:38 PM
<PAGE>
FINANCIAL REVIEW
(dollars in millions, except per share amounts)
OVERVIEW
Genentech, Inc. (the Company) is a biotechnology company that uses human
genetic information to discover, develop, manufacture and market human
pharmaceuticals for significant unmet medical needs. Twelve of the approved
products of biotechnology stem from Genentech science. The Company
manufactures and markets eight products (see Actimmune discussion below)
directly in the United States (U.S.), including:
- - Herceptin, registered trademark, (trastuzumab) for the treatment of
patients with metastatic breast cancer whose tumors overexpress the human
epidermal growth factor receptor2 (HER2) protein;
- - Rituxan, registered trademark, (rituximab) for the treatment of patients
with relapsed or refractory low-grade or follicular, CD20-positive B-cell
non-Hodgkins lymphoma;
- - Activase, registered trademark, (alteplase, recombinant) a tissue
plasminogen activator (t-PA) for the treatment of heart attack, acute
ischemic stroke and acute massive pulmonary embolism;
- - Protropin, registered trademark, (somatrem for injection), growth hormone
for the treatment of growth hormone deficiency (GHD) in children;
- - Nutropin, registered trademark, [somatropin (rDNA origin) for injection]
growth hormone for the treatment of GHD in children and in adults, growth
failure associated with chronic renal insufficiency (CRI) prior to kidney
transplantation and short stature associated with Turner syndrome;
- - Nutropin AQ, registered trademark, [somatropin (rDNA origin)] a liquid
formulation of Nutropin for the same indications as Nutropin;
- - Pulmozyme, registered trademark, (dornase alfa, recombinant) inhalation
solution for the management of cystic fibrosis; and
- - Actimmune, registered trademark, (interferon gamma-1b) for the treatment
of chronic granulomatous disease, a rare, inherited disorder of the immune
system. In 1998, the Company licensed its marketing and development
rights to Actimmune to Connetics Corporation (Connetics). Following a
transition period ending January 1999, the Company will no longer
market Actimmune, and Connetics has agreed to pay the Company royalties
on its sales of Actimmune.
The Company receives royalties on sales of its products outside of the United
States (U.S.) from F. Hoffmann-La Roche Ltd (HLR), a subsidiary of Roche
Holdings, Inc. (Roche) (see below for further discussion). The Company also
receives royalties on sales of growth hormone and t-PA outside of the U.S.
and Canada through other licensees. The Company receives worldwide royalties
on five additional licensed products, and received royalties on one other
licensed product for which those royalties expired in August 1998 (see
below), that originated from the Company's technology and are marketed by
other companies.
RELATIONSHIP WITH ROCHE HOLDINGS, INC.
On 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 will expire. This arrangement was the result
of the October 1995 agreement (the Agreement) between the Company and Roche.
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, within thirty business days commencing
July 1, 1999, the Company's stockholders will have the option (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).
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). As of May 1997, the Company and HLR agreed
in principle to changes to the License Agreement that, in general, allow for
the sharing of U.S. and European development costs regardless of location or
purpose of studies. Under the License Agreement, as revised, HLR may
exercise its option to license any such future product of the Company either
when the Company determines to move such product into development or at the
end of Phase II clinical trials. Also, as part of this Agreement, the
Company receives royalties on sales of certain of its products in Canada, on
sales of Pulmozyme outside of the U.S. and on sales of rituximab outside of
the U.S., excluding Japan.
In addition, on July 6, 1998, the Company entered into an agreement with HLR
to provide HLR exclusive marketing rights outside of the U.S. for Herceptin.
Under the agreement, HLR paid $40.0 million and has agreed to pay cash
milestones tied to future product development activities, to contribute
equally with the Company up to a maximum of $40.0 million on global
development costs and to make royalty payments on product sales. As of
December 31, 1998, no additional amounts have been paid.
See the Relationship with Roche Holdings, Inc. note in the Notes to
Consolidated Financial Statements for further information.
<TABLE>
<CAPTION>
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Annual % Change
1998 1997 1996 98/97 97/96
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Revenues $1,150.9 $1,016.7 $ 968.7 13% 5%
</TABLE>
Revenues for 1998 increased from 1997 primarily as a result of higher product
sales. Revenues for 1997 increased from 1996 in all areas, but primarily
from royalties and contract revenues.
<TABLE>
<CAPTION>
Annual % Change
Product Sales 1998 1997 1996 98/97 97/96
- ------------------------------------------------------------------------------
<S> <S> <C> <C> <C> <C>
Herceptin $ 30.5 - - - -
Rituxan 162.6 $ 5.5 - 2,856 % -
Activase 213.0 260.7 $284.1 (18) (8)%
Protropin, Nutropin
and Nutropin AQ 214.0 223.6 218.2 (4) 2
Pulmozyme 93.8 91.6 76.0 2 21
Actimmune 3.9 3.5 4.5 11 (22)
------------------------------------------------------
Total product sales $717.8 $584.9 $582.8 23 % 0 %
% of revenues 62% 58% 60%
</TABLE>
Product sales increased in 1998 as a result of a full year of Rituxan sales
and initial Herceptin sales. These increases were partly offset by lower
Activase and growth hormone sales. Product sales in 1997 increased over
1996 due to increases in Pulmozyme, growth hormone, new sales from the
introduction of Rituxan, offset by a decrease in Activase sales. Product
sales to HLR in conjunction with the License Agreement were $28.7 million in
1998, $17.4 million in 1997, and $13.2 million in 1996.
Herceptin: In September 1998, the Company received U.S. Food and Drug
Administration (FDA) approval to market Herceptin in the U.S. for use as
first line therapy in combination with paclitaxel and as a single agent in
second and third line therapy in patients with metastatic breast cancer who
have tumors that overexpress the HER2 protein. The Company recorded $30.5
million of initial net sales of Herceptin in 1998. However, not enough time
has passed for this figure to be indicative of the future trend of Herceptin
sales. Herceptin is the first humanized monoclonal antibody for the
treatment of HER2 overexpressing metastatic breast cancer and the second U.S.
approval in this new class of biotherapeutic cancer drugs; the first was
Rituxan, which was approved in November 1997. Pursuant to an agreement
entered into with the Company, HLR received exclusive marketing rights to
Herceptin outside of the U.S.
Rituxan: Rituxan was approved for marketing by the FDA in late November
1997. The Company launched Rituxan on December 16, 1997, and recorded
initial sales of $5.5 million for 1997. Net sales of Rituxan were $162.6
million in 1998. The increase from 1997 was the result of one full year of
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 holds marketing rights for MabThera,
trademark, (rituximab) outside of the U.S., excluding Japan, and has agreed
to pay to the Company royalties and a mark-up on MabThera supplied to HLR.
In December 1998, a letter was sent to physicians advising them of some
deaths associated with administration of Rituxan. As a result, the Company
and IDEC have updated the Warning section of the package insert to include
information on infusion-related reactions and cardiovascular events.
During the first quarter of 1998, the Company received FDA approval for
the large-scale (12,000-liter) manufacture of rituximab. Rituximab
manufactured by the Company will supplement the rituximab manufactured by
IDEC on the Company's behalf. Also in 1998, the Company's and IDEC's
partner, HLR, received approval from the European Commission to market
rituximab under the tradename MabThera in the European Union.
Activase: Sales of Activase in 1998 and 1997 decreased primarily due to a
competitive thrombolytic agent, Centocor Inc.'s (Centocor's) Retavase,
registered trademark. This decrease also resulted, to a lesser extent, from
a decline in the size of the thrombolytic market due to increasing use of
mechanical reperfusion and from a temporary decrease in the available
commercial market due to patients receiving therapy through large recently
completed Phase III clinical trials.
In March 1998, the Company received two new patents related to variant
forms of t-PA. Based on these patents, the Company filed an infringement
action against Centocor in the Northern District of California which alleges
that Centocor's sale, offer for sale, use in, and importation into, the U.S.
of Retavase (reteplase, recombinant), a t-PA, infringes these two new patents
of the Company. The Company is seeking a permanent injunction and damages.
In July 1998, the Company discontinued development of Activase for
treating acute ischemic stroke (AIS) in patients presenting later than three
hours from symptom onset after the termination of two clinical trials, one in
AIS patients presenting three to five hours from symptom onset, and another
in AIS patients presenting zero to six hours from symptom onset. Neither
study showed clinical benefit. Activase is approved for the treatment of AIS
within three hours of symptom onset.
Protropin, Nutropin and Nutropin AQ: Net sales of the Company's three growth
hormone products - Protropin, Nutropin and Nutropin AQ, decreased in 1998
from 1997, but increased slightly in 1997 from 1996. A small loss of market
share has been seen in 1998 due to increased competition. The Company
continues to face increased competition from five other companies with growth
hormone products, although one company has been preliminarily enjoined from
selling its product. In December 1997, the Company received approval from
the FDA to market Nutropin and Nutropin AQ, respectively, in the U.S. for the
treatment of growth hormone deficiency in adults. In December 1996 and
January 1997, the Company received approval from the FDA to market Nutropin
and Nutropin AQ, respectively, in the U.S. for the treatment of short stature
associated with Turner syndrome.
Pulmozyme: Net sales of Pulmozyme were slightly higher in 1998 compared to
1997 as a result of new patients in the mild to moderate cystic fibrosis (CF)
patient population in addition to new patients from the 1998 FDA approval for
a label extension to include CF patients under the age of five. Net sales in
1997 were higher primarily due to continued penetration in the mild to
moderate CF patient populations as well as from variations in customer
ordering patterns for U.S. sales. In February 1998, the Company received
approval from the FDA for a label extension which includes the safety and
alternative administration of Pulmozyme in children with CF under the age of
five, adding to the product's previous approvals for patients five years of
age and older. In November 1996, Pulmozyme was approved by the FDA for
marketing in the U.S. for the management of CF patients with advanced
disease.
Actimmune: In the second quarter of 1998, the Company licensed U.S.
marketing and development rights to interferon gamma, including Actimmune, to
Connetics. Following a transition period ending January 1999, the Company
will no longer market Actimmune, but has agreed to supply bulk materials to
Connetics at cost plus a mark-up. The Company will receive royalties on
Connetics' sales of Actimmune.
<TABLE>
<CAPTION>
Royalties, Contract and Other, Annual % Change
and Interest Income 1998 1997 1996 98/97 97/96
- ---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Royalties $ 229.6 $ 241.1 $ 214.7 (5)% 12%
Contract and other 114.8 121.6 107.0 (6) 14
Interest income 88.7 69.1 64.2 28 8
</TABLE>
Total royalties decreased in 1998 over 1997 due to the expiration of
royalties from Eli Lilly and Company (Lilly) in August 1998. Royalties in
1997 increased over 1996 primarily due to increased licensee sales from
various licensees. Under a December 1994 settlement agreement with Lilly,
royalties of $30.0 million per year were payable, subject to possible offsets
and contingent upon Humulin, registered trademark, continuing to be marketed
in the U.S., to the Company through 1998. These royalty obligations have now
expired. Under a prior license agreement with Lilly, the Company received
royalties from Lilly's sales of its human insulin product until this royalty
obligation expired in August 1998. Cash flows from royalty income include
nondollar 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 two years. See below for
discussion of market risks related to these financial instruments.
Contract and other revenues in 1998 decreased from 1997 as a result of higher
1997 contract payments and gains from the sale of biotechnology equity
securities. Although the Company received significant nonrecurring payments
from HLR for exclusive marketing rights outside of the U.S. for Herceptin
(discussed above) and from Novo Nordisk A/S (Novo) on the patent infringement
litigation settlement (discussed below), other contract revenues from HLR
decreased significantly from 1997 primarily due to the discontinuation of
several projects or indications in development. Contract and other revenues
were higher in 1997 compared to 1996 primarily due to $30.9 million from
Sumitomo Pharmaceuticals Co., Ltd. (Sumitomo) and Pharmacia & Upjohn (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.
In July 1998, the Company and Novo agreed to settle a lawsuit brought by
the Company in the U.S. District Court for the Southern District of New York
relating to the Company's patents for human growth hormone and insulin and a
lawsuit brought in October 1997, by 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. Under the settlement agreement, Novo and the
Company agreed to cross-license worldwide certain patents relating to human
growth hormone. In August 1998, Novo received a worldwide license under the
Company patents relating to insulin and the Company received certain payments
from Novo that were recorded in contract revenues.
As part of a strategic alliance with Sumitomo, the Company has agreed to
provide Sumitomo exclusive distributorship rights in Japan for Nutropin AQ
and a sustained release formulation of human growth hormone.
In an agreement 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 are jointly developing TPO for one
indication; however, the Company has no marketing rights for this indication.
The Company recorded nonrecurring contract revenues from HLR of $40.0
million for Herceptin marketing rights outside of the U.S. in 1998 and $44.7
million for the exercise of their options under the License Agreement with
respect to three development projects [Rituxan, insulin-like growth factor
(IGF-I) which was subsequently terminated, and nerve growth factor] in 1996.
All other contract revenue from HLR, including reimbursement for ongoing
development expenses after the option exercise date, totaled $21.6 million in
1998, $67.6 million in 1997 and $50.6 million in 1996.
Interest income increased in 1998 primarily due to an increase in the
investment portfolio and, to a lesser extent, a higher average yield on the
investment portfolio. The increase in 1997 from 1996 was due to an increase
in the average yield on the investment portfolio and 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.
<TABLE>
<CAPTION>
Annual % Change
Costs and Expenses 1998 1997 1996 98/97 97/96
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cost of sales $ 138.6 $ 102.5 $ 104.5 35% (2)%
Research and
development 396.2 470.9 471.1 (16) 0
Marketing, general and
administrative 358.9 269.9 240.1 33 12
Interest expense 4.6 3.6 5.1 28 (29)
---------------------------------------------------
Total costs
and expenses $ 898.3 $ 846.9 $ 820.8 6% 3%
% of revenues 78% 83% 85%
Cost of sales as % of
product sales 19% 18% 18%
R&D as % of revenues 34 46 49
MG&A as % of revenues 31 27 25
</TABLE>
Cost of Sales: Cost of sales as a percent of product sales increased in 1998
to 19%. This increase was primarily the result of increased sales to HLR as
well as a shift in the product mix, including the first full year of Rituxan
sales and the introduction of Herceptin. Cost of sales as a percent of
product sales was 18% in 1997, which was comparable to 1996. The economic
benefits from sales to HLR are reflected in product sales and royalties.
Research and Development: Research and development (R&D) expenses decreased
in 1998 from 1997 primarily due to the wind-down of certain large late-stage
clinical trials and lower costs to license technology from third parties.
These decreases were partly offset by higher costs related to large scale
development collaborations. In 1997, R&D expenses were flat compared to
1996. R&D as a percentage of revenues decreased to 34% in 1998, from 46% in
1997 and from 49% in 1996. The decrease in this percentage from year to year
reflects growing revenues and more recently in 1998 a decrease in R&D
expenses.
To gain additional 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 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. This has included the acquisition by the Company
of the equity and convertible debt of such companies. 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 1998 from 1997. The marketing and sales (M&S)
increases were driven by the introduction of Rituxan and the resultant profit
sharing with IDEC, the launch of Herceptin, and the defense of Activase and
the Company's growth hormone products against new competition and the launch
of a new indication, growth hormone deficiency in adults, for Nutropin and
Nutropin AQ. General and administrative expenses were higher principally as
a result of the write-down of certain biotechnology equity securities. MG&A
expenses were also higher in 1997 compared to 1996 primarily due to increased
M&S expenses in the oncology area and competitive conditions with other
marketed products.
Interest Expense: Interest expense will fluctuate depending on the amount of
capitalized interest related to the amount of construction projects.
Interest expense, net of amounts capitalized, relates to interest on the
Company's 5% convertible subordinated debentures.
<TABLE>
<CAPTION>
Income Before Taxes and Income Taxes 1998 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Income before taxes $ 252.6 $ 169.8 $ 147.9
Income tax provision 70.7 40.8 29.6
Effective tax rate 28% 24% 20%
</TABLE>
The Company's effective tax rate increased in 1998 over 1997 to 28%. This
increase is primarily due to the decreased benefit of R&D tax credits. The
tax rate for 1998 and 1997 reflected the legislative extension of R&D tax
credits effective beginning in the third quarter of 1997. The increase in
the effective tax rate in 1997 over 1996 was attributable to the
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. The effective tax rate in 1998, 1997 and 1996
was less than the U.S. statutory rate of 35% due in part to the R&D tax
credits, tax benefit of certain realized gains on securities available-for-
sale, and realized foreign losses, except in 1997.
<TABLE>
<CAPTION>
Annual % Change
Net Income 1998 1997 1996 98/97 97/96
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net income $ 181.9 $ 129.0 $ 118.3 41% 9%
Earnings per share:
Basic $ 1.45 $ 1.05 $ 0.98
Diluted $ 1.40 $ 1.02 $ 0.95
</TABLE>
The increase in net income in 1998 from 1997 was driven primarily by sales of
Rituxan and Herceptin, lower R&D expenses and higher interest income. These
revenue increases and savings were partly offset by higher MG&A expenses, a
decrease in Activase sales, higher cost of sales and higher income taxes.
Net income in 1997 increased over 1996 primarily due to higher royalties and
contract and other revenues partly offset by higher MG&A expenses.
<TABLE>
<CAPTION>
LIQUIDITY AND CAPITAL RESOURCES 1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash, cash equivalents, short-term
investments and long-term marketable
debt and equity securities $1,604.6 $1,286.5 $1,159.1
Working capital 950.6 904.4 705.1
Cash provided by (used in):
Operating activities 349.9 118.3 139.7
Investing activities (421.1) (168.4) (141.7)
Financing activities 107.9 87.3 72.2
Capital expenditures
(included in investing activities above) (88.1) (154.9) (141.8)
Current ratio 4.3:1 4.1:1 3.8:1
</TABLE>
Cash generated from operations, income from investments and proceeds from
stock issuances were used to purchase marketable securities and make capital
investments in 1998.
Capital expenditures in 1998 included improvements to existing office and
laboratory facilities and equipment, and equipment purchases. In 1997,
capital expenditures 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.
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 new
products and additional indications for existing products in 1999 and beyond.
Competition: The Company faces growing competition in two of its therapeutic
markets and expects new competition in a third. First, Activase lost market
share and could lose additional market share in the thrombolytic market to
Centocor's Retavase and the resulting adverse effect on sales could be
material. Retavase received FDA approval in October 1996 for the treatment
of AMI. In addition, there is an increasing use of mechanical reperfusion in
lieu of thrombolytic therapy for the treatment of AMI, which is expected to
continue. Second, in the growth hormone market, the Company continues to
face increased competition from five other companies with growth hormone
products, although one company has been preliminarily enjoined from selling
its product. As a result of this competition, the Company has experienced a
loss in new patient market share. Four of these competitors have also
received approval to market their existing human growth hormone products for
additional indications. The Company expects that such competition could have
an adverse effect on its sales of Protropin, Nutropin and Nutropin AQ and
such effect could be material. Third, in the NHL market, Coulter recently
filed for approval with the FDA with respect to a product for a similar
indication for which Rituxan is approved. Genentech is aware of other
potentially competitive biologic therapies in development.
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 1998 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 reimbursements, if any; variations in HLR's sales and other licensees'
sales of licensed products; 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 and
other licensees; whether and when contract benchmarks are achieved; and the
conclusion of existing arrangements with other companies and HLR.
R&D: The Company is committed to aggressive R&D investment to discover and
develop new products. 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, as
revenues increase, R&D as a percent of revenues should decrease to the 20% to
25% range.
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 that may delay, limit or prevent
regulatory approvals. The length of time necessary to complete clinical
trials and to submit an application for marketing approval for a final
decision by a regulatory authority varies significantly and may be difficult
to predict. Factors affecting the Company's R&D expenses include, but are
not limited to: the number of and the outcome of clinical trials currently
being conducted by the Company and/or its collaborators; 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.
Income Tax Provision: The Company expects its effective tax rate to be 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,
interpretation of existing tax laws, 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 been, 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: The Company uses and relies on a wide variety of information
technologies, computer systems and scientific and manufacturing equipment
containing computer related components (such as programmable logic
controllers and other embedded systems). Some of the Company's older
computer software programs and equipment are unable to distinguish between
the year 1900 and the year 2000. As a result, time-sensitive functions of
those software programs and equipment may misinterpret dates after January 1,
2000, to refer to the twentieth century rather than the twenty-first century.
This could cause system or equipment shutdowns, 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 a Year 2000 Project (Y2K Project) in place to address
the potential exposures related to the impact on its computer systems and
scientific and manufacturing equipment containing computer related components
for the Year 2000 and beyond. Approximately half of the Company's Year 2000
(Y2K) scheduled work is complete. The remaining work is scheduled to be
completed by the end of the third quarter of 1999. The Y2K Project phases
include: (1) inventorying and prioritizing business critical systems; (2)
Y2K compliance analysis; (3) remediation activities including repairing or
replacing identified systems; (4) testing; and (5) developing contingency
plans.
An inventory of business critical financial, informational and
operational systems, including manufacturing control systems, has been
completed. Compliance analysis is approximately 80% complete for these
systems. Remediation activities vary by department, however, on the average,
remediation activities are approximately 50% complete. Testing of the
Company's information technology infrastructure is 60% complete. Testing of
business critical application programs began in the third quarter of 1998,
and is scheduled to be complete by the third quarter of 1999. Contingency
planning will begin in the first quarter of 1999. The Company believes that
with the completed modifications, the Y2K issue will not pose significant
operational problems for its computer systems and equipment. 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 precise degree of which cannot be known at
this time.
In addition to risks associated with the Company's own computer systems
and equipment, the Company has relationships with, and is to varying degrees
dependent upon, a large number of third parties that provide information,
goods and services to the Company. These include financial institutions,
suppliers, vendors, research partners, governmental entities and customers.
If significant numbers of these third parties experience failures in their
computer systems or equipment due to Year 2000 noncompliance, it could affect
the Company's ability to process transactions, manufacture products, or
engage in similar normal business activities. While some of these risks are
outside the control of the Company, the Company has instituted programs,
including internal records review and use of external questionnaires, to
identify key third parties, assess their level of Year 2000 compliance,
update contracts and address any noncompliance issues.
The total cost of the Year 2000 systems assessments and conversions is
funded through operating cash flows and the Company is expensing these costs
as they are incurred. The Company has created a mechanism to trace costs
directly related to the Year 2000 issue and has budgeted funds to address the
issues of assessment and conversion. The financial impact of making the
required systems changes cannot be known precisely at this time, but it is
currently expected to be less than $10.0 million. The actual financial
impact could, however, exceed this estimate.
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, 1998, Roche held approximately 65.3%
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. See also
Relationship with Roche Holdings, Inc. note in Notes to Consolidated
Financial Statements for a discussion of the terms of the put and call
pursuant to the Agreement.
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 investment 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, 1998.
The Company evaluates this potential value at risk throughout the year.
During 1998, there were no significant changes in the estimated exposures to
market risk from those disclosed as of December 31, 1997.
Interest Rates - The Company's interest income is sensitive to changes
in the general level of interest rates, primarily U.S. interest rates. In
this regard, changes in U.S. interest rates affect the interest earned on the
Company's cash equivalents, short-term investments, convertible preferred
stock investments, convertible 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,
1998, 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 (primarily Japan) and Canada. The Company's exposure to foreign
exchange rates primarily exists with the Euro. 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 a portion of its portfolio primarily in nondollar
denominated investments. As a result, the Company is exposed to changes in
the exchange rates of the countries in which these nondollar 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 25% to 90% of probable future revenues so that the
potential adverse impact of movements in currency exchange rates on the
nondollar 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
nondollar denominated investments in the portfolio, the Company also enters
into forward contracts.
Based on the Company's overall currency rate exposure at December 31,
1998, 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
holds dividend bearing convertible preferred stock and has made interest
bearing loans that are convertible into the equity securities of the debtor.
Based on the Company's overall exposure to fluctuations from market
value changes in marketable equity prices at December 31, 1998, 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 $10.6 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.
New Accounting Standard: In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards (FAS) 133,
"Accounting for Derivative Instruments and Hedging Activities," effective
beginning in the first quarter of 2000. FAS 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. It
requires companies to recognize all derivatives as either assets or
liabilities on the balance sheet and measure those instruments at fair value.
Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedge accounting under FAS 133. Based on the requirements of
FAS 133, there may be changes to the balance sheet and reported assets and
liabilities. The Company is currently evaluating the impact of FAS 133 on
its financial position and results of operations.
Legal Proceedings: The Company is a party to various legal proceedings
including patent infringement cases and other matters. See the Leases,
Commitments and Contingencies note in the Notes to Consolidated Financial
Statements for further information.
<PAGE>
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 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 is included in
this Annual Report.
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, 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 -
Chief Executive Officer and Chief Financial Officer Finance
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
(thousands, except per share amounts)
YEAR ENDED DECEMBER 31 1998 1997 1996
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues
Product sales (including amounts from
related parties: 1998-$28,738;
1997-$17,396; 1996-$13,216) $ 717,795 $ 584,889 $ 582,829
Royalties (including amounts
from related parties: 1998-$35,028;
1997-$25,362; 1996-$26,240) 229,589 241,112 214,702
Contract and other (including amounts
from related parties: 1998-$61,583;
1997-$67,596; 1996-$95,299) 114,795 121,587 107,037
Interest 88,764 69,160 64,110
--------------------------------------
Total revenues 1,150,943 1,016,748 968,678
Costs and expenses
Cost of sales (including amounts from
related parties: 1998-$23,155;
1997-$14,348; 1996-$10,900) 138,623 102,536 104,527
Research and development (including
contract related: 1998-$27,660;
1997-$67,596; 1996-$50,586) 396,186 470,923 471,143
Marketing, general and administrative 358,931 269,852 240,063
Interest 4,552 3,642 5,010
--------------------------------------
Total costs and expenses 898,292 846,953 820,743
Income before taxes 252,651 169,795 147,935
Income tax provision 70,742 40,751 29,587
--------------------------------------
Net income $ 181,909 $ 129,044 $ 118,348
======================================
Earnings per share:
Basic $ 1.45 $ 1.05 $ 0.98
Diluted $ 1.40 $ 1.02 $ 0.95
======================================
Weighted average shares used to compute
diluted earnings per share: 129,872 126,397 123,969
======================================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
Increase (decrease) in Cash
and Cash Equivalents
YEAR ENDED DECEMBER 31 1998 1997 1996
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 181,909 $ 129,044 $ 118,348
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization 78,101 65,533 62,124
Deferred income taxes 29,792 19,660 (34,021)
Gain on sales of securities available-for-sale (9,542) (13,203) (1,010)
Loss on sales of securities available-for-sale 1,809 2,096 663
Write-down of nonmarketable securities 16,689 - -
Write-down of securities available-for-sale 20,249 4,000 -
Loss on fixed asset dispositions 1,015 318 5,309
Changes in assets and liabilities:
Net cash flow from trading securities 12,725 (109,132) (8,184)
Receivables and other current assets 33,767 11,194 (30,416)
Inventories (32,600) (24,083) 1,705
Accounts payable, other current
liabilities and other long-term liabilities 15,937 32,897 25,153
---------------------------------
Net cash provided by operating activities 349,851 118,324 139,671
Cash flows from investing activities:
Purchases of securities held-to-maturity (327,690) (304,932) (634,124)
Proceeds from maturities of securities
held-to-maturity 410,729 455,317 772,922
Purchases of securities available-for-sale (800,788) (512,727) (304,806)
Proceeds from sales of securities
available-for-sale 430,936 410,395 182,564
Purchases of nonmarketable equity securities (29,044) - (9,323)
Capital expenditures (88,088) (154,902) (141,837)
Change in other assets (17,151) (61,529) (7,046)
---------------------------------
Net cash used in investing activities (421,096) (168,378) (141,650)
Cash flows from financing activities:
Stock issuances 107,938 87,259 72,558
Reduction in long-term debt,
including current portion - - (358)
---------------------------------
Net cash provided by financing activities 107,938 87,259 72,200
---------------------------------
Increase in cash and cash equivalents 36,693 37,205 70,221
Cash and cash equivalents at beginning of year 244,469 207,264 137,043
---------------------------------
Cash and cash equivalents at end of year $ 281,162 $ 244,469 $ 207,264
=================================
Supplemental cash flow data:
Cash paid during the year for:
Interest, net of portion capitalized $ 4,552 $ 3,642 $ 5,010
Income taxes 26,189 15,474 52,243
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except par value)
DECEMBER 31 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Assets:
Current assets:
Cash and cash equivalents $ 281,162 $ 244,469
Short-term investments 606,544 588,853
Accounts receivable - trade (net of
allowances of: 1998-$14,661; 1997-$8,826) 79,411 71,415
Accounts receivable - other (net of
allowances of: 1998-$2,757; 1997-$5,709) 47,480 73,444
Accounts receivable - related party 22,850 44,386
Inventories 148,626 116,026
Prepaid expenses and other current assets 55,885 55,325
---------------------------
Total current assets 1,241,958 1,193,918
Long-term marketable securities 716,888 453,188
Property, plant and equipment, net 700,249 683,304
Other assets 196,307 177,202
---------------------------
Total assets $ 2,855,402 $ 2,507,612
===========================
Liabilities and stockholders' equity:
Current liabilities:
Accounts payable $ 40,895 $ 48,992
Income taxes payable 46,447 40,293
Accrued liabilities - related party 10,945 15,427
Other accrued liabilities 193,040 184,845
---------------------------
Total current liabilities 291,327 289,557
Long-term debt 149,990 150,000
Other long-term liabilities 70,240 36,830
---------------------------
Total liabilities 511,557 476,387
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:
1998-50,493,631; 1997-47,606,785 1,010 952
Common stock, $0.02 par value;
authorized: 200,000,000 shares;
outstanding: 1998 and 1997-76,621,009 1,532 1,532
Additional paid-in capital 1,588,990 1,463,768
Retained earnings 693,050 511,141
Accumulated other comprehensive income 59,263 53,832
---------------------------
Total stockholders' equity 2,343,845 2,031,225
---------------------------
Total liabilities and stockholders' equity $ 2,855,402 $ 2,507,612
===========================
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(thousands)
Shares
---------------- Accumulated
Special Special Additional Other
Common Common Common Common Paid-in Retained Comprehensive
Stock Stock Stock Stock Capital Earnings Income Total
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance December 31, 1995 42,647 76,621 $ 853 $1,532 $1,281,640 $263,749 $54,273 $1,602,047
Comprehensive income
Net income 118,348 118,348
Net unrealized (loss)
on securities
available-for-sale (324) (324)
-----------
Comprehensive income 118,024
-----------
Issuance of stock
upon exercise of
options and warrants 1,738 35 55,103 55,138
Issuance of stock under
employee stock plan 421 8 17,412 17,420
Income tax benefits
realized from employee
stock option exercises 8,430 8,430
----------------------------------------------------------------------------------------
Balance December 31, 1996 44,806 76,621 $896 $1,532 $1,362,585 $382,097 $53,949 $1,801,059
----------------------------------------------------------------------------------------
Comprehensive income
Net income 129,044 129,044
Net unrealized (loss)
on securities
available-for-sale (117) (117)
-----------
Comprehensive income 128,927
-----------
Issuance of stock
upon exercise of
options and warrants 2,350 47 68,346 68,393
Issuance of stock under
employee stock plan 451 9 18,857 18,866
Income tax benefits
realized from employee
stock option exercises 13,980 13,980
----------------------------------------------------------------------------------------
Balance December 31, 1997 47,607 76,621 $952 $1,532 $1,463,768 $511,141 $53,832 $2,031,225
----------------------------------------------------------------------------------------
Comprehensive income
Net income 181,909 181,909
Net unrealized gain
on securities
available-for-sale 5,431 5,431
-----------
Comprehensive income 187,340
-----------
Issuance of stock
upon exercise of
options and warrants 2,460 49 86,835 86,884
Issuance of stock under
employee stock plan 427 9 21,055 21,064
Income tax benefits
realized from employee
stock option exercises 17,332 17,332
----------------------------------------------------------------------------------------
Balance December 31, 1998 50,494 76,621 $1,010 $1,532 $1,588,990 $693,050 $59,263 $2,343,845
========================================================================================
<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Genentech, Inc. (the Company) is a biotechnology company that uses human
genetic information to discover, develop, manufacture and market human
pharmaceuticals for significant unmet medical needs. Twelve of the approved
products of biotechnology stem from Genentech science. The Company
manufactures and markets eight products directly in the United States (U.S.).
In 1998, the Company licensed its marketing and development rights to
Actimmune, registered trademark, to Connetics Corporation (Connetics).
Following a transition period ending January 1999, the Company will no longer
market Actimmune, and Connetics has agreed to pay the Company royalties on
its sales of Actimmune.
In conjunction with the October 1995 agreement (the Agreement), the Company
receives royalties on sales of certain of its products in Canada, on sales of
Pulmozyme, registered trademark, outside of the U.S. and on sales of
rituximab, outside of the U.S. (excluding Japan) from F. Hoffmann-La Roche
Ltd (HLR), a subsidiary of Roche Holdings, Inc. (Roche). See Relationship
with Roche Holdings, Inc. note for further discussion.
The Company receives royalties on sales of two of its products, growth
hormone and tissue-plasminogen activator, outside of the U.S. and Canada
through other licensees. The Company also receives worldwide royalties on
five additional licensed products, and received royalties on the sale of one
other licensed product for which those royalties expired in August 1998, that
originated from the Company's technology and are marketed by other companies.
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, treasury
notes, asset-backed securities and municipal bonds. As part of its strategic
alliance efforts, the Company also invests in equity securities, dividend
bearing convertible preferred stock 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, 1998 and 1997, the Company had investments of $55.8 million and
$55.2 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 original 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
accumulated other comprehensive income 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, 1998, 1997 and 1996 were $35.9 million, $32.9 million and $28.8
million, respectively. Capitalized interest on construction-in-progress of
$3.0 million in 1998, $3.9 million in 1997 and $2.5 million in 1996 is
included in property, plant and equipment.
Property, plant and equipment balances at December 31 are summarized below
(in thousands):
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------
<S> <C> <C>
At cost:
Land $ 69,437 $ 69,010
Buildings 378,133 339,708
Equipment 607,369 494,874
Leasehold improvements 3,565 3,270
Construction in progress 86,960 152,533
--------------------------
1,145,464 1,059,395
Less: accumulated depreciation 445,215 376,091
--------------------------
Net property, plant and equipment $ 700,249 $ 683,304
==========================
</TABLE>
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. Nonrefundable contract fees
for which no further performance obligations exist are recognized when the
payments are received or when collection is assured. In return for contract
payments, contract partners may receive certain marketing and manufacturing
rights, products for clinical use and testing, and/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 $38.3 million, $39.8 million and $36.0 million in 1998, 1997
and 1996, 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, 1998, 1997 and 1996, were $47.7 million, $41.8
million and $28.0 million, respectively.
Income Taxes: The Company accounts for income taxes by the asset and
liability approach for financial accounting and reporting of income taxes.
Earnings Per Share: Basic earnings per share is computed based on the
weighted average number of shares of the Company's Callable Putable Common
Stock (Special Common Stock) and Common Stock outstanding. Diluted earnings
per share is computed based on the weighted average number of shares of the
Company's Special Common Stock, Common Stock and other dilutive securities.
See also Earnings Per Share note.
Financial Instruments: As part of its overall portfolio, the Company uses
two external money managers to manage its investment portfolios that are held
for trading purposes and one external manager that manages an available-for-
sale portfolio. The investment portfolios consist 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 nondollar revenues so that the potential adverse impact of movements
in currency exchange rates on the nondollar 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,
if any, 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 investments
in biotechnology companies whose risk of market fluctuations is greater than
the stock market in general. To manage a portion of 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
1998, 1997 and 1996, the Company provided $7.3 million, $6.7 million and $6.1
million, respectively, for the Company match under the Plan.
Comprehensive Income: The Company adopted Statement of Financial Accounting
Standards (FAS) 130, "Reporting Comprehensive Income," at 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.
The measurement and presentation of net income did not change. Comprehensive
income is comprised of net income and other comprehensive income. Other
comprehensive income includes certain changes in equity of the Company that
are excluded from net income. Specifically, FAS 130 requires unrealized
holding gains and losses on the Company's available-for-sale securities,
which were reported separately in stockholders' equity, to be included in
accumulated other comprehensive income. Comprehensive income for years ended
December 31, 1998, 1997 and 1996 has been reflected in the Consolidated
Statements of Stockholders' Equity.
New Accounting Standard: In June 1998, the Financial Accounting Standards
Board issued FAS 133, "Accounting for Derivative Instruments and Hedging
Activities," effective beginning in the first quarter of 2000. FAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and
for hedging activities. It requires companies to recognize all derivatives
as either assets or liabilities on the balance sheet and measure those
instruments at fair value. Gains or losses resulting from changes in the
values of those derivatives would be accounted for depending on the use of
the derivative and whether it qualifies for hedge accounting under FAS 133.
The Company is currently evaluating the impact of FAS 133 on its financial
position and results of operations.
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, 1998 and 1997 are summarized
below (in thousands):
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------
<S> <C> <C>
Raw materials and supplies $ 21,414 $ 17,544
Work in process 106,383 84,831
Finished goods 20,829 13,651
--------------------
Total $148,626 $116,026
====================
</TABLE>
Reclassifications: Certain reclassifications of prior year amounts have been
made to conform with the current year presentation.
SEGMENT, SIGNIFICANT CUSTOMER AND GEOGRAPHIC INFORMATION
The Company adopted FAS 131, "Disclosure about Segments of an Enterprise and
Related Information," at December 31, 1998. FAS 131 establishes annual and
interim reporting standards for an enterprise's operating segments and
related disclosures about its products, services, geographic areas and major
customers. Under FAS 131, the Company's operations are treated as one
operating segment as it only reports profit and loss information on an
aggregate basis to chief operating decision makers of the Company.
Information about the Company's product sales and major customers are as
follows (in thousands):
<TABLE>
<CAPTION>
Product Sales 1998 1997 1996
- -------------------------------------------------------------------------
<S> <C> <C> <C>
Herceptin $ 30.5 - -
Rituxan 162.6 $ 5.5 -
Activase 213.0 260.7 $284.1
Growth hormone (Protropin,
Nutropin and Nutropin AQ) 214.0 223.6 218.2
Pulmozyme 93.8 91.6 76.0
Actimmune 3.9 3.5 4.5
--------------------------------
Total product sales $717.8 $584.9 $582.8
</TABLE>
HLR contributed approximately 11% of the Company's total revenues in 1998,
11% in 1997 and 14% in 1996. See the Related Party Transactions note below
for further information. Three other major customers, Caremark, Inc., Bergen
Brunswig, and Cardinal Distribution, Inc., each contributed 10% or more of
the Company's total revenues in at least one of the last three years.
Caremark, Inc., a national distributor, which accounted for 10%, 14% and 15%
of total revenues in 1998, 1997 and 1996, respectively, distributes the
Company's growth hormone products, Pulmozyme and Actimmune through its
extensive branch network and is then reimbursed through a variety of sources.
Bergen Brunswig, a national wholesale distributor of all of the Company's
products, contributed 11% in 1998 and 10% in 1997 and 1996. Cardinal
Distribution, Inc., a national wholesaler distributor of all the Company's
products, contributed 11% in 1998.
Approximate foreign sources of revenues were as follows (in millions):
<TABLE>
<CAPTION>
1998 1997 1996
- --------------------------------------------------------
<S> <C> <C> <C>
Europe $171.0 $139.5 $146.4
Asia (primarily Japan) 16.9 34.2 17.8
Canada 11.7 11.7 11.1
</TABLE>
The Company currently sells primarily to distributors and health care
companies throughout the U.S., performs ongoing credit evaluations of its
customers' financial condition and extends credit generally without
collateral. In 1998, 1997 and 1996, 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 various companies. These
strategic alliances include the acquisition of both marketable and
nonmarketable equity investments and convertible debt of companies developing
technologies that fall outside the Company's research focus and include
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.
In December 1997, the Company and Alteon Inc. (Alteon) entered into a
collaborative agreement to develop and market pimagedine, an advanced
glycosylation end-product formation inhibitor to treat kidney disease in
diabetic patients. Under the terms of the agreement, the Company licensed
pimagedine and second generation compounds from Alteon and has made
investments in Alteon stock of $37.5 million. In 1998, as a result of
unsuccessful clinical trials with pimagedine and the decline in the value of
the Company's investment in Alteon, the Company wrote down $24.2 million of
its marketable and nonmarketable equity investments in Alteon. The Company
is in discussions with Alteon as to the future direction of the
collaboration.
INCOME TAXES
The income tax provision consists of the following amounts (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
- ------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 39,945 $ 30,617 $ 61,502
State 1,004 432 2,104
Foreign - 2 2
--------------------------------
Total current 40,949 31,051 63,608
--------------------------------
Deferred:
Federal 29,006 23,799 (34,021)
State 787 (14,099) -
--------------------------------
Total deferred 29,793 9,700 (34,021)
--------------------------------
Total income tax provision $ 70,742 $ 40,751 $ 29,587
================================
</TABLE>
Actual current tax liabilities are lower by $17.3 million, $14.0 million and
$8.4 million in 1998, 1997 and 1996, respectively, due to employee stock
option related tax benefits which were credited to stockholders' equity.
A reconciliation between the Company's effective tax rate and the U.S.
statutory rate follows:
<TABLE>
<CAPTION>
Tax Rate
1998 Amount ----------------------------
(thousands) 1998 1997 1996
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tax at U.S. statutory rate $ 88,428 35.0% 35.0% 35.0%
R&D credits realized (11,919) (4.7) (11.4) (3.0)
Tax benefit of certain realized gains
on securities available-for-sale (2,982) (1.2) (3.8) -
Adjustment of deferred tax assets
valuation allowance - - - (15.3)
Foreign losses realized (10,500) (4.2) - (3.4)
State taxes 7,491 3.0 2.3 2.3
Other 224 0.1 1.9 4.4
------------------------------------------
Income tax provision $ 70,742 28.0% 24.0% 20.0%
==========================================
</TABLE>
The components of deferred taxes consist of the following at December 31
(in thousands):
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Depreciation $ 66,471 $ 55,137
Unrealized gain on securities
available-for-sale 30,617 25,086
Other 20,016 2,173
-----------------------
Total deferred tax liabilities 117,104 82,396
Deferred tax assets:
Capitalized R&D costs 42,317 33,950
Federal credit carryforwards 86,725 100,400
Expenses not currently deductible 56,699 35,000
State credit carryforwards 30,632 28,365
Other 4,992 4,398
-----------------------
Total deferred tax assets 221,365 202,113
Valuation allowance (62,844) (48,508)
-----------------------
Total net deferred tax assets 158,521 153,605
-----------------------
Total net deferred taxes $ 41,417 $ 71,209
=======================
</TABLE>
Total tax credit carryforwards of $117.4 million expire in the years 1999
through 2012, except for $43.0 million of alternative minimum tax credits
which have no expiration date. The valuation allowance at December 31, 1998,
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 $14.3 million and $12.7 million in 1998
and 1997, respectively, and decreased by $17.0 million in 1996. 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, availability of third party reimbursement for therapies and
regulatory approval of products under development.
EARNINGS PER SHARE
The following is a reconciliation of the numerator and denominators of the
basic and diluted EPS computations for the years ended December 31, 1998,
1997 and 1996 (in thousands).
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------------
<S> <C> <C> <C>
Numerator:
Net income - numerator for
basic and diluted EPS: $ 181,909 $ 129,044 $ 118,348
-------------------------------------
Denominator:
Denominator for basic EPS--
weighted-average shares 125,767 123,042 120,623
Effect of dilutive securities:
Stock options 4,105 3,355 3,325
Warrants - - 21
-------------------------------------
Denominator for diluted EPS
--adjusted weighted-average
shares and assumed conversions 129,872 126,397 123,969
=====================================
</TABLE>
Options to purchase 178,575 shares of the Company's Special Common Stock
ranging from $70.50 to $71.13 per share, 103,700 shares of Special Common
Stock at $59.00 per share and 5,251,665 shares of Special Common Stock at
$54.25 per share were outstanding during 1998, 1997 and 1996, respectively,
but were not included in the computation of diluted earnings per share.
These options' exercise price was greater than the average market price of
the Special Common Stock and therefore, the effect would be anti-dilutive.
See Capital Stock note for information on option expiration dates.
During 1998, 1997 and 1996, the Company had convertible subordinated
debentures which were convertible to 1,013,447, 1,013,514 and 1,013,514
shares, respectively, of Special 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.
INVESTMENT SECURITIES
Securities classified as trading, available-for-sale and held-to-maturity at
December 31, 1998 and 1997 are summarized below. Estimated fair value is
based on quoted market prices for these or similar investments.
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1998 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
<S> <C> <C> <C> <C>
TOTAL TRADING SECURITIES
(carried at estimated
fair value) $ 236,330 $ 3,817 $ (246) $ 239,901
==============================================
SECURITIES AVAILABLE-FOR-SALE
(carried at estimated
fair value):
Equity securities $ 42,024 $ 77,364 $ (1,042) $ 118,346
U.S. Treasury securities
and obligations of other
U.S. government agencies
maturing:
between 5-10 years 31,294 1,812 (74) 33,032
Corporate debt securities
maturing:
within 1 year 251,238 233 (515) 250,956
between 1-5 years 309,762 3,525 (934) 312,353
between 5-10 years 149,410 6,603 (472) 155,541
Other debt securities
maturing:
between 1-5 years 70,768 172 (2,502) 68,438
between 5-10 years 19,836 267 - 20,103
greater than 10 years 9,033 49 (7) 9,075
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 883,365 $ 90,025 $ (5,546) $ 967,844
==============================================
SECURITIES HELD-TO-MATURITY
(carried at amortized cost):
Corporate debt securities
maturing:
within 1 year $ 115,687 $ - $ (79) $ 115,608
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 115,687 $ - $ (79) $ 115,608
==============================================
</TABLE>
<TABLE>
<CAPTION>
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
December 31, 1997 Cost Gains Losses Value
- ------------------------------------------------------------------------------
(thousands)
<S> <C> <C> <C> <C>
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 38,979 577 (3) 39,553
Corporate debt securities
maturing:
within 1 year 100,178 51 (8) 100,221
between 1-5 years 100,713 770 (103) 101,380
between 5-10 years 149,242 4,053 - 153,295
Other debt securities
maturing:
within 1 year 41,061 - (578) 40,483
between 1-5 years 41,057 - (2,008) 39,049
----------------------------------------------
TOTAL AVAILABLE-FOR-SALE $ 517,492 $ 81,247 $ (4,847) $ 593,892
==============================================
SECURITIES HELD-TO-MATURITY
(carried at amortized cost):
Corporate debt securities
maturing:
within 1 year $ 195,522 $ 19 - $ 195,541
----------------------------------------------
TOTAL HELD-TO-MATURITY $ 195,522 $ 19 - $ 195,541
==============================================
</TABLE>
The carrying value of all investment securities held at December 31, 1998 and
1997 is summarized below (in thousands):
<TABLE>
<CAPTION>
Security 1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Trading securities $ 239,901 $ 252,627
Securities available-for-sale maturing within one year 250,956 140,704
Securities held-to-maturity maturing within one year 115,687 195,522
---------------------
Total short-term investments $ 606,544 $ 588,853
=====================
</TABLE>
Securities available-for-sale maturing between
1-10 years, including equity securities $ 716,888 $ 453,188
---------------------
Total long-term marketable securities $ 716,888 $ 453,188
=====================
In 1998, proceeds from the sales of available-for-sale securities totaled
$431.0 million; gross realized gains totaled $9.5 million and gross realized
losses totaled $1.8 million. 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. The Company recorded charges in 1998 and 1997 of $20.2 million
and $4.0 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, 1998, 1997 and 1996, net change in
unrealized holding gains/(losses) on trading securities included in net
income totaled $7.4 million, ($3.8) million and ($1.0) million, respectively.
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. Other than asset-backed securities, 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 1998, 1997 and 1996.
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 a portion of
anticipated nondollar denominated net revenues, the Company currently
purchases options and may enter into forward contracts. At December 31,
1998, the Company had hedged approximately 75% of probable net foreign
revenues anticipated within 12 months and 40% of its probable net foreign
revenues through the year 2000. At December 31, 1998 and 1997, the notional
amounts of the options totaled $75.0 million and $122.9 million,
respectively, and consisted of the following currencies: German marks,
Spanish pesetas, French francs, British pounds, Italian lire, Japanese yen
and Swedish krona. All option contracts mature within the next two years.
The fair value of the options was based on exchange rates and market
conditions at December 31, 1998 and 1997. All forward contracts were closed
out at the end of 1997 and no forward contracts were entered into in 1998.
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 interest
rates change, primarily U.S. interest rates. 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 may enter into swaps as part of its overall
strategy of managing the duration of its investment portfolio. For each
swap, the Company receives interest based on fixed rates and pays interest to
counterparties based on floating rates on a notional principal amount. 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. At December 31, 1998 and 1997, the
Company had three swap contracts outstanding with notional amounts totaling
$150.0 million. The Company's credit exposure on swaps and the net carrying
amounts of swaps held at December 31, 1998 and 1997, were not material. Net
interest income from swaps in 1998, 1997 and 1996 was also immaterial.
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 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, 1998, the notional amounts of the put
and call options were $32.0 million and $46.0 million, respectively. At
December 31, 1997, the notional amounts of the put and call options were
$33.7 million and $50.1 million, respectively.
Financial Instruments Held for Trading Purposes: As part of its 1998 overall
investment strategy, the Company has contracted with two external money
managers to manage part of its investment portfolio. These portfolios at
December 31, 1998, consisted of U.S. and nondollar denominated investments.
To hedge the nondollar denominated investments, the money managers enter into
forward contracts. The notional amounts of the forward contracts at December
31, 1998 and 1997, were $211.6 million and $209.3 million, respectively. The
fair value at December 31, 1998 and 1997, of the forward contracts, totaled
$0.4 million and $3.3 million, respectively. The average fair value during
1998 and 1997 totaled ($0.9) million and $2.1 million, respectively. Net
realized and unrealized trading gains on the portfolio totaled approximately
$16.2 million in 1998 and $9.1 million in 1997, 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, 1998 and 1997, 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):
<TABLE>
<CAPTION>
1998 1997
--------------------- ---------------------
Carrying Fair Carrying Fair
Financial Instrument Value Value Value Value
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Assets:
Investment securities
(including accrued interest
and traded forward contracts) $1,323,432 $1,323,353 $1,042,041 $1,042,060
Convertible equity loans 55,800 55,800 55,248 55,248
Purchased foreign exchange put
options 1,441 5,741 3,891 14,468
Outstanding interest rate swaps 5,742 167,535 5,742 165,559
Liabilities:
Long-term debt 149,990 148,000 150,000 139,500
Equity collars 4,857 11,600 12,161 15,533
Outstanding interest rate swaps 3,587 153,587 3,732 153,732
</TABLE>
OTHER ACCRUED LIABILITIES
Other accrued liabilities at December 31 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------
<S> <C> <C>
Accrued compensation $ 47,057 $ 44,624
Accrued clinical and other studies 35,535 47,269
Accrued royalties 23,392 23,905
Accrued marketing and promotion costs 9,417 13,369
Other 77,639 55,678
-------------------------
Total other accrued liabilities $193,040 $184,845
=========================
</TABLE>
LONG-TERM DEBT
The Company's long-term debt as of December 31, 1998 and 1997 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
Leases: Future minimum lease payments under operating leases, net of
sublease income, at December 31, 1998 are as follows (in thousands):
1999 2000 2001 2002 2003 Thereafter Total
- --------------------------------------------------------------------------
$25,855 23,591 22,470 19,627 18,637 36,707 $146,887
The Company leases various real property under operating leases that
generally require the Company to pay taxes, insurance and maintenance. Rent
expense was approximately $12.7 million, $11.7 million and $11.7 million for
the years 1998, 1997 and 1996, respectively. Sublease income was not
material in any of the three years presented.
Under four 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
$377.0 million. The Company also is required to maintain certain financial
ratios and is limited to the amount of additional debt it can assume.
Commitments: The Company and CuraGen Corporation (CuraGen) entered into a
research collaborative agreement in November 1997, whereby the Company
invested $5.0 million in equity of CuraGen and has agreed to provide a
convertible equity loan to CuraGen of up to $26.0 million. As of December
31, 1998, no loan amounts have been funded to CuraGen.
Also, in December 1997, the Company and LeukoSite Inc. (LeukoSite) 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 has agreed to 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 has agreed to
provide a second loan to LeukoSite for such funding. As of December 31,
1998, no loan amounts have been funded to LeukoSite.
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 $7.2 million was contributed as of
December 31, 1998. The Vector Fund will terminate and be dissolved in
September 2007.
Contingencies: The Company is a party to various legal proceedings,
including patent infringement cases involving human growth hormone products
and Activase, registered trademark, and other matters.
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, 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, registered trademark,
human growth hormone products infringed the Goodman Patent. The 1997 case
has been stayed pending the conclusion of the 1990 case, which is expected to
commence trial in April 1999.
Based upon the nature of the claims made and the information available to
date to the Company and its counsel through investigations and otherwise, the
Company believes the outcome of these actions is not likely to 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.
In addition to the above, 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, February 1998 and October 1998, the Company received grand
jury document subpoenas from the same court related to the same subject
matter. The government is actively investigating this matter, and the
Company is a target of that investigation. The Company expects further
activity with respect to this matter in the near future. At this time, the
Company cannot reasonably estimate a possible range of loss, if any, that may
result from this investigation due to uncertainty regarding the outcome.
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 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, 1999, the call price is $81.00 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 (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. In the
event of the put, at December 31, 1998, $14.8 million is contingently 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 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, 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 through the New Drug Application approval
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., 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 Activase, Protropin, Nutropin, Pulmozyme and Actimmune, sales of
Pulmozyme outside of the U.S. and sales of Rituxan outside of the U.S.,
excluding Japan. HLR currently has the right to sell Pulmozyme exclusively
in Canada and Europe and pays royalties to the Company 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
65.3% of the outstanding common equity of the Company as of December 31,
1998.
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. The Company recorded
nonrecurring contract revenues from HLR of $40.0 million for Herceptin,
registered trademark, (trastuzumab) marketing rights outside of the U.S. in
1998 (see below) and $44.7 million for the exercise of their options under
the License Agreement with respect to three development projects [Rituxan,
insulin-like growth factor (IGF-I) which was subsequently terminated, and
nerve growth factor] in 1996. All other contract revenue from HLR, including
reimbursement for ongoing development expenses after the option exercise
date, totaled $21.6 million in 1998, $67.6 million in 1997, $50.6 million in
1996. 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 $63.8 million in 1998,
$42.8 million in 1997 and $39.5 million in 1996.
In July 1998, the Company entered into an agreement with HLR to provide HLR
exclusive marketing rights outside of the U.S. for Herceptin. Under the
agreement, HLR paid $40.0 million and has agreed to pay cash milestones tied
to future product development activities, to contribute equally with the
Company up to a maximum of $40.0 million on global development costs and to
make royalty payments on product sales. As of December 31, 1998, no
additional amounts have been paid.
The Company has a contractual relationship with Novation, LLC (Novation), a
group purchasing organization that is a joint venture of VHA, Inc. and
University HealthSystem Consortium. One officer of VHA, Inc. is on the
Company's Board of Directors. Under the contractual relationship, the
Company pays to Novation an administrative fee, and pays to Novation member
hospitals a rebate, based on a percentage of the purchases of Activase by
such member hospitals. In 1998, administrative fees and rebates paid to
Novation and its member hospitals, respectively, were not material.
The Company has contracted with Jacobs Engineering Group Inc. (Jacobs) to
provide design and engineering services for various projects of the Company.
One of the members of the Board of Directors of Jacobs is also a member of
the Board of Directors of the Company. In 1998, the amounts the Company paid
to Jacobs were not material.
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, 3,743,789 shares have been issued as of December 31,
1998. During 1998, 2,818 of the eligible employees participated in the 1991
Plan.
The Company has elected to continue to follow Accounting Principles Board
(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 1998, 1997 and 1996, respectively: risk-
free interest rates of 5.5%, 6.2% and 5.8%; dividend yields of 0%; volatility
factors of the expected market price of the Company's Common Stock of 11.9%,
9.2% 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):
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------------
<S> <C> <C> <C>
Net income - as reported $181,909 $129,044 $118,348
Net income - pro forma 140,995 111,441 104,358
Earnings per share - as reported:
Basic 1.45 1.05 0.98
Diluted 1.40 1.02 0.95
</TABLE>
Earnings per share - pro forma:
Basic 1.12 0.91 0.87
Diluted 1.10 0.89 0.84
A summary of the Company's stock option activity and related information were
as follows:
<TABLE>
<CAPTION>
Weighted Average
Shares Price
---------- ----------------
<S> <C> <C>
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
Grants 4,594,925 67.82
Exercises (2,460,907) 35.32
Cancellations (1,248,021) 54.64
----------
Options outstanding at December 31, 1998 17,125,606 $ 51.27
==========
</TABLE>
The following table summarizes information concerning currently outstanding
and exercisable options:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------- ---------------------
Weighted
Average
Years Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$15.990 - $21.375 214,951 0.58 $ 19.87 214,951 $ 19.87
$25.500 - $38.125 3,196,155 11.08 28.18 3,155,655 28.20
$41.750 - $59.000 9,306,775 11.98 52.09 4,937,820 51.35
$67.063 - $71.125 4,407,725 9.68 67.82 1,525 67.31
----------- -----------
17,125,606 8,309,951
=========== ===========
</TABLE>
Using the Black-Scholes option valuation model, the weighted average fair
value of options granted in 1998, 1997 and 1996, respectively was $17.23,
$15.37 and $13.36. Shares of Special Common Stock available for future
grants under all stock option plans were 2,041,218 at December 31, 1998.
<PAGE>
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, 1998 and 1997, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. 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, 1998 and 1997, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December
31, 1998, in conformity with generally accepted accounting principles.
Ernst & Young LLP
San Jose, California
January 20, 199
<PAGE>
QUARTERLY FINANCIAL DATA (UNAUDITED)
(thousands, except per share amounts)
<TABLE>
<CAPTION>
1998 Quarter Ended
-------------------------------------------------
December 31 September 30 June 30 March 31
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total revenues $304,301 $313,930 $268,012 $264,700
Product sales 213,713 163,100 176,263 164,719
Gross margin from product sales 181,212 127,749 139,113 131,098
Net income 37,140 63,378 40,374 41,017
Earnings per share:
Basic 0.29 0.50 0.32 0.33
Diluted 0.28 0.49 0.31 0.32
<CAPTION>
1997 Quarter Ended
-------------------------------------------------
December 31 September 30 June 30 March 31
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
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
</TABLE>
<PAGE>
11-YEAR FINANCIAL SUMMARY (UNAUDITED)
(millions, except per share and employee data)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total revenues $1,150.9 $1,016.7 $ 968.7 $ 917.8 $ 795.4
Product sales 717.8 584.9 582.8 635.3 601.0
Royalties 229.6 241.1 214.7 190.8 126.0
Contract & other 114.8 121.6 107.0 31.2 25.6
Interest 88.7 69.1 64.2 60.5 42.8
- ----------------------------------------------------------------------------------------
Total costs and expenses $ 898.3 $ 846.9 $ 820.8 $ 745.6 $ 665.8
Cost of sales 138.6 102.5 104.5 97.9 95.8
Research & development 396.2 470.9 471.1 363.0 314.3
Marketing, general & administrative 358.9 269.9 240.1 251.7 248.6
Special charge - - - 25.0(1) -
Interest 4.6 3.6 5.1 8.0 7.1
- ----------------------------------------------------------------------------------------
Income data
Income (loss) before taxes $ 252.6 $ 169.8 $ 147.9 $ 172.2 $ 129.6
Income tax provision 70.7 40.8 29.6 25.8 5.2
Net income (loss) 181.9 129.0 118.3 146.4 124.4
Tax rate 28% 24% 20% 15% 4%
- ----------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic $ 1.45 $ 1.05 $ 0.98 $ 1.24 $ 1.07
Diluted 1.40 1.02 0.95 1.20 1.03
- ----------------------------------------------------------------------------------------
Selected balance sheet data
Cash, short-term investments
& long-term marketable securities $1,604.6 $1,286.5 $1,159.1 $1,096.8 $ 920.9
Accounts receivable 149.7 189.2 197.6 172.2 146.3
Inventories 148.6 116.0 91.9 93.6 103.2
Property, plant & equipment, net 700.2 683.3 586.2 503.7 485.3
Other long-term assets 196.3 177.2 149.2 105.5 61.0
Total assets 2,855.4 2,507.6 2,226.4 2,011.0 1,745.1
Total current liabilities 291.3 289.6 250.0 233.4 220.5
Long-term debt 150.0 150.0 150.0 150.0 150.4
Total liabilities 511.6 476.4 425.3 408.9 396.3
Total stockholders' equity 2,343.8 2,031.2 1,801.1 1,602.0 1,348.8
- ----------------------------------------------------------------------------------------
Other data
Depreciation and amortization expense $ 78.1 $ 65.5 $ 62.1 $ 58.4 $ 53.5
Capital expenditures 88.1 154.9 141.8 70.2 82.8
- ----------------------------------------------------------------------------------------
Share information
Shares used to compute EPS:
Basic 125.8 123.0 120.6 118.3 116.0
Diluted 129.9 126.4 124.0 121.7 120.2
Actual year-end 127.1 124.2 121.4 119.3 117.2
- ----------------------------------------------------------------------------------------
Per share data
Market price: High $ 79.75 $ 60.63 $ 55.38 $ 53.00* $ 53.50
Low $ 59.25 $ 53.25 $ 51.38 $ 44.50* $ 41.75
Book value $ 18.44 $ 16.35 $ 14.84 $ 13.43 $ 11.50
- ----------------------------------------------------------------------------------------
Number of employees 3,389 3,242 3,071 2,842 2,738
- ----------------------------------------------------------------------------------------
<FN>
The Company has paid no dividends.
The Financial Summary above reflects adoption of FAS 130 and 131 in 1998, FAS 128 and
129 in 1997, FAS 121 in 1996, FAS 115 in 1994, FAS 109 in 1992 and FAS 96 in 1988.
*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.
</FN>
</TABLE>
<TABLE>
<CAPTION>
1993 1992 1991 1990 1989 1988
- -------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 649.7 $ 544.3 $ 515.9 $ 476.1 $ 400.5 $ 334.8
457.4 391.0 383.3 367.2 319.1 262.5
112.9 91.7 63.4 47.6 36.7 26.7
37.9 16.7 20.4 31.9 27.5 33.5
41.5 44.9 48.8 29.4 17.2 12.1
- -------------------------------------------------------------------
$ 590.8 $ 522.3 $ 469.8 $ 572.7 $ 352.9 $ 311.7
70.5 66.8 68.4 68.3 60.6 46.9
299.4 278.6 221.3 173.1 156.9 132.7
214.4 172.5 175.3 158.1 127.9 101.9
- - - 167.7(2) - 23.3(3)
6.5 4.4 4.8 5.5 7.5 6.9
- -------------------------------------------------------------------
$ 58.9 $ 21.9 $ 46.1 $ (96.6) $ 47.6 $ 23.1
- 1.1 1.8 1.5 3.6 2.5
58.9 20.8 44.3 (98.0) 44.0 20.6
- 5% 4% - 8% 11%
- ------------------------------------------------------------------
$ 0.52 $ 0.19 $ 0.40 $ - $ - $ 0.25
0.50 0.18 0.39 (1.05)(4) 0.51(4) 0.24
- -------------------------------------------------------------------
$ 719.8 $ 646.9 $ 711.4 $ 691.3 $ 205.0 $ 152.5
130.5 93.9 69.0 58.8 66.8 63.9
84.7 65.3 56.2 39.6 49.3 63.4
456.7 432.5 342.5 300.2 299.1 289.4
64.1 37.1 42.7 61.7 85.0 89.7
1,468.8 1,305.1 1,231.4 1,157.7 711.2 662.9
190.7 133.5 118.6 101.4 75.9 95.4
151.2 152.0 152.9 153.5 154.4 155.3
352.0 297.8 281.7 264.5 242.2 263.6
1,116.8 1,007.3 949.7 893.2 469.0 399.3
- -------------------------------------------------------------------
$ 44.0 $ 52.2 $ 46.9 $ 47.6 $ 44.6 $ 38.3
87.5 126.0 71.3 36.0 37.2 110.9
- -------------------------------------------------------------------
113.9 111.9 111.0 - - 82.2
118.7 115.0 113.2 93.0(4) 86.0(4) 85.0
114.8 112.9 111.3 110.6 84.3 82.9
- -------------------------------------------------------------------
$ 50.50 $ 39.50 $ 36.25 $ 30.88 $ 23.38 $ 47.50
$ 27.50**
$ 31.25 $ 25.88 $ 20.75 $ 20.13 $ 16.00 $ 14.38
$ 21.75**
$ 9.73 $ 8.92 $ 8.53 $ 8.08 $ 5.56 $ 4.82
- -------------------------------------------------------------------
2,510 2,331 2,202 1,923 1,790 1,744
- -------------------------------------------------------------------
</TABLE>
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 an 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, 1998, there were approximately 13,374 stockholders of
record of the Company's Special Common Stock.
Stock Prices
<TABLE>
<CAPTION>
Special Common/Redeemable Common/Common Stock
1998 1997
- --------------------------------------------------------------------------
High Low High Low
------------------------------------------------
<S> <C> <C> <C> <C>
4th Quarter $ 79 3/4 $ 68 1/8 $ 60 5/8 $ 57 1/2
3rd Quarter 72 11/16 63 9/16 58 15/16 56 1/2
2nd Quarter 73 3/4 65 3/4 59 1/4 56 1/2
1st Quarter 72 1/2 59 1/4 58 53 1/4
</TABLE>
Page 1
Draft # 2 (1/22/99)
<PAGE>
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, 1999, included in the
1998 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, 1999, 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, 1998.
Ernst & Young LLP
San Jose, California
January 20, 1999
<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, 1998, 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-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 281,162
<SECURITIES> 1,323,432
<RECEIVABLES> 167,159
<ALLOWANCES> 17,418
<INVENTORY> 148,626
<CURRENT-ASSETS> 1,241,958
<PP&E> 1,145,464
<DEPRECIATION> 445,215
<TOTAL-ASSETS> 2,855,402
<CURRENT-LIABILITIES> 291,327
<BONDS> 149,990
0
0
<COMMON> 2,542
<OTHER-SE> 2,341,303
<TOTAL-LIABILITY-AND-EQUITY> 2,855,402
<SALES> 717,795
<TOTAL-REVENUES> 1,150,943
<CGS> 138,623
<TOTAL-COSTS> 138,623
<OTHER-EXPENSES> 396,186
<LOSS-PROVISION> 18,347
<INTEREST-EXPENSE> 4,552
<INCOME-PRETAX> 252,651
<INCOME-TAX> 70,742
<INCOME-CONTINUING> 181,909
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 181,909
<EPS-PRIMARY> 1.45
<EPS-DILUTED> 1.40
</TABLE>
<PAGE>
Exhibit 99.11
GENENTECH, INC. EPR INCENTIVE UNITS PROGRAM
1. Purpose. The purpose of the Genentech EPR Incentive Units Program
(the "Program") is to provide eligible employees of Genentech, Inc. (the
"Company") with a cash-based supplement to the long-term incentive and
retention value of Company stock options. Under the Program, each eligible
employee shall receive a number of Units, as defined below, which will be
assigned potential value if the Company achieves key performance benchmarks
during the term of the Program. Participating employees are entitled to earn
the potential Unit value only in the event of a Shareholder Put, as defined
below, during the period after the Shareholder Put occurs based on continuous
employment with the Company through certain defined cash payment dates,
subject to certain employment termination events provided herein.
2. Definitions. As used herein, the following definitions shall apply:
(a) "Benchmark Value" means the total dollar value per Unit
attributable to attainment of Success Benchmarks as determined in accordance
with Section 5.
(b) "Board" means the Board of Directors of the Company.
(c) "Committee" means the Compensation Committee of the Board.
(d) "Company" means Genentech, Inc., a Delaware corporation.
(e) "Continuous Employment" means the Employee's continuous and
uninterrupted employment with the Company except for approved absences and
other interruptions approved by the Executive Committee or pursuant to a
formal written Company policy.
(f) "Defined Period Employees" means Employees who are hired by
the Company to work for a specified period of time and/or on a specified
project, including post-doctoral hires, visiting scientists, and such other
Employees as determined by the Committee, in its discretion.
(g) "Disability" means total and permanent disability as
defined in Section 22(e)(3) of the Internal Revenue Code of 1986, as amended,
or any successor provision.
(h) "Early Retirement Date" means the date of which an Employee
attains both (i) age 55 and (ii) ten (10) Years of Service.
(i) "Earnings per Share" or "EPS" means, as to any fiscal year
of the Company during the Program Term, the Company's net income per share as
publicly reported by the Company to its stockholders for such fiscal year,
provided that the Committee may, in its sole discretion, determine whether
any significant item(s) shall be included or excluded from the calculation of
Earnings per Share for purposes of the Program.
(j) "Employee" means a natural person who is employed by the
Company and who is treated as an employee by the Company for tax purposes.
(k) "Ending Stock Value" means a value calculated as the
average of the closing sales prices of the Company's Callable Putable Common
Stock for each day during the period beginning July 1, 1999 and ending at the
close of business on the thirtieth (30th) business day thereafter, on which
national stock exchanges and the Nasdaq System are open for trading, as
reported in The Wall Street Journal or such other source as the Committee
deems reliable.
(l) "Executive Committee" means the committee comprised mainly
of the Chief Executive Officer's direct reports, which sets the Company's
operating objectives, approves major operating recommendations and interfaces
with the Board.
(m) "Job Elimination" means elimination of an Employee's job or
function as part of an organizational restructuring or broad-based layoff or
in connection with the elimination of all or a significant portion of a
particular corporate group or function.
(n) "Normal Retirement Age" means an Employee's 65th birthday.
(o) "Participant" means an Employee who receives an award of
Units pursuant to the Plan.
(p) "Product Approval" means the U.S. Food and Drug
Administration grants a marketing license for a product identified by the
Committee for purposes of the Program.
(q) "Program" means this EPR Incentive Units Program.
(r) "Program Term" means the period from January 1, 1997
through December 31, 2000.
(s) "Research Prospects" means research-stage products chosen
for development that are identified by the chief executive officer of the
Company in collaboration with the Executive Committee as Research Prospects
for purposes of the Program based upon their potential commercial success as
determined by the chief executive officer and the Executive Committee with
reference to internal Company projections.
(t) "Retirement" means the Employee's voluntary resignation
from his or her employment with the Company upon or after attaining his or
her Normal Retirement Age or Early Retirement Date.
(u) "Shareholder Put" means the exercise of the put right by
the Company's stockholders as described in Section 1.01(b) of the Amended and
Restated Governance Agreement between the Company and Roche Holdings, Inc.
("Roche") and a tender of sufficient shares of the Company's Callable Putable
Common Stock to the Company such that Roche owns at least eighty-five percent
(85%) of the total outstanding shares of the Company's Callable Putable
Common Stock and the Company's Common Stock, when considered in the
aggregate.
(v) "Stock Appreciation" means the per share increase, if any,
in the value of the Company's Callable Putable Common Stock over the Program
Term, calculated as the excess of the Ending Stock Value over $53.53 (the
average per share stock price during the 4th quarter, 1996).
(w) "Success Benchmarks" means Company performance milestones
based on (i) Earnings per Share targets, (ii) Product Approvals, (iii)
Research Prospects, or (iv) such other performance milestones as the
Committee may establish.
(x) "Units" means the incentive Units awarded by the Committee
under this Program.
(y) "Unit Value" means the dollar value of a Unit calculated as
the excess of the Benchmark Value over the Stock Appreciation.
3. Administration of the Program.
(a) Administration. The Program shall be administered by the
Committee.
(b) Powers of the Committee. Subject to the provisions of the
Program and to the specific duties, if any, delegated by the Board to the
Committee, the Committee shall have the authority, at its discretion:
(i) to select the Employees to whom Units may be granted
hereunder and the number of Units to be covered by each such award;
(ii) to identify Success Benchmarks under the Program and
the values associated therewith;
(iii) to determine the terms and conditions of Units
awarded under the Program to the extent consistent with the terms of the
Program including, but not limited to, Benchmark Value, Earnings per Share,
Ending Stock Value, Product Approval and Research Prospects;
(iv) to construe and interpret the terms of the Program
and Units granted pursuant to the Program; and
(v) to make all other determinations deemed necessary or
advisable for administering the Program.
(c) Effect of Committee's Decisions. The Committee's
decisions, determinations and interpretations shall be final and binding on
all Participants.
4. Award of Units.
(a) Eligibility. All Employees other than Defined Period
Employees are eligible to receive Units under the Program.
(b) Number of Units - General Rule. Unless determined
otherwise by the Executive Committee, each Employee shall be awarded a number
of Units similar to the aggregate number of shares of the Company's Callable
Putable Common Stock covered by stock options granted to the Employee under
the Company's stock option plans in 1995 and 1996. Each Employee who is
hired after December 31, 1996 shall be awarded a number of Units similar to
the number of shares of the Company's Callable Putable Common Stock covered
by stock options granted to the Employee under the Company's stock option
plans upon becoming an Employee.
(c) Number of Units - Special Rules. Unless determined
otherwise by the Committee, each eligible Employee who did not receive stock
options under the Company's stock option plans in 1995 or 1996 or otherwise
does not receive stock options during the Program Term shall be awarded 100
Units. If an Employee first becomes an eligible Employee after June 30,
1997, the number of Units shall be equal to the product of (i) the number of
stock options granted upon hire or 100, if no stock options were granted upon
hire, multiplied by (ii) a fraction, the numerator of which is the number of
whole calendar months between the date the Employee first becomes an eligible
Employee and January 1, 2001, and the denominator of which is 48.
Notwithstanding the foregoing, the Committee may, in its discretion, award
Units from time to time during the Program Term and may award Units other
than as provided in Sections 4(b) and 4(c). The Committee may also make more
than one award of Units to each eligible Employee.
(d) Notice of Award. Participants who receive an award of
Units shall be given written notice thereof by the Committee stating the
number of Units awarded and the conditions (if any) to which the Units are
subject. This notice, when duly acknowledged and accepted either
electronically or in writing by the Participant, shall become a Unit
agreement between the Company and the Participant.
5. Benchmark Value. Benchmark Value shall be determined by the
Committee based upon the values assigned by the Committee to the achievement
of Success Benchmarks for the Program Term. Except as otherwise specified by
the Committee, the Success Benchmarks and their associated values shall be as
set forth in Exhibit A hereto.
6. Payment.
(a) General Rule. Payment of the Unit Value shall only occur
in the event of a Stockholder Put. If a Stockholder Put occurs, each
Participant shall, subject to Section 7, be entitled to receive a cash
payment as to the value of his or her Units as provided herein. A
Participant who becomes entitled to a payment with respect to Units hereunder
shall receive a cash payment from the Company in an amount determined by
multiplying the number of Units with respect to which the payment is to be
made by the Unit Value, valued as of December 31, 2000, less applicable
withholding, provided the
Participant remains in the Continuous Employment of the Company through such
date. Subject to Section 6(b) (Early Distribution) and to Section 7
(Termination Events), any payment to be made hereunder shall be made within
thirty (30) days after the Company's earnings are released publicly for the
year ended December 31, 2000. Notwithstanding the foregoing, the Committee
may, in its discretion, unilaterally establish that the payment to be made
with respect to Units awarded to one or more Participants who are also
Executive Committee members shall be determined by multiplying the Unit Value
by 1.25, with payment of such amount to be made as soon as the Company's
earnings are released publicly for the year ended December 31, 2000, subject
to the Participant's Continuous Employment by the Company through December
31, 2000.
(b) Early Distribution. A Participant may elect (an "Early
Distribution Election") to receive payment as to 50% of the value of his or
her Units, valued as of December 31, 1999, less applicable withholding,
provided the Participant remains in the Continuous Employment of the Company
through such date. A Participant who wishes to make an Early Distribution
Election may do so by giving written notice to the Company on a form provided
by the Committee before December 1, 1999. A Participant who makes an Early
Distribution Election will receive payment as to 50% of the value of his or
her Units within thirty (30) days after the Company's earnings are released
publicly for the year ended December 31, 1999, and as to the remaining value
of his or her Units in accordance with Sections 6(a) and 7.
7. Termination Events.
(a) General Rule. A Participant whose Continuous Employment
with the Company terminates for any reason prior to the Shareholder Put shall
forfeit his or her Units upon such termination and shall not be entitled to
receive any payment with respect thereto. Except as provided herein, a
Participant whose Continuous Employment with the Company terminates for any
reason on or before December 31, 2000, but after the Shareholder Put, shall
forfeit his or her Units and shall not be entitled to receive any payment
with respect thereto; provided, however, that a Participant who makes an
Early Distribution Election pursuant to Section 6(b) and whose Continuous
Employment terminates after December 31, 1999 but prior to receiving payment
for his or her Units shall not forfeit the payment as to 50% of the value of
his or her Units on December 31, 1999, but shall forfeit the remaining value
of his or her Units.
(b) Termination After 1999. A Participant who did not make an
Early Distribution Election pursuant to Section 6(b) and whose Continuous
Employment with the Company terminates after December 31, 1999 because of Job
Elimination, death, Retirement, or Disability shall be entitled to a payment
with respect to his or her Units as follows: (i) if such termination occurs
on or after January 1, 2000 but before December 31, 2000, the Participant
shall be entitled to payment as to 50% of the value of his or her Units,
valued as of December 31, 1999, payment to be made within fifteen (15) days
of such termination; and (ii) if such termination occurs on or after December
31, 2000, the Participant shall be entitled to payment as provided in Section
6(a).
8. Nontransferability. Units awarded to Participants pursuant to the
Program may not be sold, pledged, assigned, hypothecated, transferred or
disposed of in any manner.
9. Limitations. Neither the Program nor any award of Units shall
confer upon a Participant any right with respect to continuing the
Participant's employment relationship with the Company, nor shall it
interfere in any way with the Participant's right or the Company's right to
terminate such employment at any time, with or without cause.
10. Amendment and Termination. The Board shall have the power to amend,
suspend or terminate the Program at any time, including as to Units
previously awarded under the Program, provided that on or after the
occurrence of the Shareholder Put, if any, no such amendment, suspension or
termination shall adversely affect Units previously awarded to and held by a
Participant without the Participant's written consent. Notwithstanding the
preceding sentence, the Committee may, at the request of the Company's Chief
Executive Officer, change the Unit Value with respect to Units awarded to a
Participant who is a member of the Company's Executive Committee by applying
a multiplier of 1.25 to his or her December 31, 2000 Unit Value, subject to
the Participant's Continuous Employment with the Company through such date
and to such other terms and conditions, consistent with the Program, as the
Committee may specify.
11. Governing Law. The Program shall be governed by the internal substantive
laws, and not the choice of law rules, of the State of California.
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT A
UPDATED PRODUCT APPROVAL GOALS FOR THE EPR INCENTIVE UNITS PROGRAM
- ------------------------------------------------------------------------------------------------------
ORIGINAL DESIGN UPDATED
---------------------- --------------------------------------------------------
Product Timing Value Per Unit Timing Value Per Unit Comments
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
IDEC/C2B8 1997 $0.75 / $1.50 completed $0.75 / $1.50 -
Adult hGH 1997 $0.25 / $0.50 completed $0.25 / $0.50 -
Stroke (3-5) 1998 $0.50 / $1.00 discontinued - / - value decreased to
zero because project
discontinued
Her2 1999 $0.25 / $0.50 completed $0.75 / $1.50 value increased to
reflect current NPV
TNK 1999 $0.75 / $1.50 2000 $0.50 / $1.00 value decreased to
reflect current NPV
NGF 1999 $0.50 / $1.00 2000 $0.50 / $1.00 -
TPO 1999 $0.50 / $1.00 missed date - / - -
Anti-IgE 1999 $0.75 / $1.50 missed date - / - -
hGH (Alkermes) 2000 $0.25 / $0.50 1999 $0.25 / $0.50 -
IGF-1 (Type I) 2000 $0.50 / $1.00 discontinued - / - value decreased to
zero because project
discontinued
IGF-1 (type II) 2000 $0.50 / $1.00 discontinued - / - value decreased to
zero because project
discontinued
IGF-1 (oral fail.) 2000 $0.25 / $0.50 discontinued - / - value decreased to
zero because project
discontinued
Anti-VEGF not included 2000 $0.75 / $1.50 -
Pimagedine not included 2000 $0.50 / $1.00 -
Xubix not included 2000 $0.50 / $1.00 -
- ------------------------------------------------------------------------------------------------------
Total - $5.75 / $11.50 - $4.75 / $9.50 -
- ------------------------------------------------------------------------------------------------------
Projected Outcome(1) - $7.67 - $6.33 -
- -----------------------------------------------------------------------------------------------------------
<FN>
(1) original program design assumed 2/3 of projects approved at higher ("EPS Trigger") values
</FN>
</TABLE>
