<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the quarterly period ended September 30,
2000.
Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934. For the transition period from to .
Commission File Number
1-9813
GENENTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2347624
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
1 DNA Way, South San Francisco, California 94080-4990
(Address of principal executive offices and zip code)
(650) 225-1000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Number of Shares Outstanding
----- -----------------------------
Common Stock $0.02 par value 524,866,227
Outstanding at October 31, 2000
<PAGE>
GENENTECH, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
Condensed Consolidated Statements of Operations -
for the three months and nine months ended
September 30, 2000 and 1999 3
Condensed Consolidated Statements of Cash Flows -
for the nine months ended September 30, 2000 and 1999 4
Condensed Consolidated Balance Sheets -
September 30, 2000 and December 31, 1999 5
Notes to Condensed Consolidated Financial Statements 6-14
Independent Accountants' Review Report 15
Financial Review 16-39
PART II. OTHER INFORMATION 40
SIGNATURES 42
In this report, "Genentech," "we," "us" and "our" refer to Genentech, Inc.
"Common Stock" refers to Genentech's Common Stock, par value $0.02 per share
and "Special Common Stock" refers to Genentech's callable putable common
stock, par value $0.02 per share. All numbers related to the number of
shares, price per share and per share amounts of Common and Special Common
Stock give effect to the two-for-one split of our Common Stock in November
1999 and October 2000.
We own or have rights to various copyrights, trademarks and trade names used
in our business including the following: Actimmune, registered trademark,
interferon gamma-1b; Activase, registered trademark, (alteplase, recombinant)
tissue plasminogen activator; Herceptin, registered trademark, (trastuzumab)
anti-HER2 antibody; Nutropin, registered trademark, (somatropin (rDNA origin)
for injection) growth hormone; Nutropin AQ, registered trademark, (somatropin
(rDNA origin) injection) liquid formulation growth hormone; Nutropin Depot,
trademark, (somatropin (rDNA origin) for injectable suspension) encapsulated
sustained-release growth hormone; Protropin, registered trademark, (somatrem
for injection) growth hormone; Pulmozyme, registered trademark, (dornase
alfa, recombinant) inhalation solution; Rituxan, registered trademark,
(rituximab) antibody; TNKase, trademark, (tenecteplase) second generation
tissue plasminogen activator; and Xubix, trademark, (sibrafiban) oral
IIb/IIIa antagonist, and Xolair, trademark, (omalizumab). This report also
includes trademarks, service marks and trade names of other companies.
Page 2
<PAGE>
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------------ ------------------------
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Product sales (including amounts from
related parties: three months -
2000-$15,794; 1999-$7,371; nine months -
2000-$57,560; 1999-$34,369) $ 334,173 $ 266,968 $ 926,765 $ 770,392
Royalties (including amounts from related
parties: three months - 2000-$11,242;
1999-$11,768; nine months - 2000-$33,068;
1999-$31,879) 51,818 46,128 148,805 138,732
Contract and other (including amounts from
related parties: three months -
2000-$0; 1999-$0; nine months -
2000-$0; 1999-$19,944) 33,479 7,503 99,524 84,684
Interest 25,712 24,729 69,448 69,114
---------- ----------- ----------- -----------
Total revenues 445,182 345,328 1,244,542 1,062,922
Costs and expenses:
Cost of sales (including amounts from
related parties: three months -
2000-$13,412; 1999-$6,056; nine months -
2000-$48,740; 1999-$27,987) 91,356 92,750 295,148 191,154
Research and development (including
contract related: three months -
2000-$2,686; 1999-$2,451; nine months -
2000-$13,357; 1999-$16,877) 113,636 84,629 340,605 269,580
Marketing, general and administrative 131,726 113,613 350,830 328,186
Special charges:
Legal settlement - - - 50,000
Related to redemption - 57,800 - 1,205,104
Recurring charges related to redemption 97,780 98,986 294,399 98,986
Interest 1,175 1,326 3,701 4,045
---------- ----------- ----------- -----------
Total costs and expenses 435,673 449,104 1,284,683 2,147,055
Income (loss) before taxes 9,509 (103,776) (40,141) (1,084,133)
Income tax provision (benefit) 5,044 (40,931) (4,541) (112,511)
----------- ----------- ----------- -----------
Net income (loss) $ 4,465 $ (62,845) $ (35,600) $ (971,622)
=========== =========== =========== ===========
Earnings (loss) per share:
Basic $ 0.01 $ (0.12) $ (0.07) $ (1.90)
=========== =========== =========== ===========
Diluted $ 0.01 $ (0.12) $ (0.07) $ (1.90)
=========== =========== =========== ===========
Weighted average shares used to compute
earnings (loss) per share:
Basic 522,928 511,413 521,097 512,050
=========== =========== =========== ===========
Diluted 541,483 511,413 521,097 512,050
=========== =========== =========== ===========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Page 3
<PAGE>
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(thousands)
(unaudited)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-----------------------
2000 1999
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) $ (35,600) $ (971,622)
Adjustments to reconcile net (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 358,325 162,634
In-process research and development - 752,500
Non-cash compensation related to stock options,
net of tax - 96,033
Write-up of securities available-for-sale - (20,337)
Deferred income taxes (112,295) (99,544)
Gain on sales of securities available-for-sale (84,046) (12,283)
Loss on sales of securities available-for-sale 2,570 921
Write down of securities available-for-sale - 8,467
Write down of non-marketable equity securities - 432
Loss on fixed asset dispositions 129 155
Changes in assets and liabilities:
Investments in trading securities (13,884) (7,525)
Receivables and other current assets (35,893) (32,747)
Inventories, including inventory write-up effect 37,412 49,835
Accounts payable, other current liabilities
and other long-term liabilities (52,002) 50,430
---------- ----------
Net cash provided (used) by operating activities 64,716 (22,651)
Cash flows from investing activities:
Purchases of securities held-to-maturity - (186,612)
Proceeds from maturities of securities held-to-maturity - 286,497
Purchases of securities available-for-sale (453,077) (506,876)
Proceeds from sales of securities available-for-sale 389,165 379,849
Purchases of non-marketable equity securities (4,855) (39,990)
Capital expenditures (78,999) (65,347)
Change in other assets (20,935) (17,370)
Transfer to restricted cash included in other assets - (56,179)
---------- ----------
Net cash used in investing activities (168,701) (206,028)
Cash flows from financing activities:
Stock issuances 150,388 120,131
---------- ----------
Net cash provided by financing activities 150,388 120,131
---------- ----------
Net increase (decrease) in cash and cash equivalents 46,403 (108,548)
Cash and cash equivalents at beginning of period 337,682 281,162
---------- ----------
Cash and cash equivalents at end of period $ 384,085 $ 172,614
========== ==========
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
(thousands)
(unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 384,085 $ 337,682
Short-term investments 612,701 405,003
Accounts receivable, net (including amounts
from related party: 2000-$48,052; 1999-$33,234) 238,993 214,785
Inventories 237,834 275,245
Deferred tax assets 122,553 81,922
Prepaid expenses and other current assets 24,366 11,870
------------- ------------
Total current assets 1,620,532 1,326,507
Long-term marketable securities 1,567,247 1,214,757
Property, plant and equipment (net of accumulated
depreciation: 2000-$584,698; 1999-$519,496) 743,378 730,086
Goodwill (net of accumulated amortization:
2000-$806,868; 1999-$690,887) 1,512,773 1,628,722
Other intangible assets (net of accumulated
amortization: 2000-$1,237,866; 1999-$1,062,181) 1,321,244 1,453,268
Other long-term assets 167,366 201,101
------------- ------------
Total assets $ 6,932,540 $ 6,554,441
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 32,373 $ 33,123
Accrued liabilities - related party 10,542 14,960
Other accrued liabilities 367,768 436,044
------------- ------------
Total current liabilities 410,683 484,127
Long-term debt 149,692 149,708
Deferred tax liabilities 676,111 626,466
Other long-term liabilities 32,416 11,335
------------- ------------
Total liabilities 1,268,902 1,271,636
Commitments and contingencies
Stockholders' equity:
Preferred stock - -
Common stock 10,487 10,324
Additional paid-in capital 7,435,735 7,186,604
Retained earnings (accumulated deficit) (2,209,222) (2,173,622)
Accumulated other comprehensive income 426,638 259,499
------------- ------------
Total stockholders' equity 5,663,638 5,282,805
------------- ------------
Total liabilities and stockholders' equity $ 6,932,540 $ 6,554,441
============= ============
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
Page 5
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1. Statement of Accounting Presentation and Significant Accounting
Policies
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information
and with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting only
of adjustments of a normal recurring nature) considered necessary for a fair
presentation have been included. Operating results for the three- and nine-
month periods ended September 30, 2000 and 1999 are not necessarily
indicative of the results that may be expected for the year ending December
31, 2000. The condensed consolidated balance sheet as of December 31, 1999
has been derived from the audited financial statements as of that date. For
further information, refer to the consolidated financial statements and notes
thereto included in our Annual Report to Stockholders for the year ended
December 31, 1999.
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.
Revenue Recognition: Revenue is generally recognized when all significant
contractual obligations have been satisfied and collection of the resulting
receivable is reasonably assured. Revenue from product sales is recognized
at the time products are shipped to customers, with allowances established
for estimated product returns and discounts. Royalties from licensees are
recorded when third party sales are consummated. Research and development
contract revenues from cost-reimbursement agreements are recorded as the
related expenses are incurred, up to the contractual limits. Payments
received that are related to future performance are deferred and recorded as
revenues as they are earned over specified future performance periods.
Research and development payments for which no services are required to be
performed in the future are recognized as revenues upon receipt of such
payments. Revenues related to nonrefundable, upfront fees are recognized
over the period of the contractual arrangements as performance obligations
related to the services to be provided, if any, have been satisfied or
products have been delivered. Rental revenue is recognized proportionately
over the contract term.
Recent Pronouncements: In July 1999, the Financial Accounting Standards
Board, or FASB, announced the delay of the effective date of Statement of
Financial Accounting Standards 133, or FAS 133, "Accounting for Derivative
Instruments and Hedging Activities," for one year, to the first quarter of
2001. Also, in June 2000, the FASB issued FAS 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities." FAS 133, as amended
by FAS 138, is intended to provide comprehensive guidance on accounting for
derivatives and hedging activities and requires companies to recognize all
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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
and 138. The impact of FAS 133 and 138 on our financial position and results
of operations is not expected to be material.
On March 31, 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation," which provides guidance
on several implementation issues related to Accounting Principles Board
Opinion No. 25. The most significant of which are clarification of the
definition of employee for purposes of applying Opinion 25 and the accounting
for options that have been repriced. Under the interpretation, the employer-
employee relationship would be based on case law and Internal Revenue Service
regulations. The FASB granted an exception to this definition for outside
directors. Under the interpretation, a modification that reduces the
exercise price of a fixed stock option award, commonly referred to as
repricing, effectively changes the terms of the award to a variable award
subject to compensation expense. We currently do not have any options that
have been repriced. The impact of the adoption of the interpretation on our
financial position and results of operations was not material.
In June 2000, the Securities and Exchange Commission delayed the
implementation date of Staff Accounting Bulletin No. 101, or SAB 101,
"Revenue Recognition in Financial Statements," until no later than the fourth
quarter of 2000. SAB 101, and the "Frequently Asked Questions" document
issued on October 13, 2000, provides guidance on applying generally accepted
accounting principles to revenue recognition issues in financial statements.
We are currently evaluating the impact that the adoption of SAB 101,
effective January 1, 2000, during the fourth quarter of 2000, may have on our
financial position and results of operations.
Note 2. Redemption of Our Special Common Stock
Basis of Presentation
On June 30, 1999, we redeemed all of our outstanding Special Common Stock
held by stockholders other than Roche Holdings, Inc., commonly known as
Roche, at a price of $20.63 per share in cash with funds deposited by Roche
for that purpose. We refer to this event as the "Redemption." As a result,
Roche's percentage ownership of our outstanding Common Stock increased from
65% to 100%. Roche accounted for the Redemption as a purchase of a business.
Consequently, push-down accounting was required under generally accepted
accounting principles to reflect in our consolidated financial statements the
amounts paid for our stock in excess of our net book value at the date of the
Redemption. Under this method of accounting, our assets and liabilities,
including other intangible assets, were recorded at their fair values not to
exceed the aggregate purchase price plus Roche's transaction costs at June
30, 1999. Roche purchased 60% in 1990 and 5% in 1991 through 1997 of our
outstanding stock. In June 1999, we redeemed all of our Special Common Stock
held by stockholders other than Roche resulting in Roche owning 100% of our
Common Stock. The push-down effect of Roche's aggregate purchase price and
the Redemption price in our consolidated balance sheet as of June 30, 1999
was allocated based on Roche's ownership percentages as if the purchases
occurred at the original purchase dates for the 1990 and 1991 through 1997
purchases, and at June 30, 1999 for the Redemption. Management of Genentech
Page 7
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determined the values of tangible and intangible assets, including in-process
research and development, used in allocating the purchase prices. The
aggregate purchase prices for the acquisition of all our outstanding shares,
including Roche's estimated transaction costs of $10.0 million, was $6,604.9
million, consisting of approximately $2,843.5 million for the 1990 and 1991
through 1997 purchases and approximately $3,761.4 million for the Redemption.
The following table shows details of the excess of purchase price over net
book value (in millions):
<TABLE>
<CAPTION>
Purchase Period
--------------------
1990-1997 1999 Total
--------- --------- ---------
<S> <C> <C> <C>
Total purchase price $ 2,843.5 $ 3,761.4 $ 6,604.9
Less portion of net book value purchased 566.6 836.4 1,403.0
--------- --------- ---------
Excess of purchase price over net book value $ 2,276.9 $ 2,925.0 $ 5,201.9
========= ========= =========
</TABLE>
The following table shows the allocation of the excess of the purchase price
over net book value (in millions):
Purchase Period
--------------------
1990-1997 1999 Total
--------- --------- ---------
Inventories $ 102.0 $ 186.2 $ 288.2
Land - 16.6 16.6
In-process research and development 500.5 752.5 1,253.0
Intangible assets:
Developed product technology 429.0 765.0 1,194.0
Core technology 240.5 203.0 443.5
Developed license technology 292.5 175.0 467.5
Trained and assembled workforce 32.5 49.0 81.5
Tradenames 39.0 105.0 144.0
Key distributor relationships 6.5 73.5 80.0
--------- --------- ---------
Total intangibles assets: 1,040.0 1,370.5 2,410.5
Goodwill 1,091.2 1,228.4 2,319.6
Deferred tax liability (456.8) (629.2) (1,086.0)
--------- --------- ---------
Total $ 2,276.9 $ 2,925.0 $ 5,201.9
========= ========= =========
Push-Down Accounting Adjustments
The following is a description of accounting adjustments that reflect push-
down accounting in our financial statements. These adjustments were based on
management's estimates of the value of the tangible and intangible assets
acquired:
- The estimated useful life of the inventory adjustment to fair value
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resulting from the Redemption was approximately one year based upon the
expected time to sell inventories on hand at June 30, 1999. We currently
expect those inventories to be sold by the end of 2000. We recorded
expense of $15.8 million in the third quarter of 2000 and $90.4 million in
the first nine months of 2000 related to the inventory adjustment. The
entire inventory adjustment related to Roche's 1990 through 1997 purchases
was reflected as a charge to retained earnings at June 30, 1999.
- We recorded $1,091.2 million of goodwill less accumulated amortization of
$613.6 million through June 30, 1999, as a result of Roche's 1990 through
1997 purchases. The accumulated amortization was charged to retained
earnings at June 30, 1999. We also recorded $1,228.4 million of goodwill
as a result of the Redemption.
- We recorded $1,040.0 million of other intangible assets, including
developed product, core and developed license technology, less accumulated
amortization of $911.5 million through June 30, 1999, as a result of
Roche's 1990 through 1997 purchases. The accumulated amortization was
charged to retained earnings at June 30, 1999. We also recorded $1,370.5
million of other intangible assets as a result of the Redemption.
- We recorded amortization expense related to goodwill and other intangible
assets of $95.3 million during the third quarter of 2000 and $285.8
million in the first nine months of 2000.
- We recorded $500.5 million of in-process research and development, or
IPR&D, as a result of Roche's 1990 through 1997 purchases as a charge to
retained earnings at June 30, 1999. An additional $752.5 million of IPR&D
as a result of the Redemption was charged to operations at June 30, 1999.
At the date of each purchase, we concluded that technological feasibility
of the acquired IPR&D was not established and that it had no future
alternative uses.
- In connection with the Redemption, options under the 1996 Stock
Option/Stock Incentive Plan, or the Plan, were cancelled. Alternative
arrangements were provided for certain holders of some of the unvested
options under the Plan. We recorded compensation expense related to these
alternative arrangements of $2.5 million in the third quarter of 2000 and
$8.6 million in the first nine months of 2000.
Note 3. Relationship with Roche
On June 30, 1999, Roche exercised its option to cause us to redeem all of our
Special Common Stock held by stockholders, other than Roche, at a price of
$20.63 per share in cash with funds deposited by Roche for such purpose and
we retired all of the shares of Special Common Stock including those held by
Roche. As a result of the Redemption, Roche owned 100% of our outstanding
Common Stock. On July 23, 1999, Roche completed a public offering of 88.0
million shares of our Common Stock. On October 26, 1999, Roche completed a
public offering of 80.0 million shares of our Common Stock. On January 19,
2000, Roche completed an offering of zero-coupon notes that are exchangeable
for an aggregate of 13,034,618 shares of our Common Stock held by Roche. On
March 29, 2000, Roche completed a public offering of 34.6 million shares of
our Common Stock. Roche's percentage ownership of our Common Stock was 58.5%
at September 30, 2000.
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Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in
connection with our stock option and stock purchase plans, and we may issue
additional shares for other purposes. Our affiliation agreement with Roche
requires us to, among other things, establish a stock repurchase program
designed to maintain Roche's percentage ownership interest in our common
stock. In addition, Roche will have a continuing option to buy stock from us
at prevailing market prices to maintain its percentage ownership interest.
To ensure that, with respect to any issuance of common stock by Genentech in
the future, the percentage of Genentech common stock owned by Roche
immediately after such issuance will be no lower than Roche's lowest
percentage ownership of Genentech common stock at any time after the offering
of common stock occurring in July 1999 and prior to the time of such
issuance, except that Genentech may issue shares up to an amount that would
cause Roche's lowest percentage ownership to be no more than 2% below the
"Minimum Percentage." The Minimum Percentage equals the lowest number of
shares of Genentech common stock owned by Roche since the July 1999 offering
(to be adjusted in the future for dispositions of shares of Genentech common
stock by Roche) divided by 509,194,352 (to be adjusted in the future for
stock splits or stock combinations), which is the number of shares of
Genentech common stock outstanding at the time of the July 1999 offering
adjusted for the two-for-one split of Genentech common stock in November 1999
and October 2000. As long as Roche's percentage ownership is greater than
50%, prior to issuing any shares, Genentech must repurchase a sufficient
number of shares of its common stock to ensure that, immediately after its
issuance of shares, Roche's percentage ownership will be greater than 50%.
Genentech has also agreed, upon Roche's request, to repurchase shares of its
common stock to increase Roche's ownership to the Minimum Percentage.
Note 4. Earnings (Loss) Per Share
The following is a reconciliation of the numerator and denominators of the
basic and diluted earnings per share (EPS) computations for the three- and
nine-month periods ended September 30, 2000 and 1999 (in thousands).
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- --------------------
2000 1999 2000 1999
--------- -------- --------- ---------
<S> <C> <C> <C> <C>
Numerator:
Net income (loss) - numerator
For basic and diluted EPS: $ 4,465 $(62,845) $ (35,600) $(971,622)
--------- -------- --------- ---------
Denominator:
Denominator for basic EPS--
weighted-average shares 522,928 511,413 521,097 512,050
Effect of dilutive securities:
Stock options 18,555 - - -
--------- -------- --------- ---------
Denominator for diluted EPS
--adjusted weighted-average
shares and assumed conversions 541,483 511,413 521,097 512,050
========= ======== ========= =========
</TABLE>
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Options to purchase 169,720 shares of common stock between $85.50 per share
and $95.66 per share were outstanding in the three month period ended
September 30, 2000, but were not included in the computation of diluted EPS
because the options were anti-dilutive.
We excluded potentially dilutive securities composed of incremental common
shares issuable upon the exercise of stock options from the diluted loss per
share for the nine month period ended September 30, 2000 and the three- and
nine-month periods ended September 30, 1999 because of their anti-dilutive
effect.
Note 5. Comprehensive Income
Comprehensive income is comprised of net income and other comprehensive
income. Other comprehensive income includes certain changes in equity that
are excluded from net income. Specifically, unrealized holding gains and
losses on our available-for-sale securities, which were reported separately
in stockholders' equity, are included in accumulated other comprehensive
income. Comprehensive income (loss) and its components for the three- and
nine-month periods ended September 30, 2000 and 1999 are as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
-------------------- --------------------
2000 1999 2000 1999
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Net income (loss) $ 4,465 $ (62,845) $(35,600) $(971,622)
Change in unrealized
gain (loss) on securities
available-for-sale 103,328 27,673 167,139 6,178
-------- --------- -------- ---------
Comprehensive income (loss) $107,793 $ (35,172) $131,539 $(965,444)
======== ========= ======== =========
</TABLE>
Note 6. Legal Proceedings
We are a party to various legal proceedings, including patent infringement
litigation relating to our human growth hormone products and antibody
products, licensing and contract disputes, and other matters.
On May 28, 1999, Glaxo Wellcome Inc. filed a patent infringement lawsuit
against us in the U.S. District Court in Delaware. The suit asserts that we
infringe four U.S. patents owned by Glaxo Wellcome. Two of the patents
relate to the use of specific kinds of antibodies for the treatment of human
disease, including cancer. The other two patents asserted against us relate
to preparations of specific kinds of antibodies which are made more stable
and the methods by which such preparations are made. We have been served
with the complaint. The complaint fails to specify which of our products or
methods of manufacture are allegedly infringing the four patents at issue.
However, we believe that the suit relates to the manufacture, use and sale of
our Herceptin and Rituxan antibody products. On July 19, 1999, we filed our
answer to Glaxo's complaint, and in our answer we also stated counterclaims
against Glaxo. On or about October 27, 2000, Glaxo filed a motion for
Page 11
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summary judgment that our Herceptin and Rituxan antibody products infringe
two of the patents asserted against us in this suit. We have not yet
responded to that motion. The judge has rescheduled the trial of this suit
to begin April 16, 2001.
On September 14, 2000, Glaxo Wellcome filed another patent infringement
lawsuit against us in the U.S. District Court in Delaware, alleging that we
are infringing U.S. Patent No. 5,633,162 owned by Glaxo Wellcome. The patent
relates to specific methods for culturing Chinese Hamster Ovary cells. The
complaint fails to specify which of our products or methods of manufacture
are allegedly infringing that patent. However, the complaint makes a general
reference to Genentech's making, using, and selling "monoclonal antibodies",
and so we believe that the suit relates to our Herceptin and Rituxan antibody
products. On October 4, 2000, we filed our answer to Glaxo's complaint, and
in our answer we also stated counterclaims against Glaxo. The judge has not
yet scheduled the trial of this suit.
We and the City of Hope Medical Center are parties to a 1976 agreement
relating to work conducted by two City of Hope employees, Arthur Riggs and
Keiichi Itakura, and patents that resulted from that work, which are referred
to as the "Riggs/Itakura Patents." Since that time, Genentech has entered
into license agreements with various companies to make, use and sell the
products covered by the Riggs/Itakura Patents. On August 13, 1999 the City
of Hope filed a complaint against us in the Superior Court in Los Angeles
County, California alleging that we owe royalties to the City of Hope in
connection with these license agreements, as well as product license
agreements that involve the grant of licenses under the Riggs/Itakura
Patents. The complaint states claims for declaratory relief, breach of
contract, breach of implied covenant of good faith and fair dealing, and
breach of fiduciary duty. On December 15, 1999, we filed our answer to the
City of Hope's complaint. The judge has scheduled the trial of this suit to
begin February 5, 2001.
On December 1, 1994, Genentech filed suit against Bio-Technology General
Corporation, or BTG, in the United States District Court in Delaware charging
BTG with infringement of two Genentech patents applicable to its human growth
hormone product. On February 28, 1995, Genentech filed an Amended Complaint
against BTG alleging infringement of an additional Genentech patent. On
January 6, 1995, BTG filed suit against Genentech in the United States
District Court for the Southern District of New York seeking declaratory
judgements that those patents and another Genentech patent are invalid and
not infringed by BTG. Genentech's suit in Delaware was then transferred to
New York and consolidated with BTG's suit there.
At the time of filing its suit and thereafter, BTG alleged various
antitrust, abuse of process, civil rights, malicious prosecution, and unfair
competition claims against Genentech. All of those claims were dismissed by
the District Court.
On August 10, 1995, the District Court issued a preliminary injunction
which prohibited BTG, pending the Court's final determination of the action,
from importing, making, using, selling, offering for sale or distributing in
the United States BTG's human growth hormone products except for certain
ongoing U.S. Food and Drug Administration, or FDA, approved clinical trials.
BTG filed an appeal from the District Court's issuance of the preliminary
injunction to the United States Court of Appeals for the Federal Circuit. On
April 8, 1996, the Federal Circuit affirmed the preliminary injunction
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<PAGE>
granted by the District Court. On May 20, 1996, the Federal Circuit denied
BTG's petition for rehearing, and on October 7, 1996, the United States
Supreme Court declined to review the case.
In 1999, the case was transferred to a different judge of the District
Court for further proceedings. A jury trial of BTG's patent invalidity claim
began on January 10, 2000. On January 18, 2000, the jury returned a verdict
in Genentech's favor on a certain factual issue underlying BTG's invalidity
claim, but the judge nevertheless entered judgement in favor of BTG and
lifted the preliminary injunction that had been in effect against BTG since
1995. On February 23, 2000, we filed a motion with the Federal Circuit
requesting that the injunction against BTG be reinstated pending appeal and
for an expedited appeal. On May 8, 2000, the Federal Circuit denied our
motion.
Genentech and BTG each filed appeals with the Federal Circuit relating
to the proceedings in the District Court, and those appeals are now pending.
Genentech filed its appeal brief with the Federal Circuit on May 15, 2000.
BTG filed its appeal brief on July 11, 2000. In it, BTG included a request
that its antitrust claims against Genentech (which previously had been
dismissed by the District Court) be reinstated. The Federal Circuit has
scheduled a hearing of the appeals for December 4, 2000.
On June 7, 2000, Chiron Corporation filed a patent infringement suit against
us in the U.S. District Court in the Eastern District of California
(Sacramento), alleging that the manufacture, use, sale and offer for sale of
our Herceptin antibody product infringes Chiron's U.S. Patent No. 6,054,561.
This patent relates to certain antibodies that bind to breast cancer cells
and/or other cells. On August 4, 2000, we filed our answer to Chiron's
complaint, and in our answer we also stated counterclaims against Chiron.
The judge has scheduled the trial of this suit to begin June 25, 2002.
Based upon the nature of the claims made and the information available to
date to us and our counsel through investigations and otherwise, we believe
the outcome of these actions is not likely to have a material adverse effect
on our financial position, result of operations or cash flows. However, were
an unfavorable ruling to occur in any quarterly period, there exists the
possibility of a material impact on the operating results of that period.
Note 7. Inventories
We recognized expense of $15.8 million in the third quarter and $90.4 million
in the first nine months of 2000 related to the sale of inventory that was
written up as a result of the Redemption and push-down accounting.
Inventories are summarized below (in thousands):
September 30, December 31,
2000 1999
------------- ------------
Raw materials and supplies $ 21,467 $ 19,903
Work in process 196,973 228,092
Finished goods 19,394 27,250
------------- ------------
Total $237,834 $275,245
============= ============
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<PAGE>
Note 8. Subsequent Event
On October 24, 2000, we effected a two-for-one stock split of our Common
Stock in the form of a dividend of one share of Genentech Common Stock of
each share held at the close of business on October 17, 2000. Our stock
began trading on a split-adjusted basis on October 25, 2000. All numbers
relating to the number of shares, price per share and per share amounts of
Common Stock and Special Common Stock give effect to the split.
Page 1
<PAGE>
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
The Board of Directors and Stockholders
Genentech, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Genentech, Inc. as of September 30, 2000, and the related condensed
consolidated statements of operations for the three-month and nine-month
periods ended September 30, 2000 and 1999 and the condensed consolidated
statements of cash flows for the nine-month periods ended September 30, 2000
and 1999. These financial statements are the responsibility of Genentech's
management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data, and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with auditing standards generally accepted in the
United States, which will be performed for the full year with the objective
of expressing an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such opinion.
Based on our reviews, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial
statements referred to above for them to be in conformity with accounting
principles generally accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated balance sheet of Genentech,
Inc. as of December 31, 1999, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the year then ended (not
presented herein) and in our report dated January 18, 2000, we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 1999, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has
been derived.
ERNST & YOUNG LLP
San Jose, California
October 9, 2000, except for Note 8,
as to which the date is October 24, 2000
Page 1
<PAGE>
GENENTECH, INC.
FINANCIAL REVIEW
Overview
Genentech is a leading biotechnology company that uses human genetic
information to discover, develop, manufacture and market human
pharmaceuticals for significant unmet medical needs. Fourteen of the
approved products of biotechnology stem from our science. We co-developed
Rituxan with IDEC Pharmaceuticals Corporation from whom we license Rituxan.
We also co-developed Nutropin Depot with Alkermes, Inc. from whom we license
Nutropin Depot. We manufacture and market nine products directly in the
United States.
- Herceptin (trastuzumab) antibody for the treatment of certain patients
with metastatic breast cancer whose tumors overexpress the human epidermal
growth factor receptor2, or HER2, protein;
- Rituxan (rituximab) antibody for the treatment of patients with relapsed
or refractory low-grade or follicular, CD20-positive B-cell non-Hodgkin's
lymphoma;
- Activase (alteplase) tissue plasminogen activator, or t-PA, for the
treatment of acute myocardial infarction, acute ischemic stroke within
three hours of the onset of symptoms, and acute massive pulmonary
embolism;
- TNKase (tenecteplase) single-bolus thrombolytic agent for the treatment of
acute myocardial infarction;
- Protropin (somatrem for injection) growth hormone for the treatment of
inadequate endogenous growth hormone secretion, or growth hormone
deficiency, in children;
- Nutropin [somatropin (rDNA origin) for injection] growth hormone for the
treatment of growth hormone deficiency in children and adults, growth
failure associated with chronic renal insufficiency prior to kidney
transplantation and short stature associated with Turner syndrome;
- Nutropin AQ [somatropin (rDNA origin) injection] liquid formulation growth
hormone for the same indications as Nutropin;
- Nutropin Depot [somatropin (rDNA origin) for injectable suspension]
encapsulated long-acting growth hormone for the treatment of pediatric
growth hormone deficiency; and
- Pulmozyme (dornase alfa, recombinant) inhalation solution for the
management of cystic fibrosis.
We receive royalties on sales of rituximab outside of the United States
(excluding Japan), on sales of Pulmozyme and Herceptin outside of the United
States and on sales of certain products in Canada from F. Hoffmann-La Roche
Ltd, an affiliate of Roche Holdings, Inc., that is commonly known as
Hoffmann-La Roche. We receive royalties on sales of growth hormone products
and t-PA outside of the United States and Canada, and we will receive
royalties on sales of rituximab in Japan through other licensees. We also
receive worldwide royalties on seven additional licensed products that are
Page 16
<PAGE>
marketed by other companies. Six of these products originated from our
technology.
Stock Split
On October 24, 2000, we effected a two-for-one stock split of our Common
Stock in the form of a dividend of one share of Genentech Common Stock for
each share held at the close of business on October 17, 2000. Our stock
began trading on a split-adjusted basis on October 25, 2000. All numbers
relating to the number of shares, price per share and per share amounts of
Common Stock and Special Common Stock gives effect to the split.
Redemption of Our Special Common Stock
On June 30, 1999, we redeemed all of our outstanding Special Common Stock
held by stockholders other than Roche Holdings, Inc., commonly known as
Roche, at a price of $20.63 per share in cash with funds deposited by Roche
for that purpose. We refer to this event as the "Redemption." As a result
of the Redemption, Roche's percentage ownership of our outstanding Common
Stock increased from 65% to 100%. Consequently, under U.S. generally
accepted accounting principles, we were required to use push-down accounting
to reflect in our financial statements the amounts paid for our stock in
excess of our net book value. Push-down accounting required us to record
$1,706.0 million of goodwill and $1,499.0 million of other intangible assets
onto our balance sheet in the second quarter of 1999. For more information
about push-down accounting, you should read the "Redemption of Our Special
Common Stock" note in the Notes to Condensed Consolidated Financial
Statements.
Relationship with Roche
On July 23, 1999, October 26, 1999, and March 29, 2000, Roche completed
public offerings of our Common Stock. We did not receive any of the net
proceeds from these offerings. On January 19, 2000, Roche completed an
offering of zero-coupon notes that are exchangeable for an aggregate of
13,034,618 shares of our Common Stock held by Roche. Roche's percentage
ownership of our outstanding Common Stock is approximately 58.5% at September
30, 2000.
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in
connection with our stock option and stock purchase plans, and we may issue
additional shares for other purposes. The affiliation agreement requires us
to, among other things, establish a stock repurchase program designed to
maintain Roche's percentage ownership interest in our common stock. In
addition, Roche will have a continuing option to buy stock from us at
prevailing market prices to maintain its percentage ownership interest. To
ensure that, with respect to any issuance of common stock by Genentech in the
future, the percentage of Genentech common stock owned by Roche immediately
after such issuance will be no lower than Roche's lowest percentage ownership
of Genentech common stock at any time after the offering of common stock
occurring in July 1999 and prior to the time of such issuance, except that
Genentech may issue shares up to an amount that would cause Roche's lowest
percentage ownership to be no more than 2% below the "Minimum Percentage."
The Minimum Percentage equals the lowest number of shares of Genentech common
stock owned by Roche since the July 1999 offering (to be adjusted in the
future for dispositions of shares of Genentech common stock by Roche) divided
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<PAGE>
by 509,194,352 (to be adjusted in the future for stock splits or stock
combinations), which is the number of shares of Genentech common stock
outstanding at the time of the July 1999 offering adjusted for the two-for-
one split of our common stock in November 1999 and October 2000. As long as
Roche's percentage ownership is greater than 50%, prior to issuing any
shares, Genentech must repurchase a sufficient number of shares of its common
stock to ensure that, immediately after its issuance of shares, Roche's
percentage ownership will be greater than 50%. We have also agreed, upon
request, to repurchase shares of our common stock to increase Roche's
ownership to the Minimum Percentage.
RESULTS OF OPERATIONS
(dollars in millions, except per share amounts)
Pro forma results exclude special charges related to the Redemption and legal
settlements, and recurring charges related to the Redemption, and their
related tax effects. These charges are further discussed below in "Special
Charges" and "Recurring Charges Related to Redemption."
Three Months Ended
September 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
REVENUES Actual Pro Forma Actual Pro Forma % Change
------------------- ------ --------- ------ --------- --------
Revenues $445.2 $445.2 $345.3 $345.3 29%
====== ========= ====== ========= ========
PRODUCT SALES
-------------------
Herceptin $ 72.6 $ 72.6 $ 47.9 $ 47.9 52%
Rituxan 117.9 117.9 72.6 72.6 62
Activase/TNKase 50.7 50.7 59.2 59.2 (14)
Growth Hormone 61.1 61.1 59.9 59.9 2
Pulmozyme 30.0 30.0 27.0 27.0 11
Actimmune 1.9 1.9 0.4 0.4 375
------ --------- ------ --------- --------
Total product sales $334.2 $334.2 $267.0 $267.0 25%
====== ========= ====== ========= ========
Nine Months Ended
September 30,
-----------------------------------------
2000 1999
------------------- ------------------- Pro Forma
REVENUES Actual Pro Forma Actual Pro Forma % Change
-------------------- -------- --------- -------- --------- ---------
Revenues $1,244.5 $1,244.5 $1,062.9 $1,042.5 19%
======== ========= ======== ========= =========
PRODUCT SALES
--------------------
Herceptin $ 208.0 $ 208.0 $ 134.0 $ 134.0 55%
Rituxan 305.8 305.8 204.1 204.1 50
Activase/TNKase 155.0 155.0 169.3 169.3 (8)
Growth Hormone 166.1 166.1 175.5 175.5 (5)
Pulmozyme 89.1 89.1 85.7 85.7 4
Actimmune 2.8 2.8 1.8 1.8 56
-------- --------- -------- --------- ---------
Total product sales $ 926.8 $ 926.8 $ 770.4 $ 770.4 20%
======== ========= ======== ========= =========
Page 18
<PAGE>
Revenues increased 29% in the third quarter of 2000 and 19% in the first nine
months of 2000 from the comparable periods in 1999 primarily as a result of
higher product sales and, to a lesser extent, higher gains from the sale of
biotechnology equity securities. These increases are further discussed
below.
Total product sales increased 25% in the third quarter of 2000 and 20% in the
first nine months of 2000 from the comparable periods in 1999 primarily as a
result of higher sales from our bio-oncology products, Rituxan and Herceptin.
Herceptin: Net sales of Herceptin increased 52% in the third quarter of 2000
and 55% in the first nine months of 2000 from the comparable periods in 1999.
Since the launch of Herceptin in the fourth quarter of 1998, an increase in
penetration into the breast cancer market has contributed to a positive sales
trend.
During the third quarter of 2000, Hoffmann-La Roche received approval
from the European Commission to market Herceptin for the treatment of HER2-
positive metastatic breast cancer. We will receive royalties from Hoffmann-
La Roche for these Herceptin product sales.
On May 3, 2000, we sent a letter to physicians advising them of some
serious adverse events that have been reported related to the use of
Herceptin and that have occurred subsequent to its approval. In 15 patients
who experienced such serious adverse events following Herceptin therapy,
death ensued. Nine of these patients died within 24 hours after Herceptin
administration. Most of these patients had significant pre-existing
pulmonary compromise as a consequence of lung disease or malignancies that
had spread to the lung. On October 6, 2000, we issued a follow-up letter to
physicians which includes an amended package insert for Herceptin including
this information.
Rituxan: Net sales of Rituxan increased 62% in the third quarter of 2000 and
50% in the first nine months of 2000 from the comparable periods in 1999.
These increases were primarily due to increased market penetration for the
treatment of B-cell non-Hodgkin's lymphoma.
Activase/TNKase: Net sales of our two cardiovascular products, Activase and
TNKase, were $50.7 million in the third quarter of 2000 and $155.0 million in
the first nine months of 2000. TNKase received U.S. Food and Drug
Administration, or FDA, approval in early June 2000 and was launched in mid-
June 2000. The decreases from the prior year were due to a decline in the
overall size of the thrombolytic market as a result of increasing use of
mechanical reperfusion as well as early intervention with other therapies in
the treatment of acute myocardial infarction, and continued competition from
Centocor, Inc.'s Retavase, registered trademark, (reteplase).
Growth Hormone: Net sales of our four growth hormone products, Protropin,
Nutropin, Nutropin AQ and Nutropin Depot, increased slightly in the third
quarter of 2000 and decreased 5% in the first nine months of 2000 from the
comparable periods in 1999. The decrease in the first nine months compared
to last year was largely due to fluctuations in distributor ordering
patterns. Nutropin Depot was launched on June 28, 2000.
Pulmozyme: Net sales of Pulmozyme in the third quarter of 2000 and first
nine months for 2000 were slightly higher than the comparable periods in
1999. These increases were attributable to increased market penetration into
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<PAGE>
the early and mild patient populations for the management of cystic fibrosis
as well as a price increase for the year.
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------------------------
2000 1999
ROYALTIES, CONTRACT AND ----------------- ----------------- Pro Forma
OTHER, AND INTEREST INCOME Actual Pro Forma Actual Pro Forma % Change
-------------------------- ------ --------- ------ --------- ---------
<S> <C> <C> <C> <C> <C>
Royalties $ 51.8 $ 51.8 $ 46.1 $ 46.1 12%
Contract and other 33.5 33.5 7.5 7.5 347
Interest income 25.7 25.7 24.7 24.7 4
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------------------
2000 1999
ROYALTIES, CONTRACT, AND ----------------- ----------------- Pro Forma
OTHER, AND INTEREST INCOME Actual Pro Forma Actual Pro Forma % Change
-------------------------- ------ --------- ------ --------- ---------
<S> <C> <C> <C> <C> <C>
Royalties $148.8 $148.8 $138.7 $138.7 7%
Contract and other 99.5 99.5 84.7 64.3 55
Interest income 69.4 69.4 69.1 69.1 -
</TABLE>
Royalty Income: Royalty income increased 12% in the third quarter of 2000
and 7% in the first nine months of 2000 from the comparable periods in 1999.
These increases were due to higher third-party sales from various licensees.
Contract and Other Revenues: Contract and other revenues in the third
quarter of 2000 increased from the comparable period in 1999 primarily as a
result of higher gains from the sale of biotechnology equity securities.
Contract and other revenues in the first nine months of 2000 increased from
the comparable period in 1999 primarily as a result of higher gains from the
sale of biotechnology equity securities, offset in part by lower contract
revenues from our strategic alliances with third-party collaborators and the
1999 recognition of $20.3 million of gains related to the write-up of
marketable securities as a result of push-down accounting. These offsets are
further discussed below and in the "Redemption of Our Special Common Stock"
note in the Notes to Condensed Consolidated Financial Statements.
Pro forma contract and other revenues increased in the first nine months
of 2000 from the comparable period in 1999 due to higher gains from the sale
of biotechnology equity securities, offset in part by lower contract revenues
from our strategic alliances with third-party collaborators. In the second
quarter of 1999 we received an initial license fee and retroactive royalties
pursuant to a licensing agreement with Immunex Corporation for Enbrel,
registered trademark, a milestone payment from Schwarz Pharma AG related to a
FDA filing for Nutropin Depot and higher revenues from Hoffmann-La Roche
primarily related to Herceptin.
Interest Income: Interest income in the third quarter 2000 was slightly
higher than the comparable period in 1999 due to a higher balance in our cash
and investment portfolio. Interest income in the first nine months of 2000
was comparable to last year.
Page 20
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
COST AND EXPENSES Actual Pro Forma Actual Pro Forma % Change
------------------------- ------ --------- ------ --------- ---------
<S> <C> <C> <C> <C> <C>
Cost of sales $ 91.4 $ 75.6 $ 92.8 $ 46.0 64%
Research and development 113.6 113.6 84.6 84.6 34
Marketing, general and
administrative 131.7 131.7 113.6 113.6 16
Special charge:
Related to redemption - - 57.8 - -
Recurring charges related
to redemption 97.8 - 98.9 - -
Interest expense 1.2 1.2 1.3 1.3 (8)
------ --------- ------ --------- ---------
Total costs and expenses $435.7 $322.1 $449.0 $245.5 31%
====== ========= ====== ========= =========
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
----------------------------------------
2000 1999
------------------- ------------------ Pro Forma
COST AND EXPENSES Actual Pro Forma Actual Pro Forma % Change
------------------------- -------- --------- -------- --------- ---------
<S> <C> <C> <C> <C> <C>
Cost of sales $ 295.1 $204.7 $191.2 $144.3 42%
Research and development 340.6 340.6 269.6 269.6 26
Marketing, general and
administrative 350.8 350.8 328.2 328.2 7
Special charges:
Legal settlements - - 50.0 - -
Related to redemption - - 1,205.1 - -
Recurring charges related
to redemption 294.4 - 98.9 - -
Interest expense 3.7 3.7 4.0 4.0 (8)
-------- --------- -------- --------- ---------
Total costs and expenses $1,284.6 $899.8 $2,147.0 $746.1 21%
======== ========= ======== ========= =========
</TABLE>
Cost of Sales: Cost of sales in the third quarter of 2000 was comparable to
last year. However, cost of sales as a percent of product sales decreased to
27% in the third quarter of 2000 from 35% in the prior year. The decrease in
the ratio primarily reflects a decline in the costs recognized on the sale of
inventory that was written up at the Redemption due to push-down accounting.
This inventory had been substantially sold by September 30, 2000. The
remaining inventory that was written up is expected to be sold by the end of
this year. Cost of sales for the first nine months of 2000 increased 54%
from the comparable period in 1999. Cost of sales as a percent of product
sales for the first nine months of 2000 was 32% compared to 25% in the
previous year. These increases primarily reflect the recognition of nine
months of costs related to the sale of inventory that was written up at the
Redemption due to push-down accounting compared to three months of costs in
1999, a change in the product mix, an increase in provisions established for
nonuseable inventory and higher sales to Hoffmann-La Roche.
Pro forma cost of sales, exclusive of the expense related to the sale of
the inventory written up at the Redemption, increased 64% in the third
Page 21
<PAGE>
quarter and 42% in the first nine months of 2000 from the comparable periods
in 1999. Pro forma cost of sales as a percent of product sales was 23% in
the third quarter of 2000 compared to 17% in the prior year. Pro forma cost
of sales as a percent of product sales was 22% in the first nine months of
2000 compared to 19% in 1999. The increases in cost of sales as a percent of
product sales primarily reflects a change in the product mix, an increase in
provisions established for nonuseable inventory and higher sales to Hoffmann-
La Roche.
Research and Development: Research and development, or R&D, expenses
increased 34% in the third quarter and 26% in the first nine months of 2000
from the comparable periods in 1999. The increase in the third quarter is
primarily due to an increase in expenses related to later-stage clinical
trials. The increase in the first nine months also include a $15 million
upfront payment for the purchase of in-process research and development, or
IPR&D, under an in-licensing agreement with Actelion Ltd., for the rights to
develop and co-promote tezosentan in the United States for the potential
treatment of acute heart failure, and a milestone payment made under a
collaboration contract. We determined that the acquired IPR&D was not yet
technologically feasible and that it had no future alternative uses.
Actelion is leading the development effort of tezosentan and the project is
currently in Phase III clinical trials.
For the third quarter of 2000, we invested 26% of revenues into R&D
compared to 25% (pro forma) in the prior year. For the first nine months of
2000, we invested 27% of revenues into R&D compared to 26% (pro forma) in the
prior year. R&D expenses as a percent of revenues are expected to vary over
the next several periods dependent on possible in-licensing agreements and as
products progress through late-stage clinical trials.
Marketing, General and Administrative: Overall marketing, general and
administrative, or MG&A, expenses increased in the third quarter and first
nine months of 2000 over the comparable periods in 1999. These increases
resulted from higher marketing and sales expenses while general and
administrative expenses decreased. The marketing and sales increases were
driven by the continued support of our growing bio-oncology business,
including the Rituxan profit-sharing expense, the launch of TNKase, and
launch support of Xolair for the potential treatment of allergic asthma and
seasonal allergic rhinitis. The decreases in general and administrative
expenses were mostly due to the write-down of certain biotechnology
investments and higher legal expenses incurred in the prior year.
Special Charges: The first nine months of 1999 included a $1,205.1 million
special charge related to the Redemption and the application of push-down
accounting. This charge included a non-cash charge of $752.5 million for
IPR&D, $284.5 million for the cash-out of Special Common Stock options, and
$160.1 million as a non-cash charge for the remeasurement of the value of
continuing employee stock options. The first nine months of 1999 also
included a $50.0 million legal settlement related to a federal investigation
of our past clinical, sales and marketing activities associated with human
growth hormone.
Recurring Charges Related to Redemption: We began recording recurring
charges related to the Redemption and push-down accounting in the third
quarter of 1999. These charges were approximately $97.8 million in the third
quarter of 2000 and were comprised of $95.3 million for the amortization of
intangibles and goodwill, and $2.5 million of compensation expense related to
Page 22
<PAGE>
alternative arrangements provided at the time of the Redemption for certain
holders of some of the unvested options under the 1996 Stock Option/Stock
Incentive Plan. These charges were approximately $294.4 million in the first
nine months of 2000 and were comprised of $285.8 million for the amortization
of intangibles and goodwill, and $8.6 million of compensation expense related
to alternative arrangements provided at the time of the Redemption for
certain holders of some of the unvested options under the 1996 Stock
Option/Stock Incentive Plan.
Interest Expense: Interest expense will fluctuate depending on the amount of
capitalized interest related to the amount of construction projects.
Interest expense, net of amounts capitalized, relates to interest on our 5%
convertible subordinated debentures.
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------------------------
2000 1999
----------------- ----------------- Pro Forma
INCOME TAX Actual Pro Forma Actual Pro Forma % Change
-------------------------------- ------ --------- ------ --------- ---------
<S> <C> <C> <C> <C> <C>
Income tax provision (benefit) $ 5.0 $ 38.1 $(40.9) $ 32.9 16%
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------------------
2000 1999
----------------- ------------------ Pro Forma
INCOME TAX Actual Pro Forma Actual Pro Forma % Change
-------------------------------- ------ --------- ------- --------- ---------
<S> <C> <C> <C> <C> <C>
Income tax (benefit) provision $ (4.5) $106.9 $(112.5) $ 97.8 9%
</TABLE>
Income Tax: The income tax provision of $5.0 million for the third quarter
of 2000 consists of tax expense of $38.1 million on pretax income excluding
the impact of push-down accounting, and tax benefits of $33.1 million related
to push-down accounting. The tax provision benefit of $4.5 million for the
first nine months of 2000 consists of tax expense of $106.9 million on pretax
income excluding the impact of push-down accounting, and tax benefits of
$111.4 million related to push-down accounting. The tax provision benefit of
$40.9 million for the third quarter and $112.5 million for the first nine
months of 1999 consisted of tax expense of $32.9 million and $97.8 million,
respectively, on pretax income excluding special charges and legal settlement
and tax benefits of $73.8 million for the third quarter and $210.3 million
for the first nine months of 1999 related to the income and deductions
attributable to push-down accounting and legal settlement.
Our effective tax rates were approximately 53% for the third quarter and
11% for the first nine months of 2000, which reflect the non-deductibility of
goodwill amortization. The effective tax rate on pretax income excluding
special charges and the legal settlement was 41% for the third quarter and
first nine months of 1999, which reflected the anticipated impact of non-
deductible goodwill amortization on the full year 1999 effective tax rate.
The pro forma effective tax rate of 31% in the third quarter and first
nine months of 2000 is lower than the 33% tax rate in the comparable periods
of 1999. The decrease in the tax rate is primarily due to increased R&D tax
credits.
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<PAGE>
Three Months Ended
September 30,
---------------------------------------
2000 1999
----------------- ------------------- Pro Forma
NET INCOME (LOSS) Actual Pro Forma Actual Pro Forma % Change
------------------------- ------ --------- -------- --------- ---------
Net income (loss) $ 4.5 $ 85.0 $ (62.8) $ 66.9 27%
Earnings (loss) per share:
Basic 0.01 0.16 (0.12) 0.13 23
Diluted 0.01 0.16 (0.12) 0.13 23
Nine Months Ended
September 30,
---------------------------------------
2000 1999
----------------- ------------------- Pro Forma
NET INCOME (LOSS) Actual Pro Forma Actual Pro Forma % Change
------------------------- ------ --------- -------- --------- ---------
Net income (loss) $(35.6) $237.8 $ (971.6) $198.6 20%
Earnings (loss) per share:
Basic (0.07) 0.46 (1.90) 0.39 18
Diluted (0.07) 0.44 (1.90) 0.38 16
The modest net income for the third quarter and net loss for the first nine
months of 2000 primarily reflect recurring charges for the amortization of
goodwill and other intangible assets related to the Redemption and push-down
accounting, and costs related to the sale of inventory that was written up at
the Redemption. The net loss in the third quarter of 1999 reflects the
Redemption and push-down accounting. The net loss in the first nine months
of 1999 reflects the Redemption and push-down accounting, and the legal
settlement recorded in the first quarter of 1999. For further information,
read the "Redemption of our Special Common Stock" note in the Notes to
Condensed Consolidated Financial Statements and the "Special Charges" and
"Recurring Charges Related to Redemption" sections above.
Pro forma net income, which excludes ongoing charges related to the
Redemption and push-down accounting, for the third quarter of 2000 was $85.0
million and for the first nine months of 2000 was $237.8 million. The
increases from the prior year were largely due to higher sales of our bio-
oncology products and higher gains from the sale of biotechnology equity
securities; partly offset by higher cost of sales, R&D and MG&A expenses.
In-Process Research and Development: At June 30, 1999, the Redemption date,
we determined that the acquired in-process technology was not technologically
feasible and that the in-process technology had no future alternative uses.
As a result, $500.5 million of in-process research and development, or IPR&D,
related to Roche's 1990 through 1997 purchases of our Common Stock was
charged to retained earnings, and $752.5 million of IPR&D related to the
Redemption was charged to operations at June 30, 1999.
The amounts of IPR&D were determined based on an analysis using the
risk-adjusted cash flows expected to be generated by the products that result
from the in-process projects. The forecast data used in the analysis was
based on internal product level forecast information maintained by our
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<PAGE>
management in the ordinary course of managing the business. The inputs used
by us in analyzing IPR&D were based on assumptions, which we believed to be
reasonable but which were inherently uncertain and unpredictable. These
assumptions may be incomplete or inaccurate, and no assurance can be given
that unanticipated events and circumstances will not occur.
A brief description of projects that were included in the IPR&D charge
is set forth below, including an estimated percentage of completion as of
June 30, 1999, the Redemption date. Projects subsequently added to the
research and development pipeline are not included. Except as otherwise
noted below, there have been no significant changes to the projects since the
Redemption date. We do not track all costs associated with research and
development on a project-by-project basis. Therefore, we believe a
calculation of cost incurred as a percentage of total incurred project cost
as of the FDA approval is not possible. We estimate, however, that the
research and development expenditures that will be required to complete the
in-process projects will total at least $650.0 million, as compared to $700.0
million as of the Redemption date. This estimate reflects discontinued
projects and decreases in cost to complete estimates for other projects,
partially offset by an increase in certain cost estimates related to early
stage projects and changes in expected completion dates.
The foregoing discussion of our IPR&D projects, and in particular the
following table and subsequent paragraphs regarding the future of these
projects, our additional product programs and our process technology program
include forward-looking statements that involve risks and uncertainties, and
actual results may vary materially. For a discussion of risk factors that
may affect projected completion dates and the progress of research and
development, see "Forward-Looking Information and Cautionary Factors that May
Affect Future Results - "The Successful Development of Pharmaceutical
Products is Highly Uncertain," "- Protecting Our Proprietary Rights Is
Difficult and Costly" and "- We May be Unable to Obtain Regulatory Approvals
for Our Products."
<TABLE>
<CAPTION>
As of the Redemption Date, June 30, 1999
--------------------------------------------
PHASE OF SUBSTANTIAL
PROJECT DESCRIPTION/INDICATION DEVELOPMENT COMPLETION DATE % COMPLETE
-------------------------------- ---------------------------------- ------------- --------------- ----------
<S> <C> <C> <C> <C>
Nutropin Depot long-acting dosage form of Awaiting 2000 85%
recombinant growth hormone Regulatory
Approval
TNKase second acute myocardial infarction Awaiting 2000 90%
generation t-PA Regulatory
Approval
Anti-IgE antibody allergic asthma, seasonal Phase III 2001 75%
allergic rhinitis
Pulmozyme early-stage cystic fibrosis Phase III 2003 75%
Dornase alfa AERx, trademark, cystic fibrosis Preparing for 2003 45%
Delivery System clinical
testing
Rituxan antibody intermediate- and high-grade Phase III 2004 60%
non-Hodgkin's lymphoma
Xubix (sibrafiban) orally administered inhibitor of Phase III 2000 65%
oral IIb/IIIa antagonist platelet aggregation
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<PAGE>
Activase t-PA intravenous catheter clearance Preparing 1999 90%
for Phase III
Anti-CD11a antibody (hull24) psoriasis Preparing 2003 50%
For Phase III
Herceptin antibody adjuvant therapy for breast Preparing 2007 45%
cancer for Phase III
Thrombopoietin (TPO) thrombocytopenia related to Preparing 2002 55%
cancer treatment for Phase III
Anti-CD18 antibody acute myocardial infarction Phase II 2004 55%
Anti-VEGF antibody colorectal and lung cancer Phase II 2003 35-40%
Herceptin antibody other tumors Phase II 2004 40-45%
AMD Fab age-related macular degeneration Preparing 2004 20%
for Phase I
LDP-02 inflammatory bowel disease Phase Ib/IIa 2005 30%
</TABLE>
Our IPR&D at the Redemption date included a process technology program.
The process technology program included the research and development of ideas
and techniques that could improve the bulk production of antibodies,
including cell culture productivity, and streamlined and improved recovery
processes, and improvements in various areas of pharmaceutical manufacturing.
We estimated that the process technology program was approximately 50%
complete at the Redemption date.
The significant changes to the projects in the IPR&D charge since the
Redemption date through September 30, 2000, include:
- Nutropin Depot long-acting growth hormone - project received FDA approval
in December 1999.
- TNKase second generation t-PA - project received FDA approval in June
2000.
- Anti-IgE antibody - project has moved from Phase III studies to awaiting
regulatory approval.
- Xubix (sibrafiban) oral IIb/IIIa antagonist - project has been
discontinued.
- Anti-CD18 antibody - project has been discontinued.
- Anti-VEGF antibody - project has moved from Phase II studies to Phase III
studies.
- Dornase alfa AERx - project has moved to Phase IIa studies.
- Activase t-PA - project has completed one Phase III trial and is awaiting
regulatory approval.
- Anti-CD11a antibody - project has moved to Phase III.
- Herceptin antibody for adjuvant therapy for breast cancer - project has
moved to Phase III.
- Thrombopoietin (TPO) - project has moved to Phase III.
- AMD Fab - project has moved to Phase I trials.
- LDP-02 - project has moved to Phase II studies.
<TABLE>
<CAPTION>
LIQUIDITY AND CAPITAL RESOURCES September 30, 2000 December 31, 1999
-------------------------------------- ------------------ -----------------
<S> <C> <C>
Cash and cash equivalents, short-term
investments and long-term marketable
securities $ 2,564.0 $ 1,957.4
Working capital $ 1,209.8 842.4
</TABLE>
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<PAGE>
We used cash generated from operations, income from investments and proceeds
from stock issuances to fund operations, purchase marketable securities and
make capital and equity investments.
Cash and cash equivalents, short-term investments and long-term marketable
securities at September 30, 2000 increased from December 31, 1999. Working
capital increased by $367.4 million in the first nine months of 2000 from
December 31, 1999.
Capital expenditures totaled $79.0 million in the first nine months of 2000
compared to $65.3 million in the comparable period of 1999. The increase in
2000 compared to 1999 was primarily due to an increase in leasehold
improvements.
We believe that our cash, cash equivalents and short-term investments,
together with funds provided by operations and leasing arrangements, will be
sufficient to meet our foreseeable operating cash requirements. In addition,
we believe we could access additional funds from the debt and, under certain
circumstances, capital markets. See also "Our Affiliation Agreement with
Roche Could Adversely Affect Our Cash Position" below for factors that could
negatively affect our cash position.
FORWARD-LOOKING INFORMATION AND CAUTIONARY FACTORS THAT MAY AFFECT FUTURE
RESULTS
The following section contains forward-looking information based on our
current expectations. Because our actual results may differ materially from
this and any other forward-looking statements made by or on behalf of
Genentech, this section also includes a discussion of important factors that
could affect our actual future results, including, but not limited to, our
product sales, royalties, contract revenues, expenses and net income.
Fluctuations in Our Operating Results Could Affect the Price of Our Common
Stock
Our operating results may vary from period to period for several reasons
including:
- The overall competitive environment for our products.
For example, sales of our Activase product decreased in 1998, 1999 and
2000 primarily due to competition from Centocor Inc.'s Retavase.
- The amount and timing of sales to customers in the United States.
For example, sales of our Growth Hormone products increased in 1999 due to
fluctuations in distributor ordering patterns.
- The amount and timing of our sales to Hoffmann-La Roche of products for
sale outside of the United States and the amount and timing of its sales
to its customers, which directly impact both our product sales and royalty
revenues.
- The timing and volume of bulk shipments to licensees.
- The availability of third-party reimbursements for the cost of therapy.
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<PAGE>
- The effectiveness and safety of our various products as determined both in
clinical testing and by the accumulation of additional information on each
product after it is approved for sale.
- The rate of adoption and use of our products for approved indications and
additional indications.
For example, sales of Pulmozyme increased in 1998 due, in part, to new
patients who were attracted to our product as a result of an FDA approval
for a label extension to include cystic fibrosis patients under the age of
five.
- The potential introduction of new products and additional indications for
existing products in 2000 and beyond.
- The ability to manufacture sufficient quantities of any particular
marketed product.
The Successful Development of Pharmaceutical Products is Highly Uncertain
Successful pharmaceutical product development is highly uncertain and is
dependent on numerous factors, many of which are beyond our control.
Products that appear promising in the early phases of development may fail to
reach the market for several reasons including:
- preclinical and clinical trails that may show the product to be
ineffective or to have harmful side effects;
- failure to receive the necessary regulatory approvals;
- manufacturing costs or other factors that make the product uneconomical;
or
- the proprietary rights of others and their competing products and
technologies that may prevent the product from being commercialized.
Success in preclinical and early clinical trials does not ensure that large-
scale clinical trials will be successful. Clinical results are frequently
susceptible to varying interpretations that may delay, limit or prevent
regulatory approvals. The length of time necessary to complete clinical
trials and to submit an application for marketing approval for a final
decision by a regulatory authority varies significantly and may be difficult
to predict.
Factors affecting our research and development expenses include, but are not
limited to:
- The number of and the outcome of clinical trials currently being conducted
by us and/or our collaborators.
For example, in June 2000, we announced that the preliminary results from
our 415-patient Phase II clinical trial of our recombinant humanized anti-
CD18 monoclonal antibody fragment, which is known as rhuMAb CD18, for the
treatment of myocardial infarction, more commonly known as a heart attack,
did not meet its primary objectives.
- The number of products entering into development from late-stage research.
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<PAGE>
For example, there is no guarantee that internal research efforts will
succeed in generating sufficient data for us to make a positive
development decision or that an external candidate will be available on
terms acceptable to us. In the past, promising candidates have not
yielded sufficiently positive pre-clinical results to meet our stringent
development criteria.
- Hoffmann-La Roche's decisions whether to exercise its options to develop
and sell our future products in non-U.S. markets and the timing and amount
of any related development cost reimbursements.
- In-licensing activities, including the timing and amount of related
development funding or milestone payments.
For example, in February 2000, we entered into an agreement with Actelion
Ltd. for the purchase of rights for the development and co-promotion in
the United States of tezosentan, and paid Actelion an upfront fee of $15
million.
- Future levels of revenue.
Roche, Our Controlling Stockholder, May Have Interests That Are Adverse to
Other Stockholders
Roche, as our majority stockholder, controls the outcome of actions requiring
the approval of our stockholders. Our bylaws provide, among other things,
that the composition of our board of directors shall consist of two Roche
directors, three independent directors nominated by a nominating committee
and one Genentech employee nominated by the nominating committee. As long as
Roche owns in excess of 50% of our common stock, Roche directors will
comprise two of the three members of the nominating committee. However, at
any time until Roche owns less than 5% of our stock, Roche will have the
right to obtain proportional representation on our board. Roche intends to
continue to allow our current management to conduct our business and
operations as we have done in the past. However, we cannot assure
stockholders that Roche will not institute a new business plan in the future.
Roche's interests may conflict with your interests.
Our Affiliation Agreement with Roche Could Limit Our Ability to Make
Acquisitions and Could Have A Material Impact on Our Liquidity
The affiliation agreement between us and Roche contains provisions that:
- requires the approval of the directors designated by Roche to make any
acquisition or any sale or disposal of all or a portion of our business
representing 10% or more of our assets, net income or revenues;
- enable Roche to maintain its percentage ownership interest in our common
stock; and
- establish a stock repurchase program designed to maintain Roche's
percentage ownership interest in our common stock.
These provisions may have the effect of limiting our ability to make
acquisitions and while the dollar amounts associated with the stock
repurchase program cannot currently be estimated, those stock repurchases
could have a material adverse impact on our liquidity.
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<PAGE>
Our Stockholders May Be Unable to Prevent Transactions That are Favorable to
Roche but Adverse to Us
Our certificate of incorporation includes provisions relating to:
- competition by Roche with us;
- offering of corporate opportunities;
- transactions with interested parties;
- intercompany agreements; and
- provisions limiting the liability of specified employees.
Our certificate of incorporation provides that any person purchasing or
acquiring an interest in shares of our capital stock shall be deemed to have
consented to the provisions in the certificate of incorporation relating to
competition with Roche, conflicts of interest with Roche, the offer of
corporate opportunities to Roche and intercompany agreements with Roche.
This deemed consent may restrict your ability to challenge transactions
carried out in compliance with these provisions.
Potential Conflicts of Interest Could Limit Our Ability to Act on
Opportunities that are Adverse to Roche
Persons who are directors and/or officers of Genentech and who are also
directors and/or officers of Roche may decline to take action in a manner
that might be favorable to us but adverse to Roche. Two of our directors,
Dr. Franz B. Humer and Dr. Jonathan K.C. Knowles, currently serve as
directors, officers and employees of Roche Holding Ltd and its affiliates.
We May be Unable to Retain Skilled Personnel and Maintain Key Relationships
The success of our business depends, in large part, on our continued ability
to attract and retain highly qualified management, scientific, manufacturing
and sales and marketing personnel, and on our ability to develop and maintain
important relationships with leading research institutions and key
distributors. Competition for these types of personnel and relationships is
intense.
Roche has the right to maintain its percentage ownership interest in our
common stock. Our affiliation agreement with Roche requires us to, among
other things, establish a stock repurchase program designed to maintain
Roche's percentage ownership in our common stock if we issue or sell any
shares. This right of Roche may limit our flexibility as to the number of
shares we are able to grant under our stock option plans. We therefore
cannot assure you that we will be able to attract or retain skilled personnel
or maintain key relationships.
We Face Growing and New Competition
We face growing competition in two of our therapeutic markets and expect new
competition in a third market. First, in the thrombolytic market, Activase
has lost market share and could lose additional market share to Centocor,
Inc.'s Retavase, either alone or in combination with the use of another
Centocor, Inc. product, ReoPro, registered trademark, (abciximab); the
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<PAGE>
resulting adverse effect on sales could be material. Retavase received
approval from the U.S. Food and Drug Administration, commonly known as the
FDA, in October 1996 for the treatment of acute myocardial infarction. There
is also an increasing use of mechanical reperfusion in lieu of thrombolytic
therapy for the treatment of acute myocardial infarction, which we expect to
continue.
Second, in the growth hormone market, we continue to face increased
competition from four other companies currently selling growth hormone and an
additional company which may enter the market in the near future. As a
result of that competition, we have experienced a slight loss in market
share. The four competitors have also received approval to market their
existing human growth hormone products for additional indications. As a
result of this competition, sales of our Growth Hormone products may decline,
perhaps significantly.
Third, in the non-Hodgkin's lymphoma market, Coulter Pharmaceuticals
Inc., or Coulter, has filed and received an expedited review of a revised
Biologics License Application, or BLA, in 2000 for a product that would
compete with our product Rituxan. We are also aware of other potentially
competitive biologic therapies for non-Hodgkin's lymphoma in development.
Other Competitive Factors Could Affect Our Product Sales
Other competitive factors that could affect our product sales include, but
are not limited to:
- The timing of FDA approval, if any, of competitive products.
For example, in June 2000 one of our competitors, Novo Nordisk, received
FDA approval for a liquid formulation of its growth hormone product that
will directly compete with our liquid formulation, Nutropin AQ. And in
June 2000, another of our competitors, Serono, received FDA approval to
deliver its competitive growth hormone product in a needle-free device.
- Our pricing decisions and the pricing decisions of our competitors.
For example, we raised the prices of Rituxan in May 2000 and Pulmozyme in
June 2000 by approximately 5%.
- The degree of patent protection afforded to particular products.
For example, in January 2000, a federal court judge lifted a preliminary
injunction that had been in effect since 1995 against Bio-Technology
General Corporation, or BTG. Although an appeal of the judge's decision
is pending, BTG is now permitted to sell its competitive growth hormone
product in the United States.
- The outcome of litigation involving our patents and patents of other
companies for products and processes related to production and formulation
of those products.
For example, as further described in "Protecting Our Proprietary Rights is
Difficult and Costly," in May 1999, June 2000, and September 2000, several
companies filed patent infringement lawsuits against us alleging that we
are infringing certain of their patents.
- The increasing use and development of alternate therapies.
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<PAGE>
For example, the overall size of the market for thrombolytic therapies,
such as our Activase product, continues to decline as a result of the
increasing use of mechanical reperfusion.
- The rate of market penetration by competing products.
For example, in the past, we have lost market share to new competitors in
the thrombolytic and growth hormone markets.
In Connection with the Redemption of Our Special Common Stock, We Recorded
Substantial Goodwill and Other Intangibles, the Amortization of Which Will
Adversely Affect Our Earnings
As a result of the redemption of our special common stock, Roche owned all of
our outstanding common stock. Consequently, push-down accounting under
generally accepted accounting principles was required. Push-down accounting
required us to establish a new accounting basis for our assets and
liabilities, based on Roche's cost in acquiring all of our stock. In other
words, Roche's cost of acquiring Genentech was "pushed down" to us and
reflected on our financial statements. Push-down accounting required us to
record goodwill and other intangible assets of approximately $1,706.0 million
and $1,499.0 million, respectively, during the second quarter of 1999. The
amortization of this goodwill and other intangible assets will have a
significant negative impact on our financial results in future years. In
addition, we will continuously evaluate whether events and circumstances have
occurred that indicate the remaining balance of this and other intangible
assets may not be recoverable. If our assets need to be evaluated for
possible impairment, we may have to reduce the carrying value of our
intangible assets. This could have a material adverse effect on our
financial condition and results of operations during the periods in which we
recognize a reduction. We may have to write down intangible assets in future
periods. For more information about push-down accounting, see the notes to
our consolidated financial statements included in our annual report on Form
10-K for the year ended December 31, 1999, which we have incorporated by
reference.
Our Royalty and Contract Revenues Could Decline
Royalty and contract revenues in future periods could vary significantly.
Major factors affecting these revenues include, but are not limited to:
- Hoffmann-La Roche's decisions whether to exercise its options and option
extensions to develop and sell our future products in non-U.S. markets and
the timing and amount of any related development cost reimbursements.
- Variations in Hoffmann-La Roche's sales and other licensees' sales of
licensed products.
For example, we began receiving royalty revenues from Immunex
Corporation's sale of Enbrel in 1999.
- The conclusion of existing arrangements with other companies and Hoffmann-
La Roche.
For example, royalty revenues decreased in 1998 from 1997 due to the
expiration of royalties primarily on sales of human insulin, from Eli
Lilly and Company in August 1998.
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- The timing of non-U.S. approvals, if any, for products licensed to
Hoffmann-La Roche and other licensees.
For example, we expect the approval of Herceptin outside the United States
to have an impact on royalties.
- Fluctuations in foreign currency exchange rates.
- The initiation of new contractual arrangements with other companies.
For example, license fees from Immunex and Schwarz Pharma increased
contract revenues in 1999.
- Whether and when contract benchmarks are achieved.
For example, milestone payments from Pharmacia & Upjohn increased contract
revenue in 1997.
- The failure of or refusal of a licensee to pay royalties.
- The expiration or invalidation of patents or other licensed intellectual
property.
Protecting Our Proprietary Rights is Difficult and Costly
The patent positions of pharmaceutical and biotechnology companies can be
highly uncertain and involve complex legal and factual questions.
Accordingly, we cannot predict the breadth of claims allowed in these
companies' patents. Patent disputes are frequent and can preclude the
commercialization of products. We have in the past been, are currently, and
may in the future be involved in material patent litigation. Patent
litigation is costly in its own right and could subject us to significant
liabilities to third-parties. In addition, an adverse decision could force
us to either obtain third-party licenses at a material cost or cease using
the technology or product in dispute. For example, in late 1999 we settled a
patent infringement lawsuit brought against us by the Regents of the
University of California in which the University alleged that the manufacture
and sale of our Protropin and Nutropin growth hormone products infringed a
patent owned by the University. In connection with that settlement we paid
the University of California $150 million and donated $50 million for the
construction of a new life sciences building on the University of California,
San Francisco campus.
The presence of patents or other proprietary rights belonging to other
parties may lead to our termination of the research and development of a
particular product.
We believe that we have strong patent protection or the potential for
strong patent protection for a number of our products that generate sales and
royalty revenue or that we are developing. However, the courts will
determine the ultimate strength of patent protection of our products and
those on which we earn royalties.
Three lawsuits have been filed against us in which the companies
involved allege that we have infringed their patents by the manufacture and
sale of certain of our products:
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- In May 1999, Glaxo Wellcome Inc. filed a complaint in which it appears to
claim that our manufacture, use and sale of Rituxan and Herceptin antibody
products infringe four Glaxo Wellcome patents that relate to certain uses
and preparations of antibodies.
- In June 2000, Chiron Corporation filed a complaint in which it claims that
our manufacture and sale of Herceptin infringe a patent it owns.
- In September 2000, Glaxo Wellcome filed another complaint in which it
appears to claim that our manufacture, use and sale of Rituxan and
Herceptin antibody products infringe a Glaxo Wellcome patent that relates
to certain cell culture methods.
We May Incur Material Litigation Costs
Litigation to which we are currently or have been subjected relates to, among
other things, our patent and intellectual property rights, licensing
arrangements with other persons, product liability and financing activities.
We cannot predict with certainty the eventual outcome of pending litigation,
and we might have to incur substantial expense in defending these lawsuits.
We have in the past taken substantial special charges relating to litigation,
including special charges of $230.0 million in 1999.
We May Incur Material Product Liability Costs
The testing and marketing of medical products entail an inherent risk of
product liability. Pharmaceutical product liability exposures could be
extremely large and pose a material risk. Our business may be materially and
adversely affected by a successful product liability claim in excess of any
insurance coverage that we may have.
We May be Unable to Obtain Regulatory Approvals for Our Products
The pharmaceutical industry is subject to stringent regulation with respect
to product safety and efficacy by various federal, state and local
authorities. Of particular significance are the FDA's requirements covering
research and development, testing, manufacturing, quality control, labeling
and promotion of drugs for human use. A pharmaceutical product cannot be
marketed in the United States until it has been approved by the FDA, and then
can only be marketed for the indications and claims approved by the FDA. As
a result of these requirements, the length of time, the level of expenditures
and the laboratory and clinical information required for approval of a New
Drug Application, or NDA, or a BLA, are substantial and can require a number
of years. In addition, after any of our products receive regulatory
approval, it is subject to ongoing FDA regulation, including, for example,
changes to its label and product recall.
We cannot be sure that we can obtain necessary regulatory approvals on a
timely basis, if at all, for any of the products we are developing or that we
can maintain necessary regulatory approvals for our existing products, and
all of the following could have a material adverse effect on our business:
- Significant delays in obtaining or failing to obtain required approvals.
For example:
- in 1999, our Phase III clinical trial of recombinant human nerve
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growth factor, which is known as rhNGF, for use in diabetic
peripheral neuropathy did not meet its objectives and we decided not
to file for product approval with the FDA;
- in 1999, our Phase II clinical study of recombinant human vascular
endothelial growth factor, which is known as VEGF, protein failed to
meet the primary endpoints of the study; and
- in June 2000, our Phase II clinical trial of recombinant humanized
anti-CD18 monoclonal antibody fragment, which is known as rhuMAb CD18
for treatment of myocardial infarction, more commonly known as a
heart attack, did not meet its primary study objectives.
- Loss of or changes to previously obtained approvals.
For example, in May 2000, we issued letters to physicians advising them of
some deaths associated with the administration of Herceptin. In October
2000, we issued a new package insert for Herceptin including this
information.
- Failing to comply with existing or future regulatory requirements.
For example, in 1999, we paid a $50 million settlement in connection with
a federal investigation of our former clinical, sales and marketing
activities associated with our human growth hormone products.
Moreover, it is possible that the current regulatory framework could
change or additional regulations could arise at any stage during our product
development, which may affect our ability to obtain approval of our products.
Difficulties or Delays in Product Manufacturing Could Harm Our Business
We currently produce all of our products at our manufacturing facilities
located in South San Francisco, California and Vacaville, California or
through various contract manufacturing arrangements. Problems with any of
our or our contractors manufacturing processes could result in product
defects, which could require us to delay shipment of products or recall
products previously shipped.
For example, in March 2000, we issued an important drug notification
regarding a defect in the packaging of our Pulmozyme product. During a
quality assurance inspection, we had discovered that there was a defect in
the packaging of Pulmozyme which occasionally caused a small puncture in
ampules of that product. We suspended shipping the product while we
determined the source and extent of the defect. We ultimately recalled some
of the product.
In addition, any prolonged interruption in the operations of our or our
contractors manufacturing facilities could result in cancellations of
shipments. A number of factors could cause interruptions, including
equipment malfunctions or failures, or damage to a facility due to natural
disasters or otherwise. Because our manufacturing processes and those of our
contractors are highly complex and are subject to a lengthy FDA approval
process, alternative qualified production capacity may not be available on a
timely basis or at all. Difficulties or delays in our and our contractors
manufacturing of existing or new products could increase our costs, cause us
to lose revenue or market share and damage our reputation.
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Our Stock Price, Like That of Many Biotechnology Companies, Is Highly
Volatile
The market prices for securities of biotechnology companies in general have
been highly volatile and may continue to be highly volatile in the future.
In addition, due to the absence of the put and call that were associated with
our special common stock and the reduction in the number of shares of our
publicly traded stock, the market price of our common stock has been and may
continue to be more volatile than our special common stock was in the past.
In addition, the following factors may have a significant impact on the
market price of our common stock:
- Announcements of technological innovations or new commercial products by
us or our competitors.
For example, our stock increased by approximately 4% on the day we
announced FDA approval for our Nutropin Depot product.
- Developments concerning proprietary rights, including patents.
For example, our stock price decreased by approximately 4% on the day one
of our competitors, Chiron, announced a patent infringement suit against
us.
- Publicity regarding actual or potential medical results relating to
products under development by us or our competitors.
For example, our stock price increased by approximately 9% on the day we
announced positive preliminary Phase III results from the Anti-IgE asthma
clinic.
- Regulatory developments in the United States and foreign countries.
- Public concern as to the safety of biotechnology products.
For example, on May 8, 2000 we issued a warning concerning our Herceptin
drug after 15 deaths resulted from the administration of Herceptin. Our
stock price decreased by approximately 2% at that time.
- Economic and other external factors or other disaster or crisis.
For example, our stock hit a high of $122.50 per share in March 2000 and
decreased, as the biotech sector and stock market in general decreased, to
a low of $42.25 per share in late May 2000.
- Period-to-period fluctuations in financial results.
For example, our stock price has historically been effected by whether we
met or exceeded analyst expectations.
Our Affiliation Agreement With Roche Could Adversely Affect Our Cash Position
Our affiliation agreement with Roche requires us to, among other things,
establish a stock repurchase program designed to maintain Roche's percentage
ownership interest in our common stock. While the dollar amounts associated
with these future purchases cannot currently be estimated, those stock
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repurchases could have a material adverse effect on our cash position and may
have the effect of limiting our ability to use our capital stock as
consideration for acquisitions.
Future Sales by Roche Could Cause the Price of Our Common Stock to Decline
As of September 30, 2000, Roche owned 306,594,352 shares of our common stock
or approximately 58.5% of our outstanding shares. All of our shares owned by
Roche are eligible for sale in the public market subject to compliance with
the applicable securities laws. We have agreed that, upon Roche's request,
we will file one or more registration statements under the Securities Act in
order to permit Roche to offer and sell shares of our common stock. We have
agreed to use our best efforts to facilitate the registration and offering of
those shares designated for sale by Roche. Sales of a substantial number of
shares of our common stock by Roche in the public market could adversely
affect the market price of our common stock.
We Are Exposed to Market Risk
We are exposed to market risk, including changes to interest rates, foreign
currency exchange rates and equity investment prices. To reduce the
volatility relating to these exposures, we enter into various derivative
investment transactions pursuant to our investment and risk management
policies and procedures in areas such as hedging and counterparty exposure
practices. We do not use derivatives for speculative purposes.
We maintain risk management control systems to monitor the risks
associated with interest rates, foreign currency exchange rates and equity
investment price changes, and our derivative and financial instrument
positions. The risk management control systems use analytical techniques,
including sensitivity analysis and market values. Though we intend for our
risk management control systems to be comprehensive, there are inherent risks
that may only be partially offset by our hedging programs should there be
unfavorable movements in interest rates, foreign currency exchange rates or
equity investment prices.
Our Interest Income is Subject to Fluctuations in Interest Rates
Our 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 our 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, we 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.
We Are Exposed to Risks Relating to Foreign Currency Exchange Rates and
Foreign Economic Conditions
We receive royalty revenues from licensees selling products in countries
throughout the world. As a result, our financial results could be
significantly affected by factors such as changes in foreign currency
exchange rates or weak economic conditions in the foreign markets in which
our licensed products are sold. We are exposed to changes in exchange rates
in Europe, Asia (primarily Japan) and Canada. Our exposure to foreign
exchange rates primarily exists with the euro. When the U.S. dollar
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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 our royalty revenues as expressed in
U.S. dollars. In addition, as part of our overall investment strategy, a
portion of our portfolio is primarily in non-dollar denominated investments.
As a result, we are exposed to changes in the exchange rates of the countries
in which these non-dollar denominated investments are made.
To mitigate this risk, we hedge certain of our anticipated revenues by
purchasing option contracts with expiration dates and amounts of currency
that are based on 25% to 90% of probable future revenues so that the
potential adverse impact of movements in currency exchange rates on the non-
dollar denominated revenues will be at least partly offset by an associated
increase in the value of the option. Currently, the duration of these
options is generally one to three years. We may also enter into foreign
currency forward contracts to lock in the dollar value of a portion of these
anticipated revenues. To hedge the non-dollar denominated investment
portfolio, we enter into forward contracts.
Our Investments in Equity Securities Are Subject to Market Risks
As part of our strategic alliance efforts, we invest in equity instruments of
biotechnology companies. These investments are subject to fluctuations from
market value changes in stock prices. To mitigate this risk, certain equity
securities are hedged with costless collars and equity swaps. A costless
collar is a purchased put option and a written call option in which the cost
of the purchased put and the proceeds of the written call offset each other;
therefore, there is no initial cost or cash outflow for these instruments at
the time of purchase. The purchased put protects us from a decline in the
market value of the security below a certain minimum level (the put "strike"
level), while the call effectively limits our potential to benefit from an
increase in the market value of the security above a certain maximum level
(the call "strike" level). An equity swap is a derivative instrument where
Genentech pays the counterparty the total return of the security above the
current spot price and receives interest income on the notional amount for
the swap term. The equity swap protects us from a decline in the market
value of the security below the spot price and limits our potential benefit
from an increase in the market value of the security above the spot price.
In addition, as part of our strategic alliance efforts, we hold dividend-
bearing convertible preferred stock and have made interest-bearing loans that
are convertible into the equity securities of the debtor.
Recent Pronouncement Could Impact Our Financial Position and Results of
Operations
In July 1999, the Financial Accounting Standards Board, or FASB, announced
the delay of the effective date of Statement of Financial Accounting
Standards 133, or FAS 133, "Accounting for Derivative Instruments and Hedging
Activities," for one year, to the first quarter of 2001. 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
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whether it qualifies for hedge accounting under FAS 133. The impact of FAS
133 on our financial position and results of operations is not expected to be
material.
On March 31, 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation," which provides guidance
on several implementation issues related to Accounting Principles Board
Opinion No. 25. The most significant are clarification of the definition of
employee for purposes of applying Opinion 25 and the accounting for options
that have been repriced. Under the interpretation, the employer-employee
relationship would be based on case law and Internal Revenue Service
regulations. The FASB granted an exception to this definition for outside
directors. Under the interpretation, repriced options effectively changed
the terms of the plan, which would make it a variable plan subject to
compensation expense. We currently do not have any options that have been
repriced. The impact of the adoption of the interpretation on our financial
position and results of operations was not material.
In June 2000, the Securities and Exchange Commission delayed the
implementation date of Staff Accounting Bulletin No. 101, or SAB 101,
"Revenue Recognition in Financial Statements," until no later than the fourth
quarter of 2000. SAB 101 provides guidance on applying generally accepted
accounting principles to revenue recognition issues in financial statements.
We will adopt SAB 101 as required in the fourth quarter of 2000, effective
January 1, 2000, and we are currently evaluating the effect that such
adoption and the related "Frequently Asked Questions" document issued on
October 13, 2000, may have on our financial position and results of
operations.
We Are Exposed to Credit Risk of Counterparties
We could be exposed to losses related to the financial instruments described
above under "We are Exposed to Market Risk" should one of our counterparties
default. We attempt to mitigate this risk through credit monitoring
procedures.
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GENENTECH, INC.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In connection with our patent infringement litigation with Bio-Technology
General Corporation, or BTG, the Court of Appeals for the Federal Circuit has
scheduled a hearing of Genentech's and BTG's appeals for December 4, 2000.
In connection with the patent infringement lawsuit filed against us by Glaxo
Wellcome Inc. on May 28, 1999, on or about October 27, 2000, Glaxo filed a
motion for summary judgment that our Herceptin and Rituxan antibody products
infringe two of the patents asserted against us in this suit. We have not
yet responded to that motion. Also, the judge has rescheduled the trial of
this suit to begin April 16, 2001.
In connection with the patent infringement lawsuit filed against us by Chiron
Corporation, the judge has scheduled the trial of this suit to begin June 25,
2002.
On September 14, 2000, Glaxo Wellcome Inc. filed a patent infringement
lawsuit against us in the U.S. District Court in Delaware, alleging that we
are infringing U.S. Patent No. 5,633,162 owned by Glaxo Wellcome. The patent
relates to specific methods for culturing Chinese Hamster Ovary cells. The
complaint fails to specify which of our products or methods of manufacture
are allegedly infringing that patent. However, the complaint makes a general
reference to Genentech's making, using and selling "monoclonal antibodies",
and so we believe that the suit relates to our Herceptin and Rituxan antibody
products. On October 4, 2000, we filed our answer to Glaxo's complaint, and
in our answer we also stated counterclaims against Glaxo. The judge has not
yet scheduled the trial of this suit. This suit is in addition to and
separate from the patent infringement lawsuit filed against us by Glaxo
Wellcome on May 28, 1999.
See also Item 3 of the Company's report on Form 10-K for the period ended
December 31, 1999.
See also Item 1 of our reports on Form 10-Q for the periods ended March 31,
2000 and June 30, 2000.
See also the Legal Proceedings note in the Notes to Condensed Consolidated
Financial Statements of Part I.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
15.1 Letter re: Unaudited Interim Financial Information
27.1 Financial Data Schedule
(b) Reports on Form 8-K
There were no other reports on Form 8-K filed during the
quarter ended September 30, 2000.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Genentech's market risk disclosures set forth in the 1999 Annual Report to
Stockholders have changed. To reduce the volatility in our biotech equity
portfolio, we have entered into substantially more hedges this year on
several of our large investments. With this strategy we expect the potential
risk of loss in fair value of the equity securities to decrease.
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GENENTECH, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 13, 2000 GENENTECH, INC.
/s/ARTHUR D. LEVINSON /s/LOUIS J. LAVIGNE, JR.
------------------------------------- ----------------------------
Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr.
Chairman and Chief Executive Officer Executive Vice President and
Chief Financial Officer
/s/JOHN M. WHITING
----------------------------
John M. Whiting
Controller and
Chief Accounting Officer
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