UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________
(Mark One) | |
[x] þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the quarterly period ended June 30, 2005March 31, 2006 |
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| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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| For the transition period from to .
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For the transition period from to .
Commission file number:File Number: 1-9813
GENENTECH, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization) | 94-2347624
(I.R.S. Employer Identification Number) |
1 DNA Way, South San Francisco, California 94080-4990
(Address of principal executive offices and Zip Code)
(650) 225-1000
(
Registrant'sRegistrant’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]þ No [ ]o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [x]o No [ ]þ
Indicate the number of shares outstanding of each of the
issuer'sissuer’s classes of
common stock,Common Stock, as of the latest practicable date.
| Number of Shares Outstanding |
Common Stock $0.02 par value | 1,064,282,776
1,053,627,146Outstanding at July 21, 2005April 26, 2006 |
GENENTECH, INC.
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Item 1. | | 3
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Item 2. | | 17 - 48 17-36 |
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Item 3. | | 49 37 |
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Item 4. | | 49
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| PART II - OTHER INFORMATION
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Item 1. | | 50 38 |
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Item 1A. | | 38-49 |
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Item 2. | | 50 |
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Item 4. 6. | | 51 50 |
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Item 6.
| Exhibits
| 51
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| 52 51 |
In this report,
"Genentech," "we," "us"“Genentech,” “we,” “us” and
"our"“our” refer to Genentech, Inc.
"Common Stock"; “Common Stock” refers to
Genentech's common stock,Genentech’s Common Stock, par value $0.02 per share,
"Special“Special Common
Stock"Stock” refers to
Genentech'sGenentech’s callable putable
common stock,Common Stock, par value $0.02 per share, all of which was redeemed by Roche Holdings, Inc.
(or “Roche”) on June 30, 1999.
We own or have rights to various copyrights, trademarks and trade names used in our business including the following: Activase® (alteplase, recombinant) tissue-plasminogen activator;
Avastin™Avastin® (bevacizumab) anti-VEGF antibody; Cathflo® Activase® (alteplase for catheter clearance); Herceptin® (trastuzumab) anti-HER2 antibody; Lucentis™ (ranibizumab, rhuFab V2) anti-VEGF antibody fragment; Nutropin® (somatropin (rDNA origin) for injection) growth hormone; Nutropin AQ® and Nutropin AQ Pen® (somatropin (rDNA origin) for injection) liquid formulation growth hormone; Nutropin Depot® (somatropin (rDNA origin) for injectable suspension) encapsulated sustained-release growth hormone; Omnitarg™ (pertuzumab) HER dimerization inhibitor; Protropin® (somatrem for injection) growth hormone; Pulmozyme® (dornase alfa, recombinant) inhalation solution; Raptiva® (efalizumab) anti-CD11a antibody; and
TNKase™TNKase® (tenecteplase)
single-bo lussingle-bolus thrombolytic agent. Rituxan® (rituximab) anti-CD20 antibody is a registered trademark of Biogen Idec Inc.; Tarceva®
(erlotinib HC1)(erlotinib) is a
registered trademark of OSI Pharmaceuticals, Inc.; and Xolair® (omalizumab) anti-IgE antibody is a trademark of Novartis AG. This report also includes other trademarks, service marks and trade names of other companies.
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GENENTECH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands,millions, except per share amounts)
(Unaudited)
(Unaudited) | Three Months Ended June 30, | | Six Months Ended June 30, |
| | | | | | | | | | | |
| 2005 | | 2004 | | 2005 | | 2004 |
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Operating revenues | | | | | | | | | | | |
Product sales (including amounts from related parties: three months - 2005-$28,234; 2004-$27,668; six months - 2005-$82,355; 2004-$55,492) |
$
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1,274,115
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$
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913,366
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$
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2,460,117
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$
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1,677,066
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Royalties (including amounts from related party: three months - 2005-$107,199; 2004-$84,071; six months - 2005-$212,258; 2004-$155,368) | |
200,321
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151,860
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432,236
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305,957
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Contract revenue (including amounts from related parties: three months - 2005-$30,425; 2004-$33,891; six months - 2005-$56,885; 2004-$70,512) | |
52,443
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62,852
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96,104
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120,190
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Total operating revenues | | 1,526,879 | | | 1,128,078 | | | 2,988,457 | | | 2,103,213 |
Costs and expenses | | | | | | | | | | | |
Cost of sales (including amounts for related parties: three months - 2005-$38,826; 2004-$26,019; six months - 2005-$88,856; 2004-$48,664) | |
269,481
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186,683
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520,522
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301,163
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Research and development (including amounts for related parties: three months - 2005-$41,367; 2004-$49,457; six months - 2005-$82,078; 2004-$88,818) (including contract related: three months - 2005-$37,136; 2004-$34,571; six months - 2005-$63,711; 2004-$71,495) | |
278,124
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212,886
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521,364
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403,231
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Marketing, general and administrative | | 356,638 | | | 276,654 | | | 671,852 | | | 523,968 |
Collaboration profit sharing (including amounts for related party: three months - 2005-$28,727; 2004-$14,827; six months - 2005-$52,375; 2004-$26,649) | |
198,798
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145,221
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375,075
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271,652
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Recurring charges related to redemption | | 34,482 | | | 38,209 | | | 68,964 | | | 76,418 |
Special items: litigation-related | | 19,527 | | | 13,458 | | | 30,784 | | | 26,857 |
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Total costs and expenses | | 1,157,050 | | | 873,111 | | | 2,188,561 | | | 1,603,289 |
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Operating margin | | 369,829 | | | 254,967 | | | 799,896 | | | 499,924 |
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Other income, net | | 31,502 | | | 15,444 | | | 47,899 | | | 37,765 |
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Income before taxes | | 401,331 | | | 270,411 | | | 847,795 | | | 537,689 |
Income tax provision | | 105,165 | | | 99,640 | | | 267,455 | | | 190,331 |
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Net income | $ | 296,166 | | $ | 170,771 | | $ | 580,340 | | $ | 347,358 |
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Earnings per share | | | | | | | | | | | |
Basic | $ | 0.28 | | $ | 0.16 | | $ | 0.55 | | $ | 0.33 |
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Diluted | $ | 0.27 | | $ | 0.16 | | $ | 0.54 | | $ | 0.32 |
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Weighted-average shares used to compute earnings per share | | | | | | | | | | | |
Basic | | 1,057,564 | | | 1,060,619 | | | 1,052,228 | | | 1,057,955 |
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Diluted | | 1,083,841 | | | 1,087,087 | | | 1,076,519 | | | 1,084,618 |
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| | Three Months Ended March 31, | |
| | 2006 | | 2005 | |
Revenues | | | | | |
Product sales (including amounts from related parties: 2006-$59; 2005-$54) | | $ | 1,644 | | $ | 1,186 | |
Royalties (including amounts from a related party: 2006-$167; 2005-$104) | | | 286 | | | 232 | |
Contract revenue (including amounts from related parties: 2006-$28; 2005-$26) | | | 56 | | | 44 | |
Total operating revenues | | | 1,986 | | | 1,462 | |
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Costs and expenses | | | | | | | |
Cost of sales (including amounts for related parties: 2006 and 2005-$50) | | | 262 | | | 256 | |
Research and development (including amounts for related parties: 2006-$53; 2005-$44) (including contract related: 2006-$36; 2005-$27) | | | 374 | | | 243 | |
Marketing, general and administrative | | | 441 | | | 310 | |
Collaboration profit sharing (including amounts for a related party: 2006-$43; 2005-$24) | | | 226 | | | 176 | |
Recurring charges related to redemption | | | 26 | | | 35 | |
Special items: litigation-related | | | 13 | | | 11 | |
Total costs and expenses | | | 1,342 | | | 1,031 | |
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Operating income | | | 644 | | | 431 | |
Other income (expense): | | | | | | | |
Interest and other income, net | | | 53 | | | 18 | |
Interest expense | | | (19 | ) | | (3 | ) |
Total other income, net | | | 34 | | | 15 | |
Income before taxes | | | 678 | | | 446 | |
Income tax provision | | | 257 | | | 162 | |
Net income | | $ | 421 | | $ | 284 | |
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Earnings per share | | | | | | | |
Basic | | $ | 0.40 | | $ | 0.27 | |
Diluted | | $ | 0.39 | | $ | 0.27 | |
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Shares used to compute basic earnings per share | | | 1,054 | | | 1,047 | |
Shares used to compute diluted earnings per share | | | 1,075 | | | 1,067 | |
See Notes to Condensed Consolidated Financial Statements- 3 -
GENENTECH, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)millions)
(Unaudited)
| | Three Months Ended March 31, | |
| | 2006 | | 2005 | |
Cash flows from operating activities | | | | | |
Net income | | $ | 421 | | $ | 284 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | |
Depreciation and amortization | | | 96 | | | 88 | |
Employee stock-based compensation | | | 74 | | | - | |
Deferred income taxes | | | (50 | ) | | (21 | ) |
Deferred revenue | | | 10 | | | (9 | ) |
Litigation-related liabilities | | | 13 | | | 13 | |
Tax benefit from employee stock options | | | - | | | 51 | |
Excess tax benefit from stock-based compensation arrangements | | | (49 | ) | | - | |
Gain on sales of securities available-for-sale and other | | | (3 | ) | | (1 | ) |
Write-down of securities available-for-sale and other | | | - | | | 4 | |
Changes in assets and liabilities: | | | | | | | |
Receivables and other current assets | | | (96 | ) | | (103 | ) |
Inventories | | | (86 | ) | | 25 | |
Investments in trading securities | | | (7 | ) | | (1 | ) |
Accounts payable, other accrued liabilities, and other long-term liabilities | | | 139 | | | 55 | |
Net cash provided by operating activities | | | 462 | | | 385 | |
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Cash flows from investing activities | | | | | | | |
Purchases of securities available-for-sale | | | (454 | ) | | (72 | ) |
Proceeds from sales and maturities of securities available-for-sale | | | 193 | | | 162 | |
Capital expenditures | | | (253 | ) | | (144 | ) |
Change in other assets | | | (13 | ) | | (8 | ) |
Net cash used in investing activities | | | (527 | ) | | (62 | ) |
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Cash flows from financing activities | | | | | | | |
Stock issuances under employee stock plans | | | 89 | | | 106 | |
Stock repurchases | | | (227 | ) | | (156 | ) |
Excess tax benefit from stock-based compensation arrangements | | | 49 | | | - | |
Net cash used in financing activities | | | (89 | ) | | (50 | ) |
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Net (decrease) increase in cash and cash equivalents | | | (154 | ) | | 273 | |
Cash and cash equivalents at beginning of period | | | 1,225 | | | 270 | |
Cash and cash equivalents at end of period | | $ | 1,071 | | $ | 543 | |
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Supplemental cash flow data | | | | | | | |
Non-cash investing and financing activities | | | | | | | |
Capitalization of construction in progress related to financing lease transaction | | $ | 27 | | $ | 44 | |
Exchange of note receivable for a prepaid royalty and other long-term asset | | | - | | | 29 | |
| Six Months Ended June 30, |
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| 2005 | | 2004 |
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Cash flows from operating activities | | | | | |
Net income | $ | 580,340 | | $ | 347,358 |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation and amortization | | 181,454 | | | 178,516 |
Deferred income taxes | | (54,352) | | | (17,715) |
Deferred revenue | | (21,760) | | | (18,846) |
Litigation-related liabilities | | 25,712 | | | 25,712 |
Tax benefit from employee stock options | | 326,600 | | | 231,305 |
Loss (gain) on sales of securities available-for-sale and other, net | | 2,115 | | | (605) |
Changes in assets and liabilities: | | | | | |
Receivables, prepaid expenses, and other current assets | | (121,276) | | | (157,758) |
Inventories | | (10,520) | | | (58,009) |
Investments in trading securities | | (8,051) | | | (28,496) |
Accounts payable, other accrued liabilities, and other long-term liabilities | | (82,092) | | | (64,447) |
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Net cash provided by operating activities | | 818,170 | | | 437,015 |
| | | | | |
Cash flows from investing activities | | | | | |
Purchases of securities available-for-sale | | (313,468) | | | (684,109) |
Proceeds from sales and maturities of securities available-for-sale | | 398,576 | | | 624,227 |
Capital expenditures | | (729,810) | | | (196,633) |
Change in other assets | | (30,780) | | | (28,933) |
Transfer to restricted cash | | - | | | (52,000) |
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Net cash used in investing activities | | (675,482) | | | (337,448) |
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Cash flows from financing activities | | | | | |
Stock issuances | | 465,194 | | | 366,737 |
Stock repurchases | | (160,655) | | | (575,749) |
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Net cash provided by (used in) financing activities | | 304,539 | | | (209,012) |
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Net increase (decrease) in cash and cash equivalents | | 447,227 | | | (109,445) |
Cash and cash equivalents at beginning of period | | 270,123 | | | 372,152 |
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Cash and cash equivalents at end of period | $ | 717,350 | | $ | 262,707 |
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Supplemental disclosure of cash flow information | | | | | |
Non-cash investing and financing activities | | | | | |
Capitalization of construction in progress related to financing lease transaction | $ | 73,000 | | $ | - |
Exchange of XOMA note receivable for a prepaid royalty | | 29,205 | | | - |
See Notes to Condensed Consolidated Financial Statements.- 4 -
GENENTECH, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)millions)
(Unaudited)
(Unaudited) | June 30, 2005 | | December 31, 2004 |
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Assets | | | | | |
Current assets | | | | | |
Cash and cash equivalents | $ | 717,350 | | $ | 270,123 |
Short-term investments | | 1,293,191 | | | 1,394,982 |
Accounts receivable -- product sales (net of allowances: 2005-$65,854; 2004-$59,366; including amounts from related parties: 2005-$9,378; 2004-$11,237) | | 509,971
| | | 599,052
|
Accounts receivable -- royalties (including amounts from related party: 2005-$130,374; 2004-$119,080) | | 238,714
| | | 217,482
|
Accounts receivable -- other (net of allowances: 2005-$2,132; 2004-$2,191; including amounts from related parties: 2005-$93,989; 2004-$68,594) | | 165,133
| | | 140,838
|
Inventories | | 600,863 | | | 590,343 |
Prepaid expenses | | 196,985 | | | 45,864 |
Other current assets | | 213,598 | | | 164,073 |
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Total current assets | | 3,935,805 | | | 3,422,757 |
Long-term marketable debt and equity securities | | 901,052 | | | 1,115,327 |
Property, plant and equipment, net | | 2,792,106 | | | 2,091,404 |
Goodwill | | 1,315,019 | | | 1,315,019 |
Other intangible assets | | 603,956 | | | 668,391 |
Restricted cash and investments | | 682,000 | | | 682,000 |
Other long-term assets | | 316,672 | | | 108,497 |
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Total assets | $ | 10,546,610 | | $ | 9,403,395 |
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Liabilities and stockholders' equity | | | | | |
Current liabilities | | | | | |
Accounts payable | $ | 45,629 | | $ | 104,832 |
Taxes payable | | - | | | 134,937 |
Deferred revenue | | 44,845 | | | 45,989 |
Other accrued liabilities (including amounts to related parties: 2005-$133,266; 2004-$108,416) | | 1,051,261 | | | 957,508
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Total current liabilities | | 1,141,735 | | | 1,243,266 |
Long-term debt | | 485,250 | | | 412,250 |
Deferred revenue | | 247,192 | | | 267,805 |
Litigation-related and other long-term liabilities | | 692,428 | | | 697,884 |
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Total liabilities | | 2,566,605 | | | 2,621,205�� |
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Commitments and contingencies | | | | | |
Stockholders' equity | | | | | |
Preferred stock | | - | | | - |
Common stock | | 21,248 | | | 20,943 |
Additional paid-in capital | | 8,773,117 | | | 8,002,754 |
Accumulated other comprehensive income | | 272,967 | | | 290,948 |
Accumulated deficit, since June 30, 1999 | | (1,087,327) | | | (1,532,455) |
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Total stockholders' equity | | 7,980,005 | | | 6,782,190 |
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Total liabilities and stockholders' equity | $ | 10,546,610 | | $ | 9,403,395 |
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| | March 31, 2006 | | December 31, 2005 | |
Assets | | | | | |
Current assets | | | | | |
Cash and cash equivalents | | $ | 1,071 | | $ | 1,225 | |
Short-term investments | | | 1,213 | | | 1,140 | |
Accounts receivable—product sales (net of allowances: 2006-$93; 2005-$83; including amounts from related parties: 2006-$24; 2005-$4) | | | 615 | | | 554 | |
Accounts receivable—royalties (including amounts from related party: 2006-$199; 2005-$173) | | | 332 | | | 297 | |
Accounts receivable—other (net of allowances: 2006-$1; 2005-$1; including amounts from related parties: 2006-$129; 2005-$132) | | | 187 | | | 199 | |
Inventories | | | 804 | | | 703 | |
Prepaid expenses and other current assets | | | 311 | | | 268 | |
Total current assets | | | 4,533 | | | 4,386 | |
Long-term marketable debt and equity securities | | | 1,658 | | | 1,449 | |
Property, plant and equipment, net | | | 3,565 | | | 3,349 | |
Goodwill | | | 1,315 | | | 1,315 | |
Other intangible assets | | | 548 | | | 574 | |
Restricted cash and investments | | | 735 | | | 735 | |
Other long-term assets | | | 358 | | | 339 | |
Total assets | | $ | 12,712 | | $ | 12,147 | |
| | | | | | | |
Liabilities and stockholders’ equity | | | | | | | |
Current liabilities | | | | | | | |
Accounts payable (including amounts to related parties: 2006-$3; 2005-$1) | | $ | 328 | | $ | 339 | |
Deferred revenue | | | 45 | | | 44 | |
Taxes payable | | | 318 | | | 62 | |
Other accrued liabilities (including amounts to related parties: 2006-$148; 2005-$132) | | | 1,059 | | | 1,215 | |
Total current liabilities | | | 1,750 | | | 1,660 | |
Long-term debt | | | 2,103 | | | 2,083 | |
Deferred revenue | | | 229 | | | 220 | |
Litigation-related and other long-term liabilities | | | 736 | | | 714 | |
Total liabilities | | | 4,818 | | | 4,677 | |
Commitments and contingencies | | | | | | | |
Stockholders’ equity | | | | | | | |
Common stock | | | 21 | | | 21 | |
Additional paid-in capital | | | 9,468 | | | 9,263 | |
Accumulated other comprehensive income | | | 255 | | | 253 | |
Accumulated deficit, since June 30, 1999 | | | (1,850 | ) | | (2,067 | ) |
Total stockholders’ equity | | | 7,894 | | | 7,470 | |
Total liabilities and stockholders’ equity | | $ | 12,712 | | $ | 12,147 | |
See Notes to Condensed Consolidated Financial Statements.- 5 -
GENENTECH, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1. | Summary of Significant Accounting Policies |
We prepared the
condensed consolidated financial statementsCondensed Consolidated Financial Statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (or
"GAAP"“GAAP”) can be condensed or omitted. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the
consolidated financial statementsConsolidated Financial Statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31,
2004.2005. In the opinion of management, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results.
Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those expected for the full year or any future period.
Principles of Consolidation
The
condensed consolidated financial statementsCondensed Consolidated Financial Statements include the accounts of Genentech and all
wholly owned subsidiaries.
Genentech also consolidates a variable interest entity in which Genentech is the primary beneficiary pursuant to Financial Accounting Standards Board (or "FASB") Interpretation No. 46 (or "FIN 46") "Consolidation of Variable Interest Entities," as amended, and recorded the noncontrolling interest in "litigation-related and other long-term liabilities" in the accompanying condensed consolidated balance sheets at June 30, 2005 and December 31, 2004. Material intercompany accounts and transactions have been eliminated.
Use of Estimates and Reclassifications
The preparation of financial statements in conformity with GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported in our
condensed consolidated financial statementsCondensed Consolidated Financial Statements and accompanying notes. Actual results could differ
materially from those estimates.
Certain reclassifications of prior period amounts have been made to our
condensed consolidated financial statementsCondensed Consolidated Financial Statements to conform to the current period presentation.
Recent Accounting Pronouncements
In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or "FAS") No. 123, "Accounting for Stock-Based Compensation." The revision is referred to as "FAS 123R -- Share-Based Payment", which supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," (or "APB 25") and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee stock plans. We expect to adopt FAS 123R using the modified prospective basis on January 1, 2006. We expect that our adoption of FAS 123R will result in compensation expense comparable to those disclosed below, before the effect of capitalization of manufacturing related compensation expenses. We are currently evaluating option valuation methodologies and assumptions in light of FAS 123R; the methodologies and assumptions we ultimately use to adopt FAS 123R may be different than thos e currently used as discussed below in "Accounting for Stock-Based Compensation" section of this note. We currently expect that our adoption of FAS 123R will have a material impact on our consolidated results of operations.
- 6 -
Accounting for Stock-Based Compensation
Until we adopt FAS 123R, we will continue to follow APB 25 to account for employee stock options. Under APB 25, the intrinsic value method of accounting, no compensation expense is recognized because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant. We apply FAS 123 for disclosure purposes only.
The following proforma net income and
Earnings Per Share
Basic earnings per share
were determined as if we had accounted for our employee stock options and stock issued under our employee stock plan under(or “EPS”) are computed based on the
fair value method prescribed by FAS 123. The resulting effect on net income and earnings per share pursuant to FAS 123 is not likely to be representativeweighted-average number of
the effects in future periods, due to subsequent additional option grants and periods of vesting.The Black-Scholes option valuation model was developed for use in estimating the fair value of publicly traded options, which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions and these assumptions can vary over time. Because our employee stock options and stock plan shares have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing valuation models do not provide a single reliable measure of the fair value of our employee stock options.
| Three Months Ended June 30, | | Six Months Ended June 30, |
| | | |
| 2005 | | 2004 | | 2005 | | 2004 |
| | | | | | | |
| (In thousands, except per share amounts) |
Net income - as reported | $ | 296,166 | | $ | 170,771 | | $ | 580,340 | | $ | 347,358 |
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects | |
41,033
| | |
45,611
| | |
81,422
| | |
90,316
|
| | | | | | | | | | | |
Pro forma net income | $ | 255,133 | | $ | 125,160 | | $ | 498,918 | | $ | 257,042 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Earnings per share: | | | | | | | | | | | |
Basic-as reported | $ | 0.28 | | $ | 0.16 | | $ | 0.55 | | $ | 0.33 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Basic-pro forma | $ | 0.24 | | $ | 0.12 | | $ | 0.47 | | $ | 0.24 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Diluted-as reported | $ | 0.27 | | $ | 0.16 | | $ | 0.54 | | $ | 0.32 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Diluted-pro forma | $ | 0.23 | | $ | 0.12 | | $ | 0.45 | | $ | 0.24 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
The fair valueCommon Stock outstanding. Diluted EPS are computed based on the weighted-average number of options was estimated at the date of grant using a Black-Scholes option valuation model with the following weighted-average assumptions:
| Three Months Ended June 30, | | Six Months Ended June 30, |
| | | |
| 2005 | | 2004 | | 2005 | | 2004 |
| | | | | | | |
Risk-free interest rate | 3.7% | | 3.7% | | 3.8% | | 3.6% |
Dividend yield | 0.0% | | 0.0% | | 0.0% | | 0.0% |
Volatility factors of the expected market price of our Common Stock | 32.0%
| | 42.0%
| | 32.0%
| | 43.0%
|
Weighted-average expected life of option (years) | 4.2 | | 5 | | 4.2 | | 5 |
Due to the redemptionshares of our special common stock in June 1999 (or "Redemption") by Roche Holdings, Inc. (or "Roche"), there is limited historical information available to determine the necessary inputs to value employee stock optionsCommon Stock and the stock issued under the employee stock plan. In 2004, having completed our first full four-year option vesting cycle on options issued after the Redemption, and having further analyzed economic data from marketable instruments and comparable companies, the assumptions for volatility and expected lives were further refined to reflect what management believes to be a better measure of fair value.
- 7
Earnings Per Share
other dilutive securities.
The following is a reconciliation of the denominator used innumerators and denominators of the basic and diluted earnings per share (or "EPS")EPS computations(in thousands)millions): | Three Months Ended June 30, | | Six Months Ended June 30, |
| | | |
| 2005 | | 2004 | | 2005 | | 2004 |
| | | | | | | |
Numerator: | | | | | | | | | | | |
Net income | $ | 296,166 | | $ | 170,771 | | $ | 580,340 | | $ | 347,358 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
Denominator: | | | | | | | | | | | |
Weighted-average shares outstanding used for basic earnings per share | | 1,057,564
| | | 1,060,619
| | | 1,052,228
| | | 1,057,955
|
Effect of dilutive stock options | | 26,277 | | | 26,468 | | | 24,291 | | | 26,663 |
| | | | | | | | | | | |
Weighted-average shares and dilutive stock options used for diluted earnings per share | | 1,083,841
| | | 1,087,087
| | | 1,076,519
| | | 1,084,618
|
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
The following is a summary of the outstanding
| | Three Months Ended March 31, | |
| | 2006 | | 2005 | |
Numerator: | | | | | |
Net income | | $ | 421 | | $ | 284 | |
Denominator: | | | | | | | |
Weighted-average shares outstanding used to compute basic EPS | | | 1,054 | | | 1,047 | |
Effect of dilutive stock options | | | 21 | | | 20 | |
Weighted-average shares outstanding and dilutive securities used to compute diluted EPS | | | 1,075 | | | 1,067 | |
Employee stock options to purchase
commonapproximately 19 million shares of our Common Stock were outstanding in the first quarter of 2006. These employee stock
thatoptions were excluded from the computation of diluted EPS because
such options were anti-dilutive(in thousands, except for exercise prices):the effect would have been anti-dilutive. | | Three Months Ended June 30, | | | Six Months Ended June 30, |
| | | | | | | | | |
| | 2005 | | 2004 | | | 2005 | | 2004 |
| | | | | | | | | |
Number of shares | | 338 | | 390 | | | 598 | | 962 |
| | | | | | | | | |
Range of exercise prices | | $75.90 - $82.47 | | $59.48 - $59.61 | | | $69.35 - $82.47 | | $53.95 - $59.61 |
Comprehensive income is comprised of net income and other comprehensive income (or
"OCI"“OCI”). OCI includes certain changes in
stockholders'stockholders’ equity that are excluded from net income. Specifically, we include in OCI changes in the
estimated fair value of derivatives designated as effective cash flow hedges and unrealized gains and losses on our available-for-sale securities.
The components of accumulated OCI, net of income taxes, were as follows(in millions): | June 30, 2005 | | December 31, 2004 |
| | | | | | | | | |
Unrealized gains on securities available-for-sale | | $ | 250.4 | | | | $ | 305.1 | |
Unrealized gains (losses) on derivatives | | | 22.6 | | | | | (14.2) | |
| | | | | | | | | |
Accumulated other comprehensive income | | $ | 273.0 | | | | $ | 290.9 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | March 31, 2006 | | December 31, 2005 | |
Net unrealized gains on securities available-for-sale | | $ | 233 | | $ | 230 | |
Net unrealized gains on cash flow hedges | | | 22 | | | 23 | |
Accumulated other comprehensive income | | $ | 255 | | $ | 253 | |
The activity in comprehensive income, net of income taxes, was as follows(in millions): | Three Months Ended June 30, | | Six Months Ended June 30, |
| | | |
| 2005 | | 2004 | | 2005 | | 2004 |
| | | | | | | |
Net income | $ | 296.2 | | $ | 170.8 | | $ | 580.3 | | $ | 347.4 |
Change in unrealized gains (losses) on securities available-for-sale | | 22.1
| | | (29.8)
| | | (54.7)
| | | (4.1)
|
Change in unrealized gains (losses) on derivatives | | 23.8 | | | (4.2) | | | 36.8 | | | (0.8) |
| | | | | | | | | | | |
Comprehensive income | $ | 342.1 | | $ | 136.8 | | $ | 562.4 | | $ | 342.5 |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
- 8 -
The activity in comprehensive income, net of income taxes, related to our available-for-sale securities and cash flow hedges was as follows(in millions):
| Three Months Ended June 30, | | Six Months Ended June 30, |
| | | |
| 2005 | | 2004 | | 2005 | | 2004 |
| | | | | | | |
Unrealized gains (losses) on securities available-for-sale (net of tax effect for the second quarter of $14.7 in 2005, $(20.1) in 2004; for the first six months of $(36.6) in 2005, $(3.0) in 2004) |
$
|
22.1
| |
$
|
(30.1)
| |
$
|
(54.8)
| |
$
|
(4.4)
|
Reclassification adjustment for net gains on securities available-for-sale included in net income (tax effect in 2005 and 2004 was not material) | |
- -
| | |
0.3
| | |
0.1
| | |
0.3
|
Unrealized gains (losses) on derivatives (net of tax effect for the second quarter of $17.2 in 2005, $(3.3) in 2004; for the first six months of $25.5 in 2005, $(1.4) in 2004) | |
25.8
| | |
(5.0)
| | |
38.3
| | |
(2.1)
|
Reclassification adjustment for net (losses) gains on derivatives included in net income (net of tax effect for the second quarter of $(1.3) in 2005, $0.5 in 2004; for the first six months of $(1.0) in 2005, $1.0 in 2004) | |
(2.0)
| | |
0.8
| | |
(1.5)
| | |
1.3
|
| | | | | | | | | | | |
Change in activity in OCI | $ | 45.9 | | $ | (34.0) | | $ | (17.9) | | $ | (4.9) |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | | | | | | | | | | |
| | Three Months Ended March 31, | |
| | 2006 | | 2005 | |
Net income | | $ | 421 | | $ | 284 | |
Change in unrealized gains (losses) on securities available-for-sale | | | 3 | | | (77 | ) |
Change in unrealized gains (losses) on derivatives | | | (1 | ) | | 13 | |
Comprehensive income | | $ | 423 | | $ | 220 | |
Derivative Financial Instruments
At
June 30, 2005,March 31, 2006, estimated net gains on
cash flow hedge derivative instruments,
consisting of foreign currency exchange options and marketable equity security collars, expected to be reclassified from accumulated OCI to
"other“other income,
net"net” during the next twelve months are
$13.0$23 million.
In June 2005,
Note 2. | Employee Stock-Based Compensation |
On January 1, 2006, we entered intoadopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (or “FAS 123R”), which supersedes our previous accounting under APB Opinion No. 25, “Accounting for Stock Issued to Employees” (or “APB 25”). FAS 123R requires the recognition of compensation expense, using a series of forward start interest rate swap locks with a total notionalfair-value based method, for costs related to all share-based payments including stock options and stock issued under our employee stock plans. FAS 123R requires companies to estimate the fair value of $1.05 billion as a hedge against increases in interest rates. In these swaps, we pay a fixed rate and receive a floating-rate.share-based payment awards on the date of grant using an option-pricing model. The objectivevalue of these swaps was to protect the future semi-annual interest rate payments resulting from our planned debt issuance in July 2005 of 10-year and 30-year fixed-rate notes. These swap locks were designated and qualify as cash flow hedges and the effective portion of the lossaward that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in our Condensed Consolidated Statements of Income. Also, certain of these costs are capitalized into inventory on our Condensed Consolidated Balance Sheets, and generally will be recognized as an expense when the related products are sold. We adopted FAS 123R using the modified prospective transition method, which requires that compensation expense be recognized in the financial statements for all awards granted after the date of adoption as well as for existing awards for which the requisite service has not been rendered as of the date of adoption. The modified prospective transition method does not require restatement of prior periods to reflect the impact of FAS 123R.
In November 2005, the Financial Accounting Standards Board (or “FASB”) issued FSP No. 123R-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.” We have adopted the simplified method to calculate the beginning balance of the additional paid-in-capital (or “APIC”) pool of the excess
tax benefit, and to determine the subsequent impact on the swap locks was included as a componentAPIC pool and Condensed Consolidated Statements of accumulated OCI. The ineffective portionCash Flows of the losstax effects of employee stock-based compensation awards that were outstanding upon our adoption of FAS 123R.
Prior to the adoption of FAS 123R, we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under FAS No. 123, “Accounting for Stock-Based Compensation” (or “FAS 123”). Under the intrinsic value method, no employee stock-based compensation expense had been recognized in our Condensed Consolidated Statements of Income for any period prior to our adoption of FAS 123R on January 1, 2006, as the exercise price of the stock options granted to employees and directors equaled the fair market value of the underlying stock at the date of grant.
Employee Stock Plans
We currently have an employee stock purchase plan, adopted in 1991 and amended thereafter (or “the 1991 Plan”). The 1991 Plan allows eligible employees to purchase Common Stock at 85% of the lower of the fair market value of the Common Stock on the swap locksgrant date or the fair market value on the purchase date. The offering period under the 1991 Plan is currently 15 months, and the purchase price is established during each new offering period. Purchases are limited to 15% of each employee’s eligible compensation and subject to certain Internal Revenue Service restrictions. All of our full-time employees are eligible to participate in the 1991 Plan. Of the 52,400,000 shares of Common Stock reserved for issuance under the 1991 Plan, 45,640,634 shares have been issued as of March 31, 2006.
We currently grant options under a stock option plan adopted in 1999 and amended thereafter (or “the 1999 Plan”), that allows for the granting of non-qualified stock options, incentive stock options and stock purchase rights to our employees, directors and consultants. Incentive stock options may only be granted to employees under this plan. Generally, non-qualified options and incentive options have a maximum term of 10 years, and options vest in increments over four years from the date of grant, although we may grant options with different vesting terms from time to time. When an employee over the age of 65 retires, the number of options that would have vested in the 12 month period following the retirement date, if the retiree had remained an employee, automatically becomes fully vested. The expiration date of the exercisable options remains the original expiration date at the time the options were granted. Upon employee termination, unexercised options will expire at the end of three months. No stock purchase rights or incentive stock options have been granted under the 1999 Plan to date.
Adoption of FAS 123R
Employee stock-based compensation expense recognized in the first quarter of 2006 was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. FAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Employee stock-based compensation expense recognized under FAS 123 was as follows (in millions, except for per share data):
| | Three Months Ended March 31, 2006 | |
Research and development | | $ | 33 | |
Marketing, general and administrative | | | 41 | |
Total employee stock-based compensation expense | | | 74 | |
Tax benefit related to employee stock-based compensation expense | | | (27 | ) |
Net effect on net income | | $ | 47 | |
Effect on earnings per share: | | | | |
Basic | | $ | 0.04 | |
Diluted | | $ | 0.04 | |
As of March 31, 2006, total compensation cost related to nonvested stock options not yet recognized was $734 million, which is expected to be allocated to expense and production costs over a weighted-average period of 27 months.
The carrying value of inventory on our Condensed Consolidated Balance Sheet as of March 31, 2006 includes employee stock-based compensation costs of $16 million. Substantially all of the products sold in the first quarter of 2006 were manufactured in previous periods when we did not include employee stock-based compensation expense in our production costs. In future periods, when product manufactured after the adoption of FAS 123R is sold or written off, or reserves are required for obsolescence or lack of demand, we will recognize employee stock-based compensation expense in cost of sales.
The following pro forma net income and EPS were determined as if we had accounted for employee stock-based compensation for our employee stock plans under the fair value method prescribed by FAS 123 in prior periods and had capitalized certain costs into inventory manufactured in those prior periods, with the resulting impact on cost of sales for the quarter ended March 31, 2006 when previously manufactured products were sold. (In millions, except for per share data):
| | Three Months Ended March 31, 2006 | |
Net income as reported | | $ | 421 | |
Deduct: Total employee stock-based compensation expense includable in cost of sales, net of related tax effects | | | (8 | ) |
Pro forma net income | | $ | 413 | |
Earnings per share: | | | | |
Basic-as reported | | $ | 0.40 | |
Basic-pro forma | | $ | 0.39 | |
| | | | |
Diluted-as reported | | $ | 0.39 | |
Diluted-pro forma | | $ | 0.38 | |
Pro Forma Information for Period Prior to Adoption of FAS 123R
The following pro forma net income and EPS were determined as if we had accounted for employee stock-based compensation for our employee stock plans under the fair value method prescribed by FAS 123. (In millions, except for per share data):
| | Three Months Ended March 31, 2005 | |
Net income as reported | | $ | 284 | |
Deduct: Total employee stock-based compensation expense determined under the fair value based method for all awards, net of related tax effects | | | (40 | ) |
Pro forma net income | | $ | 244 | |
Earnings per share: | | | | |
Basic-as reported | | $ | 0.27 | |
Basic-pro forma | | $ | 0.23 | |
| | | | |
Diluted-as reported | | $ | 0.27 | |
Diluted-pro forma | | $ | 0.22 | |
Valuation Assumptions
The employee stock-based compensation expense recognized under FAS 123R and presented in the pro forma disclosure required under FAS 123 was determined using the Black-Scholes option valuation model. Option valuation models require the input of subjective assumptions and these assumptions can vary over time. The weighted-average assumptions used are as follows:
| | Three Months Ended March 31, | |
| | 2006 | | 2005 | |
Risk-free interest rate | | | 4.6 | % | | 4.0 | % |
Dividend yield | | | 0.0 | % | | 0.0 | % |
Expected volatility | | | 29.0 | % | | 32.0 | % |
Expected term (years) | | | 4.2 | | | 4.2 | |
Due to the redemption of our Special Common Stock in June 1999 by Roche, there is limited historical information available to support our estimate of certain assumptions required to value our employee stock options and the stock issued under our employee stock purchase plan. In developing our estimate of expected term, we have determined that our historical stock option exercise experience is a relevant indicator of future exercise patterns. We also take into account other available information, including industry averages. We primarily base our determination of expected volatility through our assessment of the implied volatility of our Common Stock. Implied volatility is the volatility assumption inherent in the market prices of a company’s traded options.
Stock Option Activity
The following is a summary of option activity for the first quarter of 2006 (shares in millions):
| | | | Options Outstanding | |
| | Shares Available for Grant | | Number of Shares | | Weighted- Average Exercise Price | |
December 31, 2005 | | | 84 | | | 83 | | $ | 46.64 | |
Grants | | | (1 | ) | | 1 | | | 88.10 | |
Exercises | | | - | | | (2 | ) | | 30.38 | |
Cancellations | | | 1 | | | (1 | ) | | 57.63 | |
March 31, 2006 | | | 84 | | | 81 | | $ | 47.43 | |
The intrinsic value of options exercised during the first quarters of 2006 and 2005 was $125 million and $117 million, respectively. The estimated fair value of shares vested during the first quarters of 2006 and 2005 was $90 million and $40 million, respectively. The weighted-average estimated fair value of stock options granted during the three months ended March 31, 2006 and 2005 was $27.34 and $15.95, respectively, based on the assumptions in the Black-Scholes valuation model discussed above.
The following table summarizes outstanding and exercisable options at March 31, 2006 (in millions, except exercise price data):
| | Options Outstanding | | Options Exercisable | |
Range of Exercise Prices | | Number of Shares Outstanding | | Weighted-Average Remaining Contractual Life (in years) | | Weighted-Average Exercise Price | | Number of Shares Outstanding | | Weighted-Average Remaining Contractual Life (in years) | | Weighted-Average Exercise Price | |
$6.27 - $8.89 | | | 0.5 | | | 5.61 | | $ | 7.71 | | | 0.5 | | | 5.61 | | $ | 7.71 | |
$10.00 - $14.35 | | | 13.7 | | | 5.68 | | $ | 13.73 | | | 11.2 | | | 5.51 | | $ | 13.61 | |
$15.04 - $22.39 | | | 9.0 | | | 5.09 | | $ | 20.82 | | | 8.7 | | | 5.04 | | $ | 20.91 | |
$22.88 - $33.00 | | | 0.3 | | | 5.07 | | $ | 27.53 | | | 0.3 | | | 5.07 | | $ | 27.53 | |
$35.63 - $53.23 | | | 36.9 | | | 7.53 | | $ | 46.79 | | | 18.0 | | | 6.93 | | $ | 44.71 | |
$53.95 - $75.90 | | | 1.5 | | | 8.53 | | $ | 59.26 | | | 0.5 | | | 8.34 | | $ | 56.09 | |
$81.15 - $98.80 | | | 18.9 | | | 9.49 | | $ | 86.12 | | | - | | | 9.54 | | $ | 86.04 | |
| | | 80.8 | | | | | | | | | 39.2 | | | | | | | |
At March 31, 2006, the aggregate intrinsic value of the outstanding options was $3,032 million and the aggregate intrinsic value of the exercisable options was $2,136 million.
Stock Repurchase Program
Under a stock repurchase program approved by our Board of Directors in December 2003 and most recently extended in April 2006 (see also Note 7, “Subsequent Event” for a discussion of the April 2006 extension), we are authorized to repurchase up to 100 million shares of our Common Stock for an aggregate amount of up to $6.0 billion through June 30,
2005 was not material.2007. During the first quarter of 2006, we repurchased approximately 3 million shares at an aggregate cost of $227 million. Since the program’s inception, we have repurchased approximately 52 million shares at a total price of $3.6 billion. We intend to use the repurchased stock to offset dilution caused by the issuance of shares in connection with our employee stock plans and also to maintain Roche’s minimum percentage ownership interest in our stock.
Note 2.3. | Condensed Consolidated Financial Statement Detail |
The components of inventories were as follows(in millions): | June 30, 2005 | | December 31, 2004 |
| | | | | | | | | |
Raw materials and supplies | | $ | 62.8 | | | | $ | 57.1 | |
Work in process | | | 363.3 | | | | | 451.8 | |
Finished goods | | | 174.8 | | | | | 81.5 | |
| | | | | | | | | |
Total | | $ | 600.9 | | | | $ | 590.4 | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
- 9 -
Other Intangible Assets
The components
| | March 31, 2006 | | December 31, 2005 | |
Raw materials and supplies | | $ | 89 | | $ | 79 | |
Work in process | | | 463 | | | 438 | |
Finished goods | | | 252 | | | 186 | |
Total | | $ | 804 | | $ | 703 | |
Included in work in process are approximately $47 million at March 31, 2006 and $31 million at December 31, 2005 for pre-approval inventories of
our other intangible assets, including those that are acquisition-relatedLucentis, in anticipation of the product launch, and
arising fromfor a qualification campaign at a contract manufacturing facility. During the
Redemption and push-down accounting were as follows(in millions): | June 30, 2005 | | December 31, 2004 |
| | | |
| Gross Carrying Amount | | Accumulated Amortization
| | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization
| | Net Carrying Amount |
| | | | | | | | | | | |
Developed product technology | $ | 1,194.1 | | $ | 886.7 | | $ | 307.4 | | $ | 1,194.1 | | $ | 847.7 | | $ | 346.4 |
Core technology | | 443.5 | | | 361.6 | | | 81.9 | | | 443.5 | | | 351.0 | | | 92.5 |
Developed science technology | | 467.5 | | | 467.5 | | | - | | | 467.5 | | | 452.9 | | | 14.6 |
Tradenames | | 144.0 | | | 79.5 | | | 64.5 | | | 144.0 | | | 74.7 | | | 69.3 |
Patents | | 150.6 | | | 58.7 | | | 91.9 | | | 138.0 | | | 53.2 | | | 84.8 |
Other intangible assets | | 103.6 | | | 45.3 | | | 58.3 | | | 101.3 | | | 40.5 | | | 60.8 |
| | | | | | | | | | | | | | | | | |
Total | $ | 2,503.3 | | $ | 1,899.3 | | $ | 604.0 | | $ | 2,488.4 | | $ | 1,820.0 | | $ | 668.4 |
| | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | |
Amortization expensefirst quarter of our other intangible assets was$39.7 million and $61.5 million for the second quarters of 2005 and 2004, respectively, and $79.3 million and $104.52006, approximately $16 million in the first six months of 2005 and 2004, respectively.
The expected future annual amortization expense of our other intangible assets is as follows(employee stock-based compensation costs were capitalized in millions):
For the Year Ending December 31,
| | Amortization Expense |
| | | |
2005 (remaining six months) | | $ | 64.5 |
2006 | | | 124.2 |
2007 | | | 122.8 |
2008 | | | 121.0 |
2009 | | | 72.0 |
Thereafter | | | 99.5 |
| | | |
Total expected future annual amortization | | $ | 604.0 |
| | | |
| | | |
| | | |
Note 3.
| Leases and Contingencies
|
Leases
During the six months ended June 30, 2005, there were no significant changes to our synthetic lease arrangements, or our assessment of those arrangements under the provisions of FIN 46R, a revision of Interpretation 46, as discussed in Note 6, "Leases, Commitments and Contingencies" of our Annual Report on Form 10-K for the year ended December 31, 2004. See also Note 7, "Subsequent Events -- Buyout of a Synthetic Lease" below.
In December 2004, we entered into a Master Lease Agreement with Slough SSF, LLC for the lease of property adjacent to our South San Francisco campus. The property will be developed into eight buildings and two parking structures. The lease of the property will take place in two phasesinventory pursuant to separate lease agreements for each building as contemplated by the Master Lease Agreement. Phase I building leases will begin throughout 2006 and Phase II building leases may begin as early as 2008. For accounting purposes, due to the nature of our involvement with the construction of the buildings subject to the Master Lease Agreement, we are considered to be the owner of the assets during the construction period through the lease commencement date, even though the funds to construct the building shell and some infrastructure costs are paid by the lessor. As such, in the first six months of 2005, we have capitalized $73.0 million of construction costs in property, plant and equipment, and have also recognized a corresponding amount as a construction financing obligation in "long-term debt" in the accompanying condensed
- 10 -
FAS 123R.
-11-
consolidated balance sheets. We expect at the time of completion of the project, if all the buildings and infrastructure were completed by the lessor, our construction asset and related obligation will be in excess of $365.0 million. Our aggregate lease payments as contemplated by the Master Lease Agreement through 2020 (if there is no acceleration or delay in the rent commencement date for the second phase of the buildings) will be approximately $540.1 million.
Contingencies
We are a party to various legal proceedings, including patent infringement litigation and licensing and contract disputes, and other matters.
On October 4, 2004, we received a subpoena from the United States (or
"U.S."“U.S.”) Department of Justice, requesting documents related to the promotion of Rituxan, a prescription treatment
now approved for
three indications: (1) the treatment of relapsed or refractory, low-grade or follicular,
CD20 positive,CD20-positive, B-cell
non-Hodgkin's lymphoma.non-Hodgkin’s lymphoma, (2) the first-line treatment of diffuse large B-cell, CD20-positive, non-Hodgkin’s lymphoma in combination with CHOP or other anthracycline-based chemotherapy regimens (approved on February 10, 2006), and (3) for use in combination with methotrexate to reduce signs and symptoms in adult patients with moderately- to severely- active rheumatoid arthritis who have had an inadequate response to one or more TNF antagonist therapies (approved on February 28, 2006). We are cooperating with the associated investigation, which we have been advised is both civil and criminal in nature. The
government has called and is expected to call former and current Genentech employees to appear before a grand jury in connection with this investigation. The outcome of this matter cannot be determined at this time.
On July 29, 2005, a former Genentech employee, whose employment ended in April 2005, filed a qui tam complaint under seal in the United States District Court for the District of Maine against Genentech and Biogen Idec, alleging violations of the False Claims Act and retaliatory discharge of employment. On December 20, 2005, the United States District Court filed notice of its election to decline intervention in the lawsuit. The complaint was subsequently unsealed and we were served on January 5, 2006. The outcome of this matter cannot be determined at this time.
We and the City of Hope National Medical Center (or
"COH"“COH”) are parties to a 1976 agreement relating to work conducted by two COH employees, Arthur Riggs and Keiichi Itakura, and patents that resulted from that work, which are referred to as the
"Riggs/“Riggs/Itakura Patents.
"” Since that time,
Genentech haswe have 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 COH filed a complaint against us in the Superior Court in Los Angeles County, California, alleging that we owe royalties to the COH in connection with these license agreements, as well as product license agreements that involve the grant of licenses under the Riggs/Itakura Patents. On June 10, 2002, a jury voted to award the COH approximately $300 million in compensatory damages. On June 24, 2002, a jury voted to award the COH an additional $200 million in punitive damages. Such amounts were accrued as an expense in the second quarter of
20 022002 and
wereare included in the accompanying
condensed consolidated balance sheetsCondensed Consolidated Balance Sheets in
"litigation-related“litigation-related and other long-term
liabilities"liabilities” at
June 30, 2005March 31, 2006 and December 31,
2004. Genentech2005. We filed a notice of appeal of the verdict and damages awards with the California Court of Appeal. On October 21, 2004, the California Court of Appeal affirmed the verdict and damages awards in all respects. On November 22, 2004, the California Court of Appeal modified its opinion without changing the verdict and denied
Genentech'sGenentech’s request for rehearing. On November 24, 2004,
Genentechwe filed a petition seeking review by the California Supreme Court. On February 2, 2005, the California Supreme Court granted that petition. The amount of cash paid, if any, or the timing of such payment in connection with the COH matter will depend on the outcome of the California Supreme
Court'sCourt’s review of the
matter;matter, however,
we expect that it may take longer than one year to further resolve the matter.
We recorded $13 million of accrued interest and bond costs related to the COH trial judgment of $13.5 million infor the second quarters of 2005three months ended March 31, 2006 and 2004, and $27.0 million and $26.9 million in the first six months of 2005 and 2004, respectively.2005. In conjunction with the COH judgment, we posted a surety bond and were required to pledge cash and investments of $682.0$735 million at June 30, 2005March 31, 2006 andDecember 31, 20042005 to secure the bond. These amounts are reflected in "restricted“restricted cash and investments"investments” in the accompanying condensed consolidated balance sheets.Condensed Consolidated Balance Sheets. We expect that we will continue to incur interest charges on the judgment and service fees on the surety bond each quarter through the process of appealing the COH trial results.On August 12, 2002, the U.S. Patent and Trademark Office (or "Patent Office") declared an interference between U.S. Patent No. 6,054,561, owned by Chiron Corporation (or "Chiron"), and a patent application exclusively licensed by Genentech from a university relating to anti-HER2 antibodies. On October 24, 2002, the Patent Office redeclared the interference to include, in addition to the above-referenced Chiron patent and university patent application, a number of patents and patent applications owned by either Chiron or Genentech, including Chiron's U.S. Patent No. 4,753,894 that is also at issue in the separate patent infringement lawsuit described below. On November 30, 2004, the Patent Office's Board of Patent Appeals and Interferences issued rulings on several preliminary motions. These rulings terminated both interferences involving the patent application referenced above that Genentech licensed from a university, redeclared interferences between the Genentech and Chiron patents an d patent applications, and made several determinations which could affect the validity of the Genentech and Chiron
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patents and patent applications involved in the remaining interferences. On January 28, 2005, Genentech filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit. On June 1, 2005, we and Chiron agreed to a settlement of both these interference proceedings and the below-referenced lawsuit. Under the settlement agreement, Chiron has abandoned the contest as to each count in both of the redeclared interferences referenced above. Because our own patents and patents applications are still before the Patent Office's Board of Patent Appeals and Interferences and the appeal process of the prior rulings is still ongoing, the outcome of this matter with respect to our patents and patent applications cannot be determined at this time.
On March 13, 2001, Chiron filed a patent infringement lawsuit against us in the U.S. District Court in the Eastern District of California, alleging that the manufacture, use, sale and/or offer for sale of our Herceptin antibody product infringes Chiron's U.S. Patent No. 4,753,894. Chiron was seeking compensatory damages for the alleged infringement, additional damages, and attorneys' fees and costs. Genentech filed a motion to dismiss this lawsuit, which was denied. On November 1, 2002, the parties filed a proposed stipulation to stay all proceedings in this lawsuit until (1) the interference involving U.S. Patent No. 4,753,894 is resolved or two years from entry of the proposed stipulation, whichever is sooner. On or about November 13, 2002, the Court entered the stipulation, staying the proceedings as requested by the parties. On November 10, 2004, the Court extended the stay until the resolution of all proceedings before the U.S. Supreme Court in a separate Chiron suit that has now been concluded. This lawsuit was separate from and in addition to the Chiron interference mentioned above. On June 1, 2005, we and Chiron agreed to a settlement of both the above-referenced interference proceedings and this lawsuit, pursuant to which all pending claims in this lawsuit were dismissed with prejudice. The settlement resolves and ends all the patent infringement claims that Chiron made against Genentech in this lawsuit.
On April 11, 2003, MedImmune, Inc. (or “MedImmune”) filed a lawsuit against Genentech, COH, and Celltech R & D Ltd. in the U.S. District Court for the Central District of California (Los Angeles). The lawsuit relates to U.S. Patent No. 6,331,415 (or "the '415 patent"“the ‘415 patent” or "Cabilly patent"“Cabilly patent”) that is co-owned by Genentech andwe co-own with COH and under which MedImmune and other companies have been licensed and are paying royalties to Genentech.us. The lawsuit includes claims for
violation of antitrust, patent, and unfair competition laws. MedImmune is seeking to have the
'415‘415 patent declared invalid and/or unenforceable, a determination that MedImmune does not owe royalties under the
'415‘415 patent on sales of its Synagis® antibody product, an injunction to prevent
Genentechus from enforcing the
'415‘415 patent, an award of actual and exemplary damages, and other relief. On January 14, 2004 (amending a December 23, 2003 Order), the U.S. District Court granted summary judgment in
Genentech'sour favor on all of
MedImmune's antit rust and unfair competition claims. MedImmune sought to amend its complaint to reallege certain claims for antitrust and unfair competition. On February 19, 2004, the Court denied this motion in its entirety and final judgment was entered in favor of Genentech and Celltech and against MedImmune on March 15, 2004 on allMedImmune’s antitrust and unfair competition claims.
MedImmune filed a notice of appeal of this judgment with the U.S. Court of Appeals for the Federal Circuit. Concurrently, inOn April 23, 2004, the District Court
litigation, Genentech filed agranted our motion to dismiss all remaining claims in the case. On
April 23, 2004, the District Court granted Genentech's motion and dismissed all remaining claims. Final judgment was entered in Genentech's favor on May 3, 2004, thus concluding proceedings in the District Court. MedImmune filed a notice of appeal withOctober 18, 2005, the U.S. Court of Appeals for the Federal
Circuit. Oral argumentCircuit affirmed the judgment of
MedImmune's appeal was heldthe District Court in all respects. MedImmune filed a petition for certiorari with the United States Supreme Court on November 10, 2005, seeking review of the decision to dismiss certain of its claims. The Supreme Court granted MedImmune’s petition on February
10, 2005. Because21, 2006 and the
appeal processbriefing on the merits of this case before the Supreme Court is
ongoing, the final out comeongoing. The outcome of this matter cannot be determined at this time.
On May 13, 2005, a request was filed by a third party for reexamination of the '415‘415 or Cabilly patent. The request sought reexamination on the basis of non-statutory double patenting over U.S. Patent No. 4,816,567. On July 7, 2005, the U.S. Patent Office ordered reexamination of the '415‘415 patent. On September 13, 2005, the Patent Office issued an initial “non-final” Office action rejecting the claims of the ‘415 patent. We filed our response to the Office action on November 25, 2005. The Patent Office has not yet acted on this response. On December 23, 2005, a second request for reexamination of the ‘415 patent was filed by another third party. On January 23, 2006, the Patent office granted the reexamination request.
Because the
two above-described reexamination
process isproceedings are ongoing, the final outcome of
this matterthese matters cannot be determined at this time. The
'415‘415 patent, which expires in 2018, relates to methods we and others use to make certain antibodies or antibody fragments, as well as cells and DNA used in these methods. We have licensed the
'415‘415 patent to other companies and derive
substantialsignificant royalties from those licenses.
The claims of the ‘415 patent remain valid and enforceable throughout the reexamination process.
Note 4.5. | Relationship with Roche and Related Party Transactions |
Relationship with Roche
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Roche's
Roche’s Ability to Maintain Its Percentage Ownership Interest in Our Stock
We
expect from time to time to issue additional shares of
common stockCommon 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 provides, among other things, that
we establish a stock repurchase program designedwith respect to
maintain Roche's percentage ownership interestany issuance of Common Stock by Genentech in
our common stock. The affiliation agreement provides thatthe future, we will repurchase a sufficient number of shares
pursuant to this programso that immediately after such
that, with respect to any issuance
of common stock by Genentech in the future, the percentage of Genentech
common stockCommon 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
"M inimum Percentage."“Minimum Percentage” (as defined below), provided however, as long as Roche’s percentage ownership is greater than 50%, prior to issuing any shares, we will repurchase a sufficient number of shares of our Common Stock such that, immediately after our issuance of shares, Roche’s percentage ownership will be greater than 50%. The Minimum Percentage equals the lowest number of shares of Genentech
common stockCommon Stock owned by Roche since the July 1999 offering
(to be adjusted in the future(adjusted for dispositions of shares of Genentech
common stockCommon Stock by Roche as well as for stock splits or stock combinations) divided by 1,018,388,704,
(to be adjusted in the future for stock splits or stock combinations), which is the number of shares of Genentech
common stockCommon Stock outstanding at the time of the July 1999 offering, as adjusted for
the two-for-one splits of Genentech common stock
in November 1999, October 2000 and May 2004.splits. We
have repurchased shares of our
common stock in 2005 and 2004 (see discussion below in "Liquidity and Capital Resources -- Cash Provided by or Used in Financing Activities" in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 of this Form 10-Q). As long as Roche's percentage ownership is greater than 50%, prior to issuing any shares, the affiliation agreement pro vides that we will repurchase a sufficient number of shares of our common stock such that, immediately after our issuance of shares, Roche's percentage ownership will be greater than 50%.Common Stock since 2001. The affiliation agreement also provides that, upon
Roche'sRoche’s request, we will repurchase shares of our
common stockCommon Stock to increase
Roche'sRoche’s ownership to the Minimum Percentage. In addition, Roche will have a continuing option to buy stock from us at prevailing market prices to maintain its percentage ownership interest. The Minimum Percentage at
June 30, 2005March 31, 2006 was 57.7% and, under the terms of the affiliation agreement,
Roche's lowestRoche’s ownership percentage is to be
no lower than 55.7%. At
June 30, 2005, Roche'sMarch 31, 2006, Roche’s ownership percentage was
55.3%55.7%.
We expect that future share repurchases under our share repurchase program willincrease Roche's ownership percentage.
Related Party Transactions
We enter into transactions with our related parties, Roche and other Roche affiliates (including
F. Hoffmann-La
Roche (or "Hoffmann-La Roche"))Roche) and Novartis,
Pharma AG (or "Novartis"),under existing agreements in the ordinary course of business. The accounting policies we apply to our transactions with our related parties are consistent with those applied in transactions with independent
third-parties and all related party agreements are negotiated on an arm's-length basis.third-parties.
Under our existing arrangements with Hoffmann-La Roche, including our licensing and marketing agreements, we recognized contract revenue from Hoffmann-La Roche, including amounts earned related to ongoing development activities, of $18.5$18 million and $23.7 $16million in the second quarters of 2005 and 2004, respectively, and $35.0 million and $49.6 million in the first six monthsquarters of 20052006 and 2004,2005, respectively. All other revenues from Roche, Hoffmann-La Roche and their affiliates, principally royalties and product sales, were $133.7totaled $224 million and $111.7 million in the second quarters of 2005 and 2004, respectively, and $289.5 million and $210.6$155 million in the first six monthsquarters of 20052006 and 2004,2005, respectively. Cost of sales (or “COS”) included amounts related to Hoffmann-La Roche of $26.5$49 million and $25.9 million in the second quarters of 2005 and 2004, respectively, and $73.8 million and $48.4$47 million in the first six monthsquarters of 2006 and 2005, and 2004, respectively. ResearchOur reported research and development (or "R&D"“R&D”) expenses includ ed amountsin each of the first quarters of 2006 and 2005 included $43 million and $34 million, respectively, related to development activities undertaken on projects on which we collaborate with Hoffmann-La RocheRoche.
Novartis
Based on information available to us at the time of
$35.7 million and $43.5 million in the second quarters of 2005 and 2004, respectively, and $66.7 million and $76.4 million in the first six months of 2005 and 2004, respectively.Novartis
We understand thatfiling this Form 10-Q, we believe the Novartis Group holds approximately 33.3% of the outstanding voting shares of Roche Holding Ltd. As a result of this ownership, the Novartis Group is deemed to have an indirect beneficial ownership
- 13 -
interest under FAS 57 "Related“Related Party Disclosures"Disclosures” of more than 10% of Genentech'sour voting stock.
Under
We have an arrangementagreement with Novartis a holding companyOphthalmics (now merged into Novartis AG) under which Novartis Ophthalmics has the exclusive right to develop and market Lucentis outside of the U.S. and Canada for indications related to diseases or disorders of the eye. As part of this agreement, the parties share the cost of certain of our ongoing Phase III and related development expenses.
We, along with Novartis
Group,Pharma AG (a wholly owned subsidiary of Novartis AG) and Tanox, Inc.,
are co-developing Xolair in the U.S. We and Novartis are co-promoting Xolair in the U.S. and we
both make certain joint and individual payments to Tanox; Genentech’s joint and individual payments are in the form of royalties. We record all sales and cost of sales in the U.S. and Novartis markets the product and records all sales and cost of sales in Europe. We and Novartis share the resulting U.S. and European operating profits, respectively, according to prescribed profit-sharing percentages. We are currently
supply Xolairsupplying the product and receive cost plus a mark-up similar to other supply arrangements.
On January 20, 2006, Novartis
will be manufacturing all future worldwidereceived FDA approval to manufacture bulk supply of Xolair at their Huningue production facility in
France, upon U.S. Food and Drug Administration licensure, expected in early 2006.France. Future production costs of Xolair may initially be higher than those currently reflected in our
cost of salesCOS as a result of
anythe production shift from
Genentechus to Novartis until production economies of scale can be achieved by
that manufacturing party.Novartis.
Contract revenue from Novartis related to manufacturing, commercial and ongoing development activities was $11.9 million and $10.2 million in the second quarters of 2005 and 2004, respectively, and $21.9 million and $20.9$10 million in the first six monthsquarters of 20052006 and 2004, respectively.2005. Revenue from Novartis related to product sales and COS was not material in the second quarterfirst quarters of 2006 and 2005. Our reported R&D expenses in each of the first six monthsquarters of 2006 and 2005 included approximately $10 million related to development activities undertaken on products on which we collaborate with Novartis. Collaboration profit sharing payments from us to Novartis were $43 million and 2004. Cost of sales was $12.3 million in the second quarter of 2005 and $15.1 $24million in the first six months of 2005, which included a one-time payment in the second quarter of 2005 related to our release from future manufacturing obligations. Cost of sales was not material in the second quarter and first six months on 2004. R&D expenses include amounts related to Novartis of $5.7 million and $6.0 million in the second quarters of 2006 and 2005, and 2004, respectively, and $15.4 million and $12.4 million in the first six months of 2005 and 2004, respectively. Collaboration profit sharing expenses were $28.7 million and $14.8 million in the second quarters of 2005 and 2004, respectively, and $52.4 million and $26.6 million in the first six months of 2005 and 2004, respectively.
Note 5.6. | Manufacturing Plant Acquisition
Income Taxes |
In June 2005, we acquired Biogen Idec Inc.'s Oceanside, California biologics manufacturing facility (or "Oceanside plant") for $408.1 million in cash plus $9.3 million in closing costs. The purchase price allocation for this purchase is preliminary, pending the receipt of final asset appraisals and the completion of certain other analyses, and is as follows (in millions):
Land and land improvements
| | $
| 42.2
|
Building
| | | 110.2
|
Equipment
| | | 36.7
|
Construction in progress
| | | 228.3
|
| | | |
Total
| | $
| 417.4
|
| | | |
| | | |
| | | |
The effective income tax rate was 26% in the second quarter of 2005 compared to 37% in the second quarter of 2004, and was 32%38% in the first six monthsquarter of 20052006, as compared to 35%36% in the first six monthsquarter of 2004.2005. The decreaseincrease in the income tax rate primarily reflects higher income before taxes and the December 31, 2005 expiration of provisions in federal tax law for the R&D tax credit. Currently there are bills in Congress to extend the R&D tax credit retroactively to January 1, 2006. If such legislation is passed, then at that time we will record a tax benefit for R&D tax credits.
Stock Repurchase Program
On April 19, 2006, our Board of Directors authorized the extension of our current stock repurchase program for the repurchase of up to an additional $2 billion of our common stock for a total of $6 billion through June 30, 2007. Our Board of Directors also amended the current repurchase program by increasing the maximum number of shares that can be repurchased from 2004 primarily relates80 million to 100 million shares.
Under our stock repurchase program we repurchased approximately 664,000 shares of our common stock, at a
one-time benefitcost of approximately
$39.0$53 million
from recognizing additional R&D tax credits resulting from new income tax regulations issued by the U.S. Department of Treasury during the
second quarter of 2005.Debt Issuance
On July 18, 2005, we completed a private placement of the following debt instruments: $500.0 million principal amount of 4.40% Senior Notes due 2010, $1.0 billion principal amount of 4.75% Senior Notes due 2015 and $500.0 million principal amount of 5.25% Senior Notes due 2035. Interest on each series of notes is payable on January 15 and July 15 of each year, beginning on January 15,period from April 1 through April 25, 2006. The 2010 notes, 2015 notes and 2035 notes are referred to collectively as the "Notes.'' Net proceeds resulting from issuance of the Notes, after debt discount and issuance
- 14 -
-15-
costs, were approximately $1.99 billion. We intend to use approximately $585.0 million of the net proceeds to repay our obligations under our existing synthetic lease arrangements. We also intend to use part of the proceeds to fund capital expenditures, including modifications plus start-up and validation costs at our recently acquired biologics manufacturing facility in Oceanside, California. We intend to use the balance of the net proceeds for general corporate purposes, which may include working capital requirements, stock repurchases, R&D expenses and acquisitions of or investments in products, technologies, facilities and businesses. Pending the use of the remaining funds in this manner, we intend to invest them in interest-bearing or other yield producing investments. The Notes are unsecured, non-convertible obligations and will rank equally in right of payment with all of our other unsecured unsubordinated indebtedness. The Notes have not been registered under the Securities Act or any state securities laws, however; we have committed to the buyers of such Notes that we will do so within 240 days of July 18, 2005.
Contemporaneous with the issuance of our fixed-rate 5 year Notes due in 2010, we entered into a series of interest rate swaps with a total notional value of $500.0 million. In these swaps, we pay a floating rate and receive a fixed rate that matches the coupon rate of the 5 year Notes. The objective of these swaps is to protect a portion of the debt against changes in fair value due to changes in interest rates.
Restricted Cash and Investments
Upon request by COH, on July 16, 2005, we increased the surety bond value by $50.0 million from $650.0 million to $700.0 million. As part of this arrangement, we have correspondingly increased the pledged amount to secure the bond from $682.0 million to $735.0 million.
Buyout of a Synthetic Lease
On August 1, 2005, we paid $160.0 million to buyout our synthetic lease obligation on a research facility in South San Francisco, California. As a result, we will include the value of this building in our consolidated balance sheet from August 1, 2005 onward and record depreciation expense in accordance with our accounting policies.
- 15 -
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of Genentech, Inc.
We have reviewed the condensed consolidated balance sheet of Genentech, Inc. as of
June 30, 2005,March 31, 2006, and the related condensed consolidated statements of income
for the three-month and
six-month periods ended June 30, 2005 and 2004, and the condensed consolidated statements of cash flows for the
six-monththree-month periods ended
June 30, 2005March 31, 2006 and
2004.2005. These financial statements are the responsibility of the
Company'sCompany’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Genentech, Inc. as of December 31,
2004,2005, and the related consolidated statements of income,
stockholders'stockholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated February
18, 2005,10, 2006, 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,
2004,2005, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
Palo Alto, California
July 8, 2005,
April 7, 2006,
except for Note 7, as to which the date is
April 25, 2006
August 1, 2005- 16 -
GENENTECH, INC.
Genentech is a leading biotechnology company that discovers, develops, manufactures, and commercializes biotherapeutics for significant unmet medical needs. We
manufacture and commercialize multiple biotechnology products,
directly in the United States (or "U.S.") and also receive royalties from companies that are licensed to market products based on our technology.
Recent
Major Developments in the First Quarter of 2006
In the secondfirst quarter of 2005,2006, our total operating revenues were $1,526.8$1,986 million, an increase of 36% from $1,462 million in the first quarter of 2005. Our net income was $421 million, an increase of 48% from $284 million in the first quarter of 2005. Net income in the first quarter of 2006 includes the effect of stock-based compensation expense related to employee stock options and employee stock purchases under Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (or “FAS 123R”), which decreased our net income was $296.2 million. Inby $47 million after taxes.
Significant milestones during the first six monthsquarter of 2005, our total operating revenues2006 were $2,988.5 million and our net income was $580.3 million. Foras follows:
We received the remainder of 2005, we expect the growth of our business to continue to be driven by sales of our oncology products, Rituxan, Avastin, Herceptin and Tarceva. We also expect sales of our other products, royalties and contract revenues to continue to contribute to the bottom-line.In the first half of 2005, we announced positive Phase III clinical trials for Avastin, Rituxan and Herceptin, as described more fully under the Product Sales discussions for each of those products below. In addition, on May 23, 2005, we announced that a Phase III trial of our investigational drug Lucentis in patients with minimally classic/occult wet age-related macular degeneration (or "AMD") met its primary efficacy endpoint of increasing the percentage of patients who maintained vision compared to patients receiving a sham control injection.
As part of our efforts to increase manufacturing capacity, in June 2005, we acquired Biogen Idec Inc.'s (or "Biogen Idec") Oceanside, California biologics manufacturing facility (or "Oceanside plant") for $408.1 million in cash plus $9.3 million in closing costs. The 60-acre, 500,000 square-foot Oceanside plant has 90,000 liters of bioreactor capacity. We expect manufacturing of Avastin bulk drug substance at the plant to commence in 2006 withfollowing U.S. Food and Drug Administration (or "FDA"“FDA”) licensure anticipatedapprovals:
· | Rituxan - for use in first-line treatment of patients with diffuse large B-cell, CD20-positive, non-Hodgkin’s lymphoma (or “DLBCL”); and |
· | Rituxan - to treat patients with active rheumatoid arthritis (or “RA”) who have had an inadequate response to tumor necrosis factor antagonist therapy. |
We submitted the first half of 2007. Additionally, in order to increasefollowing FDA filings:
· | a Supplemental Biologics License Application (or “sBLA”) for use of Herceptin to treat early-stage, HER2-positive breast cancer; |
· | with Biogen Idec, an sBLA for use of Rituxan to treat indolent front-line non-Hodgkin’s lymphoma (or “NHL”); and |
· | on April 11, 2006, an sBLA for use of Avastin in first-line treatment of advanced, non-squamous, non-small cell lung cancer. |
On February 28, 2006, the FDA accepted our internally available manufacturing capacity, in the second quarter of 2005 we entered into agreements with two of our collaborators to cancel and amend certain of our future manufacturing obligations, resulting in payments totaling $41.0 million. For our Porriño, Spain facility, we filed a supplemental Biologics License Application (or "sBLA"“BLA”) onfor the use of Lucentis in the treatment of neovascular wet age-related macular degeneration with an action date of June 30, 2005, for licensure2006.
In January 2006, the FDA approved the production of two 10,000-liter bioreactors at that facility to produce AvastinXolair bulk drug substance at Novartis’ production facility in Huningue, France. In addition, in February 2006, we acquired a second facility in Oceanside, California from Biogen Idec. The facility was purchased for commercial use,$29 million and includes approximately 5,500 liters of capacity to be used for clinical bulk manufacturing of new molecular entities.
On January 1, 2006, we
are planningadopted FAS 123R, which requires the measurement and recognition of compensation expense for
licensure by the end of 2005. In the second quarter we also filed a sBLA seeking licensure of Lonza Biologic's (or "Lonza") Portsmouth, New Hampshire manufacturing plantall share-based payment awards made to our employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. Employee stock-based compensation expense recognized under FAS 123R for the
production of Rituxan bulk drug substance. Increasing our manufacturing capacity and supply output continuesthree months ended March 31, 2006 was $74 million, or approximately $0.04 per diluted share. For the full year 2006, we expect employee stock-based compensation expense to be
a key business challenge for us (see below in "Difficulties or delays in product manufacturing or in obtaining materials from our suppliers could harm our business and/or negatively impact our financial performance" of "Forward-Looking Information and Cautionary Factors That May Affect Future Results").On July 18, 2005, we completed a private placement of the following debt instruments: $500.0 million principal amount of 4.40% Senior Notes due 2010, $1.0 billion principal amount of 4.75% Senior Notes due 2015 and $500.0 million principal amount of 5.25% Senior Notes due 2035. We received approximately $1.99 billion in net proceeds from this offering, after deducting estimated selling and offering expenses.
Our Strategy
We are in the final yearrange of $0.15 to $0.17 per diluted share. See also Note 2, “Employee Stock-Based Compensation” in the Condensed Consolidated Financial Statements of Part 1, Item 1 of this Form 10-Q for further information.
Our Strategy
Our business objectives for the years 2006 through 2010 are reflected in our
5x5 plan, our current 5-year business plan. We expect to exceed our most important goal of average annual non-GAAP EPS growth. We believe that we are well-positioned to exceed our goal of five- 17 -
significant products/indications in late stage developmentrevised Horizon 2010 strategy and have already exceeded our goal of five new products or indications approved through 2005. We expect to have substantive progress against our goal of $500 million in new revenue from alliances and/or acquisitions; however it is uncertain whether we will meet this goal since we have changed our strategic focus to pursue earlier stage opportunities. We do not expect to meet our non-GAAP net income as a percentage of total operating revenues goal, due primarily to the success of Rituxangoals summarized below and the associated profit split with Biogen Idec. Information on our 5x5 plan can be found on our website at http://www.gene.com.
We have a long-term plan (Horizon 2010) and the key elements of Horizon 2010 include:
build a leading immunology business by expanding the fundamental understanding of immune disorders, bringing at least five new immunology products or indications into clinical development, and obtaining FDA approval of at least five new indications or products by 2010;
increase our leadership in developing biotherapeutics for disorders of tissue growth and repair, with a major focus on angiogenic disorders, and to move at least three new projects into late-stage research or developmental research and three or more new projects into clinical development by 2010; and
achieve average annual non-GAAP EPS growth rates through 2010 sufficient to be considered a growth company.
Achieving these goals depends on our ability to make and capitalize on advances in basic research, to rapidly complete clinical development while designing high-quality trials, to shape the markets for our products, to increase our manufacturing capabilities and to maintain our unique corporate culture.
· | To bring at least 20 new molecules into clinical development. |
· | To bring at least 15 major new products or indications onto the market. |
· | To become the number one U.S. oncology company in sales. |
· | To achieve compound annual non-GAAP earnings per share(1) growth of 25 percent. |
· | To achieve cumulative free cash flow(2) of $12 billion. |
___________
| Non-GAAP financial goals are included because our management uses non-GAAP financial measures to monitor and evaluate Genentech’s operating results and trends on an ongoing basis and to facilitate internal comparison to historical operating results. Excluding the effects of charges related to employee stock-based compensation expense, Roche’s redemption of our special common stock, litigation, and changes in accounting principles from our operating results provides users of our financial statements an important insight into our operating results and related trends that affect our business. In addition, our management uses non-GAAP financial information and measures internally for operating, budgeting and financial planning purposes, including the establishment of corporate, functional, departmental and individual performance goals. |
(1) | The non-GAAP EPS goal for 2006 through 2010 excludes the after-tax effect of the following items: employee stock-based compensation expense associated with our adoption of FAS 123R, recurring charges related to the redemption of our special common stock by Roche, litigation-related special charges for accrued interest and associated bond costs on the City of Hope judgment and other potential special charges related to existing or future litigation or its resolution, and changes in accounting principles, all of which may be significant. GAAP EPS for 2006 through 2010 will include the items described above. |
(2) | Our free cash flow measure is defined as cash from ongoing operations less gross capital expenditures. Cash from ongoing operations is derived from the “net cash provided by operating activities” line in our consolidated statements of cash flows, but this number may be adjusted for items that would allow the measure to better reflect our operational performance. These adjustments include, for example, cash receipts or payments related to litigation settlements, investments in trading securities and other potential items, any of which may be significant. |
Economic and Industry-wide Factors
Our goals and objectives are
further challenged by economic and industry-wide factors that affect our business. Some of the most important factors are discussed below:
Successful development of biotherapeutics is highly difficult and uncertain. Our long-term business growth depends upon our ability to commercialize important new therapeutics to treat unmet medical needs such as cancer. Since the underlying biology of these diseases is not completely understood, it is very challenging to discover and develop safe and effective treatments, and the majority of potential new therapeutics fail to generate the safety and efficacy data required to obtain regulatory approval. In addition, there is tremendous competition in the diseases of interest to us. Our business requires significant investments in research and development (or "R&D") over many years, often for products that fail during the R&D process. In addition, after our products receive FDA approval, they remain subject to ongoing FDA regulation, including changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisement to physicians, or pr oduct recalls. We believe that our continued focus on excellent science, compelling biological mechanisms, and designing high quality clinical trials to address significant medical needs positions us well to deliver sustainable growth.
Intellectual property protection of our products is crucial to our business. Loss of effective intellectual property protection on one or more products could result in lost sales to competing products and negatively affect our sales, royalty revenues and operating results. We are often involved in disputes over contracts and intellectual property and we work to resolve these disputes in confidential negotiations or litigation. We expect legal challenges in this area to continue. We plan to continue to build upon and defend our intellectual property position.
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· | Successful development of biotherapeutics is highly difficult and uncertain. Our long-term business growth depends upon our ability to commercialize important new therapeutics to treat unmet medical needs such as cancer. Since the underlying biology of these diseases is not completely understood, it is very challenging to discover and develop safe and effective treatments, and the majority of potential new therapeutics fail to generate the safety and efficacy data required to obtain regulatory approval. In addition, we face tremendous competition in the diseases of interest to us. Our business requires significant investments in research and development (or “R&D”) over many years, often for products that fail during the R&D process. In addition, after our products receive FDA approval, they remain subject to ongoing FDA regulation, including changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisement to physicians, and/or product recalls. |
-18-
Manufacturing biotherapeutics is difficult and complex, and requires facilities specifically designed and validated to run biotechnology production processes where protein biotherapeutics are involved. The manufacture of a biotherapeutic requires proper formulation of the product involved, executing on and scaling the manufacturing process used for that product, obtaining regulatory approval to manufacture the product, and is subject to changes in regulatory requirements or standards that may require modifications to the involved manufacturing process or to a manufacturing process used by our contract-manufacturers (see below in "Difficulties or delays in product manufacturing or in obtaining materials from our suppliers could harm our business and/or negatively impact our financial performance" of "Forward-Looking Information and Cautionary Factors That May Affect Future Results").
The Medicare Modernization Act was enacted into law in December 2003. On November 3, 2004, the 2005 Physician Fee Schedule and Hospital Outpatient Prospective Payment System Final Rules were announced and were in-line with our expectations. As Centers for Medicare and Medicaid Services (or "CMS") is our single largest payer, the new rules represent an important area of focus in 2005. We will be monitoring the situation closely and, in 2005, we continue to anticipate minimal impact to our revenues. To date, we have not seen any detectable effects of the new rules on our product sales. On July 1, 2005, CMS released its Interim Final Rule (or "IFR") with comment on the Medicare Part B Competitive Acquisition Program (or "CAP"). The CAP option, required under the Medicare Modernization Act, will be offered to physicians providing services under Part B of Medicare, beginning January 1, 2006. Under the CAP, physicians could choose to either obtain drugs directly from qualified CAP vendors, or continue to purchase drugs directly and be reimbursed by the Medicare program at the Average Selling Price + 6% rate. Although final details of the program will not be made public until later this year, we anticipate that the impact of the program on Genentech will be minimal.
With respect to follow-on biologics, we believe that current technology cannot prove a follow-on biotechnology product to be safe and effective outside the New Drug Application and Biologics License Application process. We filed a Citizen Petition with the FDA in April 2004 requesting that the agency re-assess its approach to approvals of follow-on biologics and put processes in place to protect trade secrets and confidential commercial data and information from use and disclosure by others. The FDA initiated a public process to discuss the complex scientific issues surrounding follow-on biologics and we participated in the FDA Stakeholder meeting in September 2004. Following this meeting, the FDA and Drug Information Association held a scientific workshop in February 2005, which we hope will be followed by a similar public discussion of the critical legal issues involved with establishing an approval pathway for follow-on biologics.
Our ability to attract and retain highly qualified and talented people in all areas of the company, and our ability to maintain our unique culture, will be critical to our success over the long-term. In 2004 we experienced a 23% growth in the number of employees to approximately 7,600 employees and we have since grown to approximately 8,300 employees company-wide as of June 30, 2005. This significant growth in employees is challenging to manage and we are working diligently across the company to make sure that we successfully hire, train and integrate new employees into the Genentech culture and environment. Consistent with our desire to maintain and protect our culture, we have made a decision to continue with a broad based stock option program in 2005. We believe our broad-based stock option program is critical to attracting, retaining, and motivating our employees in the marketplace where we compete for talent, and we believe that employee ownership drives commitment to meeting our c orporate goals.
· | Intellectual property protection of our products is crucial to our business. Loss of effective intellectual property protection on one or more products could result in lost sales to competing products and may negatively affect our sales, royalty revenues and operating results. We are often involved in disputes over contracts and intellectual property and we work to resolve these disputes in confidential negotiations or litigation. We expect legal challenges in this area to continue. We plan to continue to build upon and defend our intellectual property position. |
· | Manufacturing biotherapeutics is difficult and complex, and requires facilities specifically designed and validated to run biotechnology production processes. The manufacture of a biotherapeutic requires developing and maintaining a process to reliably manufacture and formulate the product at an appropriate scale, obtaining regulatory approval to manufacture the product, and is subject to changes in regulatory requirements or standards that may require modifications to the manufacturing process or FDA action (see “Difficulties or delays in product manufacturing or in obtaining materials from our suppliers could harm our business and/or negatively affect our financial performance” of “Risk Factors” in Part II, Item 1A of this Form 10-Q). |
· | The Medicare Prescription Drug Improvement and Modernization Act (or “Medicare Act”) was enacted into law in December 2003 and on November 3, 2004, the 2005 Physician Fee Schedule and Hospital Outpatient Prospective Payment System Final Rules were announced. As Centers for Medicare and Medicaid Services (or “CMS”) is our single largest payer, the new rules continue to represent an important area of focus. To date, we have not seen any detectable effects of the new rules on our product sales, and we anticipate minimal effects on our revenues in 2006. On November 2, 2005, CMS released its Final Rule with comment on the Medicare Part B Competitive Acquisition Program (or “CAP”). The CAP option, which the CMS expects to begin in July 2006, required under the Medicare Act, will be available to physicians providing services under Part B of Medicare. Under the CAP, physicians could choose to either obtain drugs directly from qualified CAP vendors, or continue to purchase drugs directly and be reimbursed by CMS at the Average Selling Price + 6% rate. Although CMS is still finalizing details of the program, we anticipate that the impact of the program on our sales will be minimal. |
· | Our ability to attract and retain highly qualified and talented people in all areas of the company, and our ability to maintain our unique culture, will be critical to our success over the long-term. In the first quarter of 2006 we grew to over 10,000 employees. We are working diligently across the company to make sure that we successfully hire, train and integrate new employees into the Genentech culture and environment. |
We commercialize in the
U.S.United States (or “U.S.”) the biotechnology products listed below.
Oncology
Rituxan(rituximab) anti-CD20 antibody, which we commercialize with Biogen Idec,
Avastin (bevacizumab) is approved for the treatment of patients with relapsed or refractory, low-grade or follicular, CD20-positive, B-cell non-Hodgkin's lymphoma.- 19 -
Avastin(bevacizumab) is aan anti-VEGF humanized antibody that binds to vascular endothelial growth factor (or "VEGF") approved for use in combination with intravenous 5-fluorouracil-based5-fluorouracil based chemotherapy as a treatment for patients with first-line (or previously untreated) metastatic cancer of the colon or rectum.
Herceptin(trastuzumab) anti-HER2
Rituxan (rituximab) is an anti-CD20 antibody which we commercialize with Biogen Idec Inc. It is approved for the treatment of patients with relapsed or refractory, low-grade or follicular, CD20-positive, B-cell non-Hodgkin’s lymphoma, including retreatment and bulky disease, and on February 10, 2006, it was approved for use in first-line treatment of patients with diffuse large B-cell, CD20-positive, non-Hodgkin’s lymphoma (or “DLBCL”) in combination with CHOP (cyclophosphamide, doxorubicin, vincristine and prednisone) or other anthracycline-based chemotherapy regimens. On February 28, 2006 Rituxan was approved for use in combination with methotrexate for reducing signs and symptoms in adult patients with moderately-to-severely active rheumatoid arthritis (or “RA”) who have had an inadequate response to one or more tumor necrosis factor (or “TNF”) antagonist therapies.
Herceptin (trastuzumab) is a humanized anti-HER2 antibody approved for the treatment of certain patients with metastatic breast cancer. Herceptin is approved for use as a first-line therapy in combination with Taxol® (paclitaxel), a product made by Bristol-Myers Squibb Company,paclitaxel and as a
single agent in second- and third-line therapy
infor patients with metastatic breast cancer who have tumors that overexpress the
HER2human epidermal growth factor receptor 2 (or “HER2”) protein.
Tarceva(erlotinib HC1)
Tarceva (erlotinib), which we commercialize with OSI Pharmaceuticals, Inc. (or "OSI"), is a small molecule designed to block tumor cell growth by inhibiting thesmall-molecule tyrosine kinase activityinhibitor of the HER1/epidermal growth factor receptor (or "EGFR"“EGFR”) signaling pathway,pathway. Tarceva is approved for the treatment of patients with locally advanced or metastatic non-small cell lung cancer (or "NSCLC"“NSCLC”) after failure of at least one prior chemotherapy regimen.Specialty Biotherapeutics
Nutropin( It is also approved, in combination with gemcitabine chemotherapy, for the first-line treatment of patients with locally advanced, unresectable or metastatic pancreatic cancer.
Xolair (omalizumab) is a humanized anti-IgE antibody, which we commercialize with Novartis AG (or “Novartis”). Xolair is approved for the treatment of moderate-to-severe persistent allergic asthma in adults and adolescents 12 years and older.
Raptiva (efalizumab) is a humanized anti-CD11a antibody approved for the treatment of chronic moderate-to-severe plaque psoriasis in adults age 18 or older who are candidates for systemic therapy or phototherapy.
Nutropin (somatropin [rDNA origin] for injection) is aand Nutropin AQ are growth hormone products approved for the treatment of growth hormone deficiency in children and adults, growth failure associated with chronic renal insufficiency prior to kidney transplantation, short stature associated with Turner syndrome and long-term treatment of idiopathic short stature (or "ISS").Nutropin AQ(somatropin [rDNA origin] for injection) is a liquid formulation growth hormone approved for the same indications as Nutropin.
Activase(stature.
Activase (alteplase, recombinant) is a tissue plasminogen activator (or "t-PA"“t-PA”) approved for the treatment of acute myocardial infarction (heart attack), acute ischemic stroke (blood clots in the brain) within three hours of the onset of symptoms and acute massive pulmonary embolism (blood clots in the lungs).
TNKase (tenecteplase) is a modified form of t-PA approved for the treatment of acute myocardial infarction (heart attack).
Cathflo Activase(Activase (alteplase, recombinant) is a t-PA approved in adult and pediatric patients for the restoration of function to central venous access devices that have become occluded due to a blood clot.TNKase(tenecteplase) is a single-bolus thrombolytic agent approved for the treatment of acute myocardial infarction (heart attack).
Pulmozyme(
Pulmozyme (dornase alfa, recombinant) is an inhalation solution of recombinant human deoxyribonuclease (rhDNase) I, approved for the treatment of cystic fibrosis.Xolair(omalizumab) is a humanized anti-IgE antibody, which we commercialize with Novartis in the U.S., approved for the treatment of moderate-to-severe persistent asthma in adults and adolescents.
Raptiva(efalizumab) is a humanized anti-CD11a antibody approved for the treatment of chronic moderate-to-severe plaque psoriasis in adults age 18 or older who are candidates for systemic therapy or phototherapy.
We receive royalties from F. Hoffmann-La Roche (or
"Hoffmann-La Roche"“Hoffmann-La Roche”) on sales of:
Herceptin, Pulmozyme, and Avastin outside of the U.S.,
Rituxan outside of the U.S., excluding Japan, and
Nutropin products, Activase, Cathflo Activase and TNKase in Canada.
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· | Herceptin, Pulmozyme, and Avastin outside of the U.S., |
· | Rituxan outside of the U.S., excluding Japan, and |
· | Nutropin products, Activase and TNKase in Canada. |
The following information can be found on our website at http://www.gene.com or can be obtained free of charge by contacting our Investor Relations Department at (650) 225-1599 or by sending an e-mail message to investor.relations@gene.com:
our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission;
our policies related to corporate governance, including Genentech's Principles of Corporate Governance, Good Operating Principles (Genentech's code of ethics applying to Genentech's directors, officers and employees) as well as Genentech's Code of Ethics applying to our Chief Executive Officer, Chief Financial Officer and senior financial officials; and
the charter of the Audit Committee of our Board of Directors.
· | our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission; |
· | our policies related to corporate governance, including Genentech’s Principles of Corporate Governance, Good Operating Principles (Genentech’s code of ethics applying to Genentech’s directors, officers and employees) as well as Genentech’s Code of Ethics applying to our CEO, CFO and senior financial officials and; |
· | the charter of the Audit Committee of our Board of Directors. |
Critical Accounting Policies and the Use of Estimates
The accompanying discussion and analysis of our financial condition and results of operations are based upon our
condensed consolidated financial statementsCondensed Consolidated Financial Statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States (or
"GAAP"“GAAP”). The preparation of these
condensed consolidated financial statementsCondensed Consolidated Financial Statements requires
usmanagement to make estimates, assumptions and judgments that affect the reported amounts in our
condensed consolidated financial statementsCondensed Consolidated Financial Statements and accompanying notes. These estimates form the basis for making judgments about the carrying values of assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the
circumstances.circumstances, and we have established internal controls related to the preparation of these estimates. Actual
results and the timing of the results could differ materially from these estimates.
We believe the following policies to be
the most critical to
an understanding
of our financial condition,
and results of operations,
and our expectations for 2006 because
theythese policies require
usmanagement to make
significant estimates, assumptions and judgments about matters that are inherently uncertain.
We are currently, or have been, involved in certain legal proceedings as discussed in Note 3, "Leases and Contingencies,"4, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q. We assess the likelihood of any adverse judgments or outcomes tofor these legal matters as well as potential ranges of probable losses. As of June 30, 2005, we have accrued $651.0 millionIncluded in "litigation-related“litigation-related and other long-term liabilities"liabilities” in the accompanying condensed consolidated balance sheets,Condensed Consolidated Balance Sheet at March 31, 2006 is $689 million, which represents our estimate of the costs for the current resolution of these matters.The nature of these matters is highly uncertain and subject to change; as a result, the amount of our liability for certain of these matters could exceed or be less than the amount of our current estimates, depending on the final outcome of these matters. An outcome of such matters different than previously estimated could materially impacthave a material effect on our financial position or our results of operations in any one quarte r.Revenue Recognition
We recognize revenue from the sale of our products, royalties earned and contract arrangements. Our revenue arrangements with multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.
- 21 -
Product Sales Allowances
Revenues from product sales, when there is persuasive evidence that an arrangement exists, title passes,which are principally generated in the price is fixed and determinable, and collectibility is reasonably assured. AllowancesU.S., are establishedrecorded net of allowances for estimatedrebates, wholesaler chargebacks, prompt pay sales discounts, product returns, wholesaler incentives, and bad debts, all of which are established at the time of sale. In order to prepare our Condensed Consolidated Financial Statements, we are required to make estimates regarding the amounts earned or to be claimed on the related product sales.
Rebate reserves and
rebates.We recognize revenueaccruals represent our estimated obligations to wholesalers and third parties (clinics, hospitals and pharmacies), respectively. These reserves and accruals result from royaltiesperformance-based offers that are primarily based on licensees'attaining contractually specified sales volumes and growth. As a result, the calculation for these rebates requires an estimate of the customer’s buying patterns and the resulting applicable contractual rebate rate(s) to be earned over a contractual period. If our estimate of a customer’s buying patterns is incorrect, we may need to adjust our estimates in future periods. In the first quarter of 2006, the majority of these reserves and accruals relate to our non-oncology products.
To date, we have not recorded any adjustments to our estimates of product sales allowances that were material to our Condensed Consolidated Financial Statements. However, it is possible that we may need to adjust our estimates in future periods. As of March 31, 2006, our Condensed Consolidated Balance Sheet reflected product sales allowance reserves and accruals totaling approximately $134 million and for the three months ended March 31, 2006, our net
product sales were approximately $1,644 million.
Royalties
For substantially all of our
products or technologies. Royaltiesagreements with licensees, we estimate royalty revenue and royalty receivables in the periods these royalties are
recognized as earned,
in accordance with the contract terms when royalties from licensees can be reliably measured and collectibility is reasonably assured. Royalty estimates are made in advance of
amounts collected usingcollection. Our estimate of royalty revenue and receivables in those instances is based upon communication with some licensees, historical information and forecasted
sales trends.
Contract revenue generally includes upfront Differences between actual revenues and continuing licensing fees, manufacturing fees, milestone payments and reimbursements of development and post-marketing costs.
Nonrefundable upfront fees, including product opt-ins,estimated royalty revenues are adjusted for which no further performance obligations exist are recognized as revenue on the earlier of when payments are received or collection is assured.
Nonrefundable upfront licensing fees, including product opt-ins, and certain guaranteed, time-based payments that require continuing involvement in the formperiod in which they become known, typically the following quarter. Historically, such adjustments have not been material to our condensed consolidated financial condition or results of development, manufacturing or other commercialization efforts by us are recognized as revenue:
operations.
Income tax expense is based on
pretax financial accounting income
underbefore taxes and is computed using the liability method. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Significant estimates are required in determining our provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations. Various internal and external factors may have favorable or unfavorable effects on our future effective
income tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations,
changes in estimates of prior years’ items, past and future levels of R&D spending, and changes in overall levels of
pretax earnings.income before taxes.
Inventories consist of currently marketed products, products manufactured under contract,
and product candidates
awaiting regulatory approval, currently marketed products manufactured at facilities awaiting regulatory approval, which are capitalized based on
management'smanagement’s judgment of probable near term
commercialization.commercialization, and include employee stock-based compensation costs capitalized under FAS 123R. The valuation of inventory requires us to estimate
the value of inventory that may become obsolete
prior to use or
excess inventory.that may fail to be released. The determination of obsolete
or excess inventory requires us to estimate the future demands for our products, and in the case of pre-approval inventories, an estimate of the regulatory approval date for the product. We may be required to expense previously capitalized
inventory costs
related to pre-approval inventory upon a change in
suchour judgment, due to,
- 22 -
among other potential factors, a denial or delay of approval by the necessary regulatory bodies.bodies or new information that suggests that the inventory will not be saleable. In the event that a pre-approval product candidate receives regulatory approval, subsequent sales of previously reserved inventory willmay result in increased gross margins.
Employee Stock-Based Compensation—Adoption of FAS 123R
Beginning January 1, 2006, we account for employee stock-based compensation in accordance with FAS 123R. Under the provisions of FAS 123R, we estimate the fair value of our employee stock awards at the date of grant using the Black-Scholes option-pricing model, which requires the use of certain subjective assumptions. The most significant of these assumptions are our estimates of the expected volatility of the market price of our stock and the expected term of the award. Due to the redemption of our Special Common Stock in June 1999 (or “Redemption”) by Roche Holdings, Inc. (or “Roche”), there is limited historical information available to support our estimate of certain assumptions required to value our stock options. When establishing an estimate of the expected term of an award, we consider the vesting period for the award, our historical experience of employee stock option exercises (including forfeitures), the expected volatility, and a comparison to relevant peer group data. As required under the accounting rules, we review our valuation assumptions at each grant date and, as a result, we are likely to change our valuation assumptions used to value employee stock-based awards granted in future periods.
Further, FAS 123R requires that employee stock-based compensation costs be recognized over the requisite service period, or the vesting period, in a manner similar to all other forms of compensation paid to employees. Accordingly, in the first quarter of 2006, we recognized employee stock-based compensation as part of our operating expenses with an allocation of $33 million to R&D, $41 million to marketing, general and administrative (or “MG&A”), and we recognized a related tax benefit of $27 million. In addition, we capitalized $16 million of
employee stock-based compensation costs in inventory as a cost of production during the first quarter of 2006. We adopted FAS 123R on a modified prospective basis. Substantially all of the products sold in the first quarter of 2006 were manufactured in previous periods when we did not include employee stock-based compensation expense in our production costs; therefore, we did not record any employee stock-based compensation expense as a component of cost of sales in the first quarter of 2006. In future periods, when product manufactured after the adoption of FAS 123R is sold or written off, or reserves are required for obsolescence or lack of demand, we will recognize employee stock-based compensation expense in cost of sales. The allocation of employee stock-based compensation costs to each operating expense line and to inventory are estimated based on specific employee headcount information at each grant date and revised, if necessary, in future periods if actual employee headcount information differs materially from those estimates. As a result, the amount of employee stock-based compensation costs we record in future periods in each operating expense line and capitalize in inventory may differ significantly from what we have recorded in the current period. As of March 31, 2006, total compensation cost related to nonvested stock options not yet recognized was $734 million, which is expected to be allocated to expense and production costs over a weighted-average period of 27 months.
There was no stock-based compensation expense related to employee stock options and employee stock purchases recognized under FAS 123R during the three months ended March 31, 2005.
Results of Operations
(In millions) | | Three Months Ended June 30, | | | | | Six Months Ended June 30, | | | |
| | | | | | | | | | | | | | | | | | |
| | 2005 | | 2004 | | % Change* | | 2005 | | 2004 | | % Change* |
| | | | | | | | | | | | | | | | | | |
Product sales | | $ | 1,274.1 | | $ | 913.4 | | 39 | % | | $ | 2,460.1 | | $ | 1,677.1 | | 47 | % |
Royalties | | | 200.3 | | | 151.9 | | 32 | | | | 432.3 | | | 305.9 | | 41 | |
Contract revenue | | | 52.4 | | | 62.9 | | (17) | | | | 96.1 | | | 120.2 | | (20) | |
| | | | | | | | | | | | | | | | | | |
Total operating revenues | | | 1,526.8 | | | 1,128.2 | | 35 | | | | 2,988.5 | | | 2,103.2 | | 42 | |
| | | | | | | | | | | | | | | | | | |
Cost of sales | | | 269.5 | | | 186.7 | | 44 | | | | 520.5 | | | 301.2 | | 73 | |
Research and development | | | 278.1 | | | 212.9 | | 31 | | | | 521.4 | | | 403.2 | | 29 | |
Marketing, general and administrative | | | 356.6 | | | 276.7 | | 29 | | | | 671.8 | | | 523.9 | | 28 | |
Collaboration profit sharing | | | 198.8 | | | 145.2 | | 37 | | | | 375.1 | | | 271.7 | | 38 | |
Recurring charges related to redemption | | | 34.5 | | | 38.2 | | (10) | | | | 69.0 | | | 76.4 | | (10) | |
Special items: litigation-related | | | 19.5 | | | 13.5 | | 44 | | | | 30.8 | | | 26.8 | | 15 | |
| | | | | | | | | | | | | | | | | | |
Total costs and expenses | | | 1,157.0 | | | 873.2 | | 33 | | | | 2,188.6 | | | 1,603.2 | | 37 | |
| | | | | | | | | | | | | | | | | | |
Operating margin | | | 369.8 | | | 255.0 | | 45 | | | | 799.9 | | | 500.0 | | 60 | |
Other income, net | | | 31.5 | | | 15.4 | | 105 | | | | 47.9 | | | 37.7 | | 27 | |
| | | | | | | | | | | | | | | | | | |
Income before taxes | | | 401.3 | | | 270.4 | | 48 | | | | 847.8 | | | 537.7 | | 58 | |
Income tax provision | | | 105.1 | | | 99.6 | | 6 | | | | 267.5 | | | 190.3 | | 41 | |
| | | | | | | | | | | | | | | | | | |
Net income | | $ | 296.2 | | $ | 170.8 | | 73 | | | $ | 580.3 | | $ | 347.4 | | 67 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
Operating margin as a % of operating revenues | | | 24 | % | | 23 | % | | | | | 27 | % | | 24 | % | | |
COS as a % of product sales | | | 21 | | | 20 | | | | | | 21 | | | 18 | | | |
R&D as a % of operating revenues | | | 18 | | | 19 | | | | | | 17 | | | 19 | | | |
MG&A as a % of operating revenues | | | 23 | | | 25 | | | | | | 22 | | | 25 | | | |
NI as a % of operating revenues | | | 19 | | | 15 | | | | | | 19 | | | 17 | | | |
| | Three Months Ended March 31, | | | |
| | 2006 | | 2005 | | % Change | |
Product sales | | $ | 1,644 | | $ | 1,186 | | | 39 | % |
Royalties | | | 286 | | | 232 | | | 23 | |
Contract revenue | | | 56 | | | 44 | | | 27 | |
Total operating revenues | | | 1,986 | | | 1,462 | | | 36 | |
| | | | | | | | | | |
Cost of sales | | | 262 | | | 256 | | | 2 | |
Research and development | | | 374 | | | 243 | | | 54 | |
Marketing, general and administrative | | | 441 | | | 310 | | | 42 | |
Collaboration profit sharing | | | 226 | | | 176 | | | 28 | |
Recurring charges related to redemption | | | 26 | | | 35 | | | (26 | ) |
Special items: litigation-related | | | 13 | | | 11 | | | 18 | |
Total costs and expenses | | | 1,342 | | | 1,031 | | | 30 | |
| | | | | | | | | | |
Operating income | | | 644 | | | 431 | | | 49 | |
| | | | | | | | | | |
Other income (expense): | | | | | | | | | | |
Interest and other income, net | | | 53 | | | 18 | | | 194 | |
Interest expense | | | (19 | ) | | (3 | ) | | 533 | |
Total other income, net | | | 34 | | | 15 | | | 127 | |
| | | | | | | | | | |
Income before taxes | | | 678 | | | 446 | | | 52 | |
Income tax provision | | | 257 | | | 162 | | | 59 | |
Net income | | $ | 421 | | $ | 284 | | | 48 | |
| | | | | | | | | | |
Earnings per share: | | | | | | | | | | |
Basic | | $ | 0.40 | | $ | 0.27 | | | 48 | |
Diluted | | $ | 0.39 | | $ | 0.27 | | | 44 | |
| | | | | | | | | | |
Pretax operating margin | | | 32 | % | | 29 | % | | | |
Cost of sales as a % of product sales | | | 16 | | | 22 | | | | |
Research and development as a % of operating revenues | | | 19 | | | 17 | | | | |
Marketing, general and administrative as a % of operating revenues | | | 22 | | | 21 | | | | |
Net income as a % of operating revenues | | | 21 | | | 19 | | | | |
___________
*
| Percentages in this table and throughout ourmanagement’s discussion and analysis of financial condition and results of operations may reflect rounding adjustments. |
Total operating revenues increased
35% in the second quarter of 2005 and 42%36% in the first
six monthsquarter of
20052006 from the comparable
periodsperiod in
2004. This increase was2005. These increases were primarily due to higher product sales and royalty
income. This increase isincome, and are further discussed below.
- 23 -
Total Product Sales
(In millions) | | Three Months Ended June 30, | | | | | | Six Months Ended June 30, | | | |
| | | | | | | | | | | | | | | | | | | |
Product Sales | | 2005 | | 2004 | | % Change | | | 2005 | | 2004 | | % Change |
| | | | | | | | | | | | | | | | | | | |
Net U.S. Product Sales | | | | | | | | | | | | | | | | | | | |
Rituxan | | $ | 450.3 | | $ | 390.0 | | 15 | % | | | $ | 890.8 | | $ | 751.8 | | 18 | % |
Avastin | | | 245.7 | | | 133.0 | | 85 | | | | | 448.6 | | | 171.1 | | 162 | |
Herceptin | | | 152.4 | | | 118.0 | | 29 | | | | | 282.0 | | | 226.7 | | 24 | |
Tarceva | | | 70.2 | | | - | | - | | | | | 117.8 | | | - | | - | |
Nutropin products | | | 97.1 | | | 88.0 | | 10 | | | | | 187.0 | | | 172.0 | | 9 | |
Thrombolytics | | | 51.6 | | | 50.0 | | 3 | | | | | 102.2 | | | 94.3 | | 8 | |
Pulmozyme | | | 46.9 | | | 36.5 | | 28 | | | | | 90.9 | | | 74.5 | | 22 | |
Xolair | | | 80.4 | | | 43.6 | | 84 | | | | | 145.7 | | | 73.4 | | 99 | |
Raptiva | | | 21.3 | | | 13.4 | | 59 | | | | | 37.9 | | | 19.7 | | 92 | |
| | | | | | | | | | | | | | | | | | | |
Total U.S. product sales | | | 1,215.9 | | | 872.5 | | 39 | | | | | 2,302.9 | | | 1,583.5 | | 45 | |
| | | | | | | | | | | | | | | | | | | |
Net product sales to collaborators | | | 58.2 | | | 40.9 | | 42 | | | | | 157.2 | | | 93.6 | | 68 | |
| | | | | | | | | | | | | | | | | | | |
Total product sales | | $ | 1,274.1 | | $ | 913.4 | | 39 | | | | $ | 2,460.1 | | $ | 1,677.1 | | 47 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
| | 2006 | | 2005 | | % Change | |
Net U.S. Product Sales | | | | | | | |
Rituxan | | $ | 477 | | $ | 440 | | | 8 | % |
Avastin | | | 398 | | | 203 | | | 96 | |
Herceptin | | | 290 | | | 130 | | | 123 | |
Tarceva | | | 93 | | | 48 | | | 94 | |
Xolair | | | 95 | | | 65 | | | 46 | |
Raptiva | | | 21 | | | 17 | | | 24 | |
Nutropin products | | | 87 | | | 90 | | | (3 | ) |
Thrombolytics | | | 59 | | | 50 | | | 18 | |
Pulmozyme | | | 49 | | | 44 | | | 11 | |
Total U.S. product sales | | $ | 1,569 | | $ | 1,087 | | | 44 | |
| | | | | | | | | | |
Net product sales to collaborators | | | 75 | | | 99 | | | (24 | ) |
Total product sales | | $ | 1,644 | | $ | 1,186 | | | 39 | |
Total product sales increased 39% to $1,274.1 million in the second quarter and 47% to $2,460.1 $1,644million in the first six monthsquarter of 20052006 from the comparable periodsperiod in 2004. Net2005. Total U.S. product sales increased 39%44% to $1,215.9 million in the second quarter and 45% to $2,302.9 $1,569million in the first six monthsquarter of 20052006 from the comparable periodsperiod in 2004. These increases2005. The increase in net U.S. product sales werewas due to higher sales across allmost products, in particular higher sales of our new product, Tarceva, launched in November 2004, and higher sales of Avastin, Rituxan and Xolair. Net U.S. oncology sales accounted for 76% of net U.S. product sales in the second quarter of 2005 compared to 73% in the second quarter of 2004, and 76% in the first six months of 2005 compared to 73% in the first six months of 2004.products. Increased U.S. sales volume including new product shipments, accounted for 90%88%, or $308.1 $429million, of the increase in U.S. net product sales in the secondfirst quarter of 2005,2006, and 91%92%, or $644.3$346 million, of the increase in the first six monthsquarter of 2005. Changes in net U.S. sales prices across the portfolio accounted for substantially allmost of the remainder of the increasesremaining increase in net U.S. net product sales in the secondfirst quarter of 2005 and in the first six months of 2005.Rituxan
2006.
Avastin
Net U.S. sales of RituxanAvastin increased 15%96% to $450.3million in the second quarter and 18% to $890.8$398 million in the first six monthsquarter of 20052006 from the comparable periodsperiod in 2004.2005. The increase in sales was primarily a result of increased use of Avastin in first-line metastatic colorectal cancer (or “mCRC”) in combination with 5FU-based chemotherapies (our approved indication) and in first-line non small cell lung cancer (or “NSCLC”) (an unapproved use). In first-line mCRC patients, we estimate that Avastin penetration was over 70% during the first quarter of 2006 compared to penetration of 61% during the first quarter of 2005. Duration of treatment among patients in the first-line mCRC setting who completed Avastin therapy increased modestly relative to the first quarter of 2005, but was comparable to the fourth quarter of 2005. Due to competing products entering the market in the first quarter of 2006, we have seen a slight decline in the adoption of Avastin in renal cell carcinoma, an unapproved use of Avastin. Net U.S. sales in the first six monthsquarter of 2005 included $9.62006 include a $3 million reimbursement for a reorder to replace a shipment that was destroyed while in transit to a wholesaler in the first quarter of 2005. There were no price increases in the first quarter of 2006 or in 2005.
While there has been increased uptake in the first-line mCRC setting, opportunities remain to continue to appropriately identify eligible patients. We also anticipate growth in 2006 from use in potential new (but currently unapproved) indications, including relapsed mCRC, metastatic first-line NSCLC and metastatic first-line breast cancers.
In December 2005, we submitted an sBLA to the FDA for Avastin in relapsed mCRC, and priority review has been granted with an action date of June 20, 2006.
On April 11, 2006, we submitted an sBLA to the FDA for Avastin in combination with platinum-based chemotherapy for first-line treatment of advanced, non-squamous, NSCLC.
Rituxan
Net U.S. sales of Rituxan increased 8% to $477million in the first quarter of 2006 from the comparable period in 2005. Net U.S. sales in the first quarter of 2005 included $10 million for a reorder to replace a shipment that was destroyed while in transit to a wholesaler. The sales growth resulted from increased use of Rituxan in NHL and chronic lymphocytic leukemia (or “CLL”), including areas of unapproved use. We estimate that Rituxan’s overall adoption rate in combined markets of NHL and CLL, including areas of unapproved use, was 82% at the end of the first quarter of 2006 compared to 77% at the end of the first quarter of 2005. Also contributing to the increase in product sales were price increases that were effective on July 6, 2005 and October 5, 2005. U.S. Rituxan sales in the first quarter of 2006 decreased 1% from $484 million in the fourth quarter of 2005 and the overall adoption rate remained flat at 82% as compared to the fourth quarter of 2005. Rituxan for the treatment of adult patients with moderately-to-severely active RA was launched in the first quarter of 2006. There are significant hurdles to reliably measuring the portion of Rituxan sales attributable to RA, and we do not expect to be able to precisely attribute revenues to the RA indication (or any other non-oncology indication) in the foreseeable future.
On March 30, 2006, we and Biogen Idec submitted an sBLA to the FDA for the use of Rituxan as first-line treatment of previously-untreated patients with low-grade or follicular, CD20-positive, B-cell non-Hodgkin’s lymphoma in combination with CVP (cyclophosphamide, vincristine, prednisone) or CHOP chemotherapy or following CVP chemotherapy in those patients who achieved a response of stable disease or better.
Herceptin
Net U.S. sales of Herceptin increased 123% to $290 million in the first quarter of 2006 from the comparable period in 2005. The sales growth resulted from increased treatment of first-line HER2-positive metastatic breast cancer and increased cumulative treatment duration relative to the comparable period in 2005, as well as increased use of Herceptin in adjuvant breast cancer (an unapproved use). We believe that continued Herceptin sales growth will primarily occur in the adjuvant setting.Also contributing to the increase in product sales, to a lesser extent, was as a price increase effective on February 24, 2005. Net U.S. sales in the first quarter of 2006 include a $2 million reimbursement for a shipment that was destroyed while in transit to a wholesaler in the first quarter of 2005.
On February 15, 2006, we submitted an sBLA with the FDA for use of Herceptin to treat early-stage HER2-positive breast cancer, and priority review was granted with an action date of August 17, 2006.
Tarceva
Net U.S. sales of Tarceva increased 94% to $93 million in the first quarter of 2006 from $48 million in the first quarter of 2005, driven by growth in penetration in second-line NSCLC and first-line pancreatic cancer. In the first quarter of 2006, we estimate that Tarceva’s penetration averaged 34% in second-line NSCLC and 40% in first-line pancreatic cancer. Also affecting our product sales were price increases that were effective on April 5, 2005 and November 9, 2005. Future sales growth in NSCLC will depend on further gains in penetration against chemotherapy within second-line NSCLC.
Xolair
Net U.S. sales of Xolair increased 46% to $95 million in the first quarter of 2006 from the comparable period in 2005. The sales growth was primarily driven by increased sales volumes resulting from greater adoption in the non-Hodgkin's lymphoma (or "NHL") and chronic lymphocytic leukemia (or "CLL") markets, specifically front line indolent NHL, front line CLL, and indolent maintenance, which are all unapproved uses. With respect to indolent maintenance, we are working with the FDA toward a nomenclature that the FDA feels better describes this approach to treating patients with Rituxan.Also contributing to thean increase in the second quarterour patient and first six months of 2005 over the co mparable periods in 2004,prescriber base and, to a lesser extent, was a price increase that was effective on September 9, 2004.July 21, 2005.
RaptivaIn the recently published 2005 Centers for Medicare and Medicaid Services Final Rules for Medicare Reimbursement, there is minimal change in the overall reimbursement for Rituxan in 2005 when compared to that in 2004. To date, we have not seen any detectable effects of the new rules on our product sales, but we are closely monitoring the situation. We anticipate that this change will have a limited impact on Rituxan sales in 2005.
While adoption in the main hematological uses of Rituxan may be approaching peak levels, we believe there may be continued growth in the use of Rituxan in the maintenance setting (an unapproved use) in treating NHL. We are in
- 24 -
discussions with the FDA on the filing strategy for this indication. Opportunities for long-term Rituxan sales growth lie in other potential new indications, particularly in immunologic diseases such as rheumatoid arthritis.
On April 5, 2005, we, Biogen Idec and Hoffmann-La Roche announced that a Phase III clinical study of Rituxan met its primary endpoint of a greater proportion of Rituxan-treated patients achieving an American College of Rheumatology 20 response at week 24, compared to those patients receiving a placebo. The study included patients with active rheumatoid arthritis who have had an inadequate response or were intolerant to prior treatment with one or more anti-TNF therapies.
Avastin
Net U.S. sales of
AvastinRaptiva increased
85%24% to
$245.7$21 million
in the second quarter and 162% to $448.6 million in the first six months of 2005 from the comparable periods in 2004, mainly driven by increased use in colorectal cancer, which represents approximately 90% of current Avastin use. In both the first-line (our approved indication) and relapsed/refractory (an unapproved indication) settings, Avastin is being combined with a wide range of 5FU-based chemotherapies. While there has been rapid uptake in the colorectal market, there remains potential for increased sales in this indication driven mainly by increased duration of therapy. We also anticipate longer-term growth to be driven by use in potential new indications, including non-small-cell lung and breast cancers. Our market research conducted after the annual meeting of the American Society of Clinical Oncology (or "ASCO") in May 2005, indicates that approximately 10% of patients receiving Avastin in the second quarter of 2005 ar e outside of metastatic colorectal cancer, compared to approximately 5% in the first quarter of
2005. Adoption has been seen across several tumor types, particularly in metastatic renal cell carcinoma and metastatic NSCLC, which are unapproved uses.On January 28, 2005, CMS published its final National Coverage Decision which had a positive outcome for Avastin. Specifically, the final decision provides Medicare coverage of drugs used in nine specified clinical trials, seven of which include Avastin. At present, all Medicare carriers and all of our targeted commercial payers are covering Avastin and reimbursement has proceeded as expected.
On March 14, 2005, we and Roche announced that an interim analysis of a Phase III study of Avastin plus paclitaxel and carboplatin chemotherapies in first-line non-squamous, NSCLC met its primary efficacy endpoint of improving overall survival, or a reduction in the risk of death, compared to chemotherapy alone.
On April 14, 2005, we and Roche announced that an interim analysis of a Phase III study of Avastin plus paclitaxel chemotherapy in first-line metastatic breast cancer met its primary efficacy endpoint of showing a statistically significant improvement in progression-free survival, compared to chemotherapy alone.
Herceptin
Net U.S. sales of Herceptin increased 29% to $152.4 million in the second quarter and 24% to $282.0 million in the first six months of 20052006 from the comparable periodsperiod in 2004. This growth was driven by multiple factors including increased first-line penetration and longer treatment duration for metastatic breast cancer. We also have anecdotal evidence of increased use in2005. Contributing to the second quarter of 2005 in the adjuvant setting, which is an unapproved use. Also contributing to our increase in the first six months of 2005 and our future sales growth was a price increase that was effective on February 22, 2005. We currently believe there will be limited impact on Herceptin's usage under the new Medicare Act. Additionally, we believe that the opportunity for long-term Herceptin sales growth will be in the adjuvant setting, an unapproved use.
On April 25, 2005, we announced that two Phase III trials of Herceptin were stopped early after a preliminary joint interim analysis in early-stage HER2 positive breast cancer demonstrated an improvement in the primary endpoint of disease-free survival and in the secondary endpoint of overall survival.
Tarceva
Net U.S. sales of Tarceva were $70.2 million in the second quarter and $117.8 million in the first six months of
- 25 -
2005, as compared to $13.3 million in the fourth quarter of 2004. Tarceva was approved by the FDA on November 18, 2004. The increase in net U.S. product sales was driven primarily by rapid growth in patient market share in second-line and third-line NSCLC. Tarceva's share of the oral EGFR market continues to increase. New patient share reached 95 percent in the second quarter of 2005, while total patient share reached 76 percent for the same period. In light of the share levels already achieved and the recent changes to the labeling for Iressa™ (gefitinib), a competing product, we expectwere price increases that Tarceva's total prescription share of the oral EGFR class will near 100 percent over time. Future sales growth in NSCLC will therefore be driven by gains in penetration within second-line and third-line NSCLC against chemotherapy.Also impacting our product sales was a price increase that waswere effective on April 5,21, 2005 and November 17, 2005.
In April 2005, OSI submitted a supplemental New Drug Application (or "sNDA") with the FDA for use of Tarceva plus gemcitabine chemotherapy for the treatment of advanced pancreatic cancer in patients who have not received any previous treatment. OSI received notification from the FDA that Tarceva was granted priority review and we anticipate FDA action by November 2005.
Combined net U.S. sales of our Nutropin products
increased 10%decreased 3% to
$97.1 million in the second quarter and 9% to $187.0$87 million in the first
six monthsquarter of
20052006 from the comparable
periodsperiod in
2004, primarily as2005. Nutropin sales have decreased due to declining market share of new patients and loss of managed care product placement due to price discounting. The decrease in sales volume was partially offset by a
result of price
increases.On June 28, 2005, the FDA approved Nutropin and Nutropin AQ for the treatment of the long-term treatment of ISS, also called non-growth hormone-deficient short stature.
increase that was effective on March 3, 2005.
Combined net U.S. sales of our three thrombolytics products, Activase, Cathflo Activase, and TNKase, increased
3%18% to
$51.6 million in the second quarter and 8% to $102.2$59 million in the first
six monthsquarter of
20052006 from the comparable
periodsperiod in
2004.2005. The
increases were primarily driven byincrease was due to growth in
ourCathflo Activase sales in the catheter clearance
market and
increased Activase sales in the acute ischemic stroke
markets, as well asmarket. Also contributing to the increase in product sales were price
increases. Sales ofincreases effective on January 11, 2005. Aggressive price discounting by competitors affected our
thrombolytic products used to treat acute myocardial infarction
continue to be impacted by the adoption by physicians of mechanical reperfusion strategies; however, the declinebusiness in
the use of thrombolytics in the acute myocardial infarction market has been offset by growth in our other markets. Our sales in the first six months of 2005 and 2004 were impacted by continued competition from Retavase® (reteplase), a competing product, and its aggressive price discounting.some hospitals.
Net U.S. sales of Pulmozyme increased 28%11% to $46.9 million in the second quarter and 22% to $90.9$49 million in the first six monthsquarter of 20052006 from the comparable periodsperiod in 2004.2005. The increasesincrease primarily reflect an increasedreflects a price increase effective on April 26, 2005 and, to a lesser extent, a greater focus on aggressive treatment of cystic fibrosis early in the course of the disease anddisease.
Product Distribution—Changes in Commercial Terms
We recently renegotiated our distribution agreements with a
price increasenumber of our major wholesalers which will result in
April 26, 2005.Xolair
Net U.S. salesa number of Xolair increased 84% to $80.4millionchanges in commercial terms effective July 1, 2006, most notably resulting in the second quarterreduction of certain allowances provided to the wholesalers on certain products. Further, our commercial shipping terms with all our domestic customers and 99% to $145.7 million in the first six monthsresulting point at which we recognize products sales revenue for all of 2005our products will change from the comparable periods in 2004. This overall growth was driven by an increase of our patient and prescriber base.
Raptiva
Net U.S. sales of Raptiva increased 59% to $21.3million intime at which we ship the second quarter and 92% to $37.9 million in the first six months of 2005 from the comparable periods in 2004. Contributingproduct to the increase in product sales wastime at which our products arrives at a price increase that was effective on April 21, 2005.
- 26 -
designated receiving location. We do not expect the 2006 annual net effect of these changes to be material to our results of operations.
Product sales to collaborators, the majority of which were
infor non-U.S. markets,
were $58.2decreased 24% to $75 million
in the first quarter of 2006 from the comparable period in 2005. The decrease primarily reflects the discontinuation of our Enbrel® sales to Amgen due to the cancellation of our manufacturing obligation in the second quarter
and $157.2 millionof 2005. This decrease was partially offset by an increase in
the first six months of 2005, compared with $40.9 million and $93.6 million for the comparable periods in 2004, respectively. The increases were primarily due to sales of product manufactured under a contract with a third party and sales of Avastin to Hoffman-La Roche.
For the full year
2005,2006, given Roche’s higher supply needs, we expect sales to collaborators to increase by approximately
50% relative to sales of $197.730% over the $326 million in
2004.2005.
Royalty revenues increased 32%23% to $200.3 million in the second quarter and 41% to $432.3$286 million in the first six monthsquarter of 20052006 from the comparable periodsperiod in 2004.2005. The increases wereincrease was due to higher sales by Hoffmann-La Roche primarily onof our Herceptin, Avastin and Rituxan products, a new license arrangement with ImClone under which we receiveproducts. Of the overall royalties on sales of ERBITUX®, and to higher sales by various other licensees on other products. The increase in the first six months included a one-time payment to usreceived, royalties from Hoffmann-La Roche represented approximately 58% in the first quarter of 2005, relating to ERBITUX® sales2006. Royalties from the period between launch of the product last year and the signing of the agreement in January 2005.other licensees include royalty revenue on our patents including our Cabilly patents noted below. For the full year 2005,2006, we expect royalties to increase by approximately 35%30% compared to $641.1$935 million in 2004.2005 based on higher sales forecasts from our licensees, in particular Roche.
We have confidential licensing agreements with a number of companies on U.S. Patent No. 6,331,415 and No. 4,816,567 (the “Cabilly patents”), under which we receive royalty revenue on sales of products that are covered by one or more of the Cabilly patents. The ‘567 patent expired in March 2006, while the ‘415 patent expires in December 2018. The licensed products for which we receive the most significant Cabilly royalties are Humira®, Remicade®, Synagis® and ERBITUX®. Cabilly royalties impact three lines on our Condensed Consolidated Statement of Income: (i) We record gross royalties we receive from Cabilly patent licensees as royalty revenue;
(ii) On royalties we receive from Cabilly licensees, we in turn pay City of Hope National Medical Center (or “COH”) a percentage of our royalty income and these payments to COH are recorded with our MG&A expenses as royalty expense; (iii) We pay royalty expenses directly to COH on sales of our products that are covered by the Cabilly patents and these payments to COH are recorded in cost of sales (or “COS”). The overall net after-tax contribution from revenues and expenses related to the Cabilly patents was approximately $19 million in the first quarter of 2006, or approximately $0.02 per diluted share. We expect our full year 2006 Cabilly related net income after taxes to be approximately $0.06 per diluted share. See
"Related Party Transactions" belowalso Note 4, “Contingencies” in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for
morefurther information on
royalties from Hoffmann-La Roche.our Cabilly patent reexamination.
Cash flows from royalty income include revenues denominated in foreign currencies. We currently purchase simple foreign currency put option contracts (or
"options"“options”) and forwards to hedge these foreign
royaltycurrency cash flows. The terms of these options and forwards are generally one to five years. See also Note 1,
"Summary“Summary of Significant Accounting
Policies -- Policies—Derivative Financial
Instruments"Instruments” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.
Contract revenues
decreased 17%increased 27% to
$52.4 million in the second quarter and 20% to $96.1$56 million in the first
six monthsquarter of
20052006 from the comparable
periodsperiod in
2004.2005. The
decreases wereincrease was primarily due to
lowerhigher contract revenues from
Hoffman-La Roche and our
other collaborators,
including Hoffmann-La Roche.driven by higher reimbursements related to R&D development efforts on Avastin, Rituxan and second generation anti-CD20. See
"Related“Related Party
Transactions"Transactions” below for more information on contract revenue from Hoffmann-La Roche.
Contract revenues vary each quarter and are dependent on a number of factors, including the timing and level of reimbursements from ongoing development efforts, milestones and opt-in payments received, and new contract arrangements. For the full year
2005,2006, we expect contract revenues to
decrease by approximately 15%be relatively flat as compared to
$231.2$210 million in
2004.2005.
Cost of SalesCost of sales (or "COS") as a percentage of product sales were 21% in the second quarter of 2005 and 20% in the second quarter of 2004.
COS as a percentage of product sales
were 21% forwas 16% in the first
six monthsquarter of
2005 and 18% for the same period in 2004. These increases were primarily driven by: (i) one-time charges of $41.0 million2006 compared to 22% in the
secondfirst quarter of
2005, representing payments2005. This decrease is primarily due to the discontinuation of our lower margin Enbrel® sales to Amgen
Inc. and
another collaborator to cancel and amend certain future manufacturing obligations, and (ii) higher production costs and inventory reserves. These increases were partially offset by higher sales volume of our higher margin products (primarily
Avastin and Rituxanoncology products)
, prior year charges of $18.8 million related to Nutropin Depot inventory and our decision to discontinue its commercialization, and a provision of $21.3 million related to filling failures for other products. Also contributing to the increase for the six month period, as compared to the prior year, was the impact of lower costs in the first quarter of 2004 related to sales of previously reserved pre-launch products and lower production costs due to manufacturing efficiencies primarily related to Herceptin and Rituxan products..
For the full year
2005,2006, we expect COS to be approximately
19%16% of net product sales,
up fromcompared to 18% in
2004.2005. We
- 27 -
expect continued quarter-to-quarter variability based on product volume and mix changes, acknowledging thatand there is always potential for an increase in COS if we have unforeseen manufacturing, contract manufacturing, or inventory related issues.
R&D expenses increased
31%54% to
$278.1 million in the second quarter and 29% to $521.4$374 million in the first
six monthsquarter of
2005 from2006 over the comparable
periodsperiod in
2004. These increases2005. The higher level of expenses reflect increased activity across our entire product portfolio, including
increased spending on late-stage clinical
development oftrials (notably Avastin and Rituxan Immunology) and early stage projects, higher research expenses due to increased headcount and headcount related expenses and higher clinical manufacturing expenses at our
Lucentis, Rituxan Immunology, Tarceva and Avastin products, ongoing development of various other pipeline products and an increase in new early-stage projects.Oceanside manufacturing facility. Also contributing to the
increasesincrease were post-marketing studies
foron new and existing indications
onfor Avastin, Rituxan and
Tarceva and increased in-licensing activity.Tarceva. In addition, R&D
as a percentage of revenues was 18% in the second quarter and 17% inexpenses for the first
six monthsquarter of
2005 as compared to 19% in the comparable periods2006 included $33 million of
2004, primarily due to higher revenues.We expect R&D absolute dollar expenses to continue to rise in the second half of 2005 due to continued growth in headcount and outside services to support increased activity in our late-stage clinical trials including the preparation of 9 potential regulatory filings, higher clinical production costs, increased activity on early-stage research projects, and higher expensesemployee stock-based compensation expense related to in-licensing. For the full year 2005, we expect FAS 123R.
R&D as a percentage of operating revenues
was 19% in the first quarter of 2006 as compared to
be approximately 20%.17% in the first quarter of 2005. We expect R&D absolute dollar spending in 2006 to continue to increase over 2005 levels as we continue to invest in our late stage pipeline and continue to add new programs in the early stage pipeline.
The major components of R&D expenses were as follows(in millions): | | Three Months Ended June 30, | | | | | | Six Months Ended June 30, | | | |
| | | | | | | | | | | | | | | | | | | |
Research and Development | | 2005 | | 2004 | | % Change | | | 2005 | | 2004 | | % Change |
| | | | | | | | | | | | | | | | | | | |
Product development | | $ | 169.6 | | $ | 127.5 | | 33 | % | | | $ | 315.5 | | $ | 239.8 | | 32 | % |
Post-marketing studies | | | 40.1 | | | 30.4 | | 32 | | | | | 74.5 | | | 58.6 | | 27 | |
| | | | | | | | | | | | | | | | | | | |
Total development | | | 209.7 | | | 157.9 | | 33 | | | | | 390.0 | | | 298.4 | | 31 | |
Research | | | 55.2 | | | 48.9 | | 13 | | | | | 105.9 | | | 92.3 | | 15 | |
In-licensing | | | 13.2 | | | 6.1 | | 116 | | | | | 25.5 | | | 12.5 | | 104 | |
| | | | | | | | | | | | | | | | | | | |
Total | | $ | 278.1 | | $ | 212.9 | | 31 | | | | $ | 521.4 | | $ | 403.2 | | 29 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | | |
Research and Development | | 2006 | | 2005 | | % Change | |
Product development (including post marketing) | | $ | 283 | | $ | 178 | | | 59 | % |
Research | | | 74 | | | 53 | | | 40 | |
In-licensing | | | 17 | | | 12 | | | 42 | |
Total R&D | | $ | 374 | | $ | 243 | | | 54 | |
Marketing, General and AdministrativeOverall marketing, general and administrative (or "MG&A")
MG&A expenses increased
29%42% to
$356.6 million in the second quarter and 28% to $671.8$441 million in the first
six monthsquarter of
20052006 from the comparable
periodsperiod in
2004.2005. The increase
in 2005 was primarily due to: (i) an increase of
$35.0$67 million
in the second quarter and $64.3 million in the first six months of 2005 in commercial activities
primarily in support of
the launch of Tarcevapre-launch activities related to Avastin in lung and
increased Avastin marketing costs; (ii) an increase of $14.4 million in the second quarter and $39.2 million in the first six months of 2005, primarily due to increased headcount and promotional costs for other recent product launches, including Xolair and Raptiva, and pre-launch costs associated with pipeline products, includingbreast cancer indications, Rituxan Immunology,
Lucentis and
Lucentis;Herceptin (adjuvant setting); (ii) $41 million of employee stock-based compensation expense related to FAS 123R; and (iii) an increase of
$27.6$23 million
in the second quarter and $35.5 million in the first six months of 2005 in general corporate expenses to support our continued growth and higher legal costs.
MG&A as a percentage of operating revenues was
23%22% in the
secondfirst quarter
and 22% for the first six months of
20052006 as compared to
25%21% for
both periodsthe comparable period in
2004. For2005. MG&A absolute dollar spending is expected to increase during the
full year 2005, we expect MG&A expenses to be approximately 22-23%remainder of
operating revenues.2006 primarily driven by marketing and sales costs in support of anticipated product launches.
Collaboration Profit Sharing
Collaboration profit sharing expenses increased
37%28% to
$198.8 million in the second quarter and 38% to $375.1$226 million in the first
six monthsquarter of
20052006 from the comparable
periodsperiod in
20042005 due to higher sales of
Rituxan,Tarceva, Xolair and
TarcevaRituxan and the related profit sharing expenses. For the full year
2005,2006, our collaboration profit sharing
- 28 -
expenses are expected to grow asin proportion to our Rituxan, Xolair and Tarceva sales grow.
growth.
Recurring Charges Related to Redemption
We record recurring charges related to the June 1999 redemption of our
special common stockSpecial Common Stock and push-down accounting (see discussion below in
"Relationship“Relationship with
Roche -- Roche—Redemption of Our Special Common
Stock"Stock”). These charges were
$34.5 million in the second quarter of 2005 and $38.2 million in the second quarter of 2004; and $69.0$26 million in the first
six monthsquarter of 2006 and $35 million in the first quarter of 2005, and
$76.4 million for the same period in 2004. These charges were comprised of the amortization of Redemption-related other intangible assets in the periods presented.
Special Items: Litigation-Related
We recorded $13 million of accrued interest and bond costs related to the City of Hope National Medical Center (or "COH")COH trial judgment in each of $13.5 million for the secondfirst quarters of 20052006 and 2004, and $27.0 million for the first six months of 2005 and $26.9 million for the same period in 2004.2005. We expect that we will continue to incur interest charges on the judgment and service fees on the surety bond each quarter through the process of appealing the COH trial results. The amount of cash paid, if any, or the timing of such payment in connection with the COH matter will depend on the outcome of the California Supreme Court'sCourt’s review of the matter; however, we expect that it may take longer than one year to resolve this matter. Also included in this line is an amount received during the first quarter of 2005 for a litigation settlement. See Note 3, "Leases and Contingencies,"4, “Contingencies,” in the Notes to the Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for further information regarding our litigation.
Operating Income
Operating income was $644 million in the first quarter of 2006, a 49% increase from the first quarter of 2005. Our operating income as a percentage of operating revenues (or “pretax operating margin”) was 32% in the first quarter of 2006 and 29% in the first quarter of 2005.
Other Income, Net
| | Three Months Ended March 31, | | | |
Other Income, Net | | 2006 | | 2005 | | % Change | |
| | (In millions) | | | |
Gains on sales of biotechnology equity securities and other | | $ | 3 | | $ | 1 | | | 200 | % |
Write-downs of biotechnology debt, equity securities and other | | | - | | | (4 | ) | | (100 | ) |
Interest income | | | 49 | | | 21 | | | 133 | |
Interest expense | | | (19 | ) | | (3 | ) | | 533 | |
Other miscellaneous income | | | 1 | | | - | | | - | |
Total other income, net | | $ | 34 | | $ | 15 | | | 127 | |
The components of other income, net have changed primarily due to the effects of our debt issuance in July 2005. Investment income increased as a result of the higher average cash balances maintained and interest expense increased due to the debt service costs incurred in the first quarter of 2006.
We expect interest income, net of interest expense, in 2006 to be 30% higher than 2005 levels, subject to changes in interest rates. Also,
included in this line is a charge in the second quarter of
2005 related to2006, we will recognize a
litigatio n settlement and amounts received during the first quartergain of
2005 for a litigation settlement.Other Income, Net
| | Three Months Ended June 30, | | | | | | Six Months Ended June 30, | | | |
| | | | | | | | | | | | | | | | | | | |
Other Income, Net (in millions) | | 2005 | | 2004 | | % Change | | | 2005 | | 2004 | | % Change |
| | | | | | | | | | | | | | | | | | | |
| | (In millions) |
Gains on sales of biotechnology equity securities and other | | $
| 0.5
| | $
| 0.4
| | 25
| %
| | | $
| 1.4
| | $
| 1.1
| | 27
| %
|
Write-downs of biotechnology debt, equity securities and other | | | - -
| | | (0.1)
| | (100)
| | | | | (3.5)
| | | (0.1)
| | 3,400
| |
Interest income | | | 34.9 | | | 16.5 | | 112 | | | | | 56.7 | | | 39.5 | | 44 | |
Interest expense | | | (3.9) | | | (1.4) | | 179 | | | | | (6.7) | | | (2.8) | | 139 | |
| | | | | | | | | | | | | | | | | | | |
Total other income, net | | $ | 31.5 | | $ | 15.4 | | 105 | | | | $ | 47.9 | | $ | 37.7 | | 27 | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Other income, net increased 105% to $31.5approximately $30 million in the second quarter and 27% to $47.9 million in the first six monthsfrom Amgen’s acquisition of 2005 from the comparable periods in 2004 primarily due to higher investment income as a result of the bond market rallyAbgenix, Inc, which resulted in market value gains in some of our fixed income investments.
closed on April 3, 2006.
The effective income tax rate was
26%38% in the
secondfirst quarter
and 32% for first six months of
2005,2006, as compared to
37%36% in the
secondfirst quarter
and 35% for the first six months of
2004.2005. The
decreaseincrease in the income tax rate
from 2004 primarily
relates to a one-time benefitreflects higher income before taxes and the December 31, 2005 expiration of
approximately $39.0 million from recognizing additionalprovisions in federal tax law for the R&D tax
credits resulting from new incomecredit. Currently there are bills in Congress to extend the R&D tax
regulations issued by the U.S. Department of Treasury during the second quarter of 2005.We expect the effectivecredit retroactively to January 1, 2006. If such legislation is passed, then at that time we will record a tax ratebenefit for the remaining quarters in 2005 to be higher than the current quarter, which benefited from the one-time benefit. R&D tax credits.
We anticipate that our annual
20052006 effective income tax rate will be
approximately 35%.fractionally above 37%, assuming the R&D tax credit is extended retroactive to January 1, 2006. Various factors may have favorable or unfavorable effects on our effective tax rate during the remainder of
20052006 and in subsequent years. These factors include, but are not limited to,
changing interpretations of existing tax laws, changes in tax laws and rates,
past and future levels of R&D spending, and changes
of estimates of prior years’ items, and changes in overall levels of
pretax earnings.- 29 -
income before taxes, all of which may result in periodic revisions to our effective tax rate.
Liquidity and Capital ResourcesLiquidity and Capital Resources | | June 30, 2005 | | December 31, 2004 |
| | | | |
| | (In millions) |
Cash, cash equivalents, short-term investments and long-term marketable debt and equity securities | | $
| 2,911.6
| | $
| 2,780.4
|
Net receivable - equity hedge instruments | | | 109.2 | | | 21.3 |
| | | | | | |
Total cash, cash equivalents, short-term investments, long-term marketable debt and equity securities, and equity hedge instruments | | | 3,020.8
| | | 2,801.7
|
| | | | | | |
| | | | | | |
| | | | | | |
| | | | | | |
Working capital | | | 2,794.1 | | | 2,179.5 |
Current ratio | | | 3.4:1 | | | 2.8:1 |
Cash,
Liquidity and Capital Resources | | March 31, 2006 | | December 31, 2005 | |
| | (In millions) | |
Unrestricted cash, cash equivalents, short-term investments and long-term marketable debt and equity securities | | $ | 3,942 | | $ | 3,814 | |
Net receivable - equity hedge instruments | | | 66 | | | 73 | |
Total unrestricted cash, cash equivalents, short-term investments, long-term marketable debt and equity securities, and equity hedge instruments | | $ | 4,008 | | $ | 3,887 | |
Working capital | | $ | 2,783 | | $ | 2,726 | |
Current ratio | | | 2.6:1 | | | 2.6:1 | |
Unrestricted cash, cash equivalents, short-term investments and long-term marketable securities, excluding restricted cash,including the fair value of the equity hedge instruments, were approximately $2.9$4.0 billion at June 30, 2005,March 31, 2006, an increase of $131.2approximately $121 million or 5%, from December 31, 2004.2005. This increase primarily reflects cash generated from operations, which includes income from investments, and proceeds from activity related to our employee stock plans; partially offset by cash used for capital expenditures purchase of marketable securities and repurchaserepurchases of our common stock, and a net decrease in unrealized gains in our biotechnology and investment portfolios.stock. To mitigate the risk of market value fluctuation, certain of our biotechnology marketable equity securities are hedged with zero-cost collars and forward contracts, which are carried at fair value. Cash, cash equivalents, short-term investments, long-term marketable debt and equity securities, net of the equity hedge instruments were approximately $3.0 billion at June 30, 2005, an increase of $219.1 mill ion from December 31, 2004. See Note 1, "Summary“Summary of Significant Accounting Policies --
Policies—Comprehensive Income,
"” in the Notes to the Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for further information regarding activity in our marketable investment portfolio and derivative instruments.
On July 18, 2005, we completed a private placement of $2.0 billion aggregate principal amount of five-year, 10-year and 30-year senior notes pursuant to exemptions from the registration requirements of the Securities Act of 1933 (the "Securities Act"). We intend to use approximately $585.0 million of the net proceeds to repay our obligations under our existing synthetic lease arrangements. We also intend to use part of the proceeds to fund capital expenditures, including modifications plus start-up and validation costs at our recently acquired biologics manufacturing facility in Oceanside, California. We intend to use the balance of the net proceeds for general corporate purposes, which may include working capital requirements, stock repurchases, R&D expenses and acquisitions of or investments in products, technologies, facilities and businesses. Pending the use of the remaining funds in this manner, we intend to invest them in interest-bearing or other yield producing investments.
See
"Leases" below for a discussion of our leasing arrangements. See "Our“Our affiliation agreement with Roche
Holdings, Inc. (or "Roche") could limit our ability to make
acquisitions and could have a material negative impact on our liquidity"acquisitions” below in the
"Forward-Looking“Forward-Looking Information and Cautionary
Factors"Factors” section and Note
3, "Leases and Contingencies,"4, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for factors that could negatively affect our cash position.
Cash Provided by Operating Activities
Cash provided by operating activities is primarily driven by increases in our net income. However, operating cash flows differ from net income as a result of non-cash charges or differences in the timing of cash flows and earnings recognition. Significant components of cash provided by operating activities are as follows:
Our "accounts receivable -- “accounts receivable—product sales"sales” was $510.0$615 million at June 30, 2005, a decreaseMarch 31, 2006, an increase of $89.1$61 million from December 31, 2004.2005. The increase is primarily due to higher product sales of Herceptin, Avastin and Tarceva. The average collection period of our "accounts receivable -- “accounts receivable—product sales"sales” as measured in days sales outstanding (or "DSO"“DSO”) was 3634 days for the secondfirst quarter 2005, as2006, compared to 43 days in the second quarter of 2004 and 52 days in the first quarter of 2005. The decline in DSO from the accounts receivable balance and the DSO reflectfirst quarter of 2005 reflects the termination of the extended payment term incentive program in the first quarter of 2005.
Our inventory balance was $804 million at March 31, 2006, an increase of $101 million from December 31, 2005. The
levelincrease is primarily due to bulk campaign production of
accounts receivable with extended dating has declined steadily as customer payments have been received. The payment of the- 30 -
remaining accounts receivables with extended dating is anticipated in the third quarter of 2005; as a result, we expect our near term DSO to be consistent with our second quarter 2005 DSO of 36 days. For future new product launches, we may offer, for a limited period, extended payment terms to allow customersAvastin and doctors purchasing the drug sufficient time to process reimbursements.
On January 12, 2005, we and XOMA Ltd. (or "XOMA") restructured our collaboration agreement related to Raptiva, effective January 1, 2005. Under this restructured agreement, the previous costs and profit sharing arrangement in the U.S. was modified to a royalty arrangement. As a result of restructuring the XOMA collaboration agreement,Herceptin products. Inventory also increased in the first quarter of 2005 we reclassified the former development loan receivable (approximately $29.2 million)2006 due to a prepaid royalty,non-cash employee stock-based compensation costs of which $4.5$16 million was includedthat were capitalized in "prepaid expenses" and $24.7 million was included in "other long-term assets" in the accompanying condensed consolidated balance sheets. The prepaid royalty is being amortizedinventory pursuant to costour adoption of sales associated with the related Raptiva revenues.
FAS 123R.
Cash Used in Investing Activities
Cash used in investing activities primarily relate to purchases, sales and maturities of investments and capital expenditures. Capital expenditures were
$729.8million during the first six months of 2005 compared to $196.6$253 million during the first
six monthsquarter of
2004.2006 compared to $144 million during the first quarter of 2005. Capital expenditures in the first
six monthsquarter of
20052006 included
the purchase of the Oceanside plant for $408.1 million in cash plus $9.3 million in closing costs, ongoing construction of our
second manufacturing facility in Vacaville, California,
ongoing start-up and validation costs at our manufacturing facility in Oceanside, California, the purchase of
land,a second facility in Oceanside, purchase of equipment and information systems, and ongoing
construction costs inexpenditures to support
of our
manufacturing and corporate infrastructure needs.
We expect to incur additional capital costs at the Oceanside plant over the next 24 months, including modifications, and start-up and validation costs.
We currently anticipate that our capital expenditures for the full year
20052006 will be approximately
$1.7 $1.5 billion,
which includes the June 2005 purchase of the Oceanside plant and $160.0 million for the buyoutprimarily driven by manufacturing expansion due to ongoing construction of our
synthetic lease obligation on a researchsecond manufacturing facility in
South San Francisco, California.Vacaville, start-up and validation of our Oceanside manufacturing facilities, and for projects related to existing facilities, increases in office space, and land purchases.
Cash Provided by or Used in Financing Activities
Cash provided by or used in financing activities is primarily related to activity under our employee stock plans and our stock repurchase program. We received $465.2used cash for stock repurchases of $227 million during the first six monthsquarter of 20052006 and $366.7$156 million during the first six monthsquarter of 2004,2005 pursuant to our stock repurchase program approved by our Board of Directors. We also received $89 million during the first quarter of 2006 and $106 million during the first quarter of 2005 related to stock option exercises and stock issuances under our employee stock plans. We also used
Prior to our adoption of FAS 123R, the tax benefit from stock option exercises was reported as operating cash flows. FAS 123R requires excess tax benefits be reported as a financing cash inflow rather than as a reduction of taxes paid. At March 31, 2006, the excess tax benefit from stock-based compensation arrangements was $49 million.
During 2006, our total cash, unrestricted cash equivalents, short-term investments and marketable securities are expected to decline modestly relative to the level at December 31, 2005 due to cash requirements for stockcapital
expenditures, share repurchases
of $160.7 million during the first six months of 2005 and $575.7 million during the first six months of 2004 pursuant tounder our stock repurchase program,
approvedand other uses of working capital. We believe our existing unrestricted funds, together with funds provided by
operations and our
Boarddebt issuance in July 2005 will be sufficient to meet our foreseeable future operating cash requirements. See “Our affiliation agreement with Roche Holdings, Inc. could adversely affect our cash position” below in Part II, Item 1A “Risk Factors” of
Directors.As a result ofthis Form 10-Q for factors that could negatively affect our recently completed debt offering, we plan to extinguish our remaining $425.0 million total lease obligation with respect to our Vacaville manufacturing facility synthetic lease during 2005.
cash position.
On
June 15, 2005,April 19, 2006, the Board of Directors approved an extension of our stock repurchase program for the repurchase of up to an additional $2.0 billion of our common stock for a total of
$4.0$6.0 billion through June 30,
2006.2007. The Board also amended the current repurchase program by increasing the maximum number of shares that can be repurchased from
5080 million to
80100 million shares. Under this stock repurchase program, purchases may be made in the open market or in privately negotiated transactions from time to time at
management'smanagement’s discretion. Genentech also may engage in transactions in other Genentech securities in conjunction with the repurchase program, including certain derivative securities. Genentech intends to use the repurchased stock to offset dilution caused by the issuance of shares in connection with
Genentech'sGenentech’s employee stock plans. Although there are currently no specific plans for the shares that may be purchased under the program, our goals for the program are (i) to make
pr udentprudent investments of our cash resources; (ii) to allow for an effective mechanism to provide stock for our employee stock plans; and (iii) to address provisions of our affiliation agreement with Roche relating to maintaining
Roche'sRoche’s minimum ownership percentage. See below in
"Relationship“Relationship with
Roche"Roche” for more information on
Roche'sRoche’s minimum ownership percentage. We have entered into Rule 10b5-1 trading plans to repurchase shares in the open market during those periods each quarter when trading in our stock is restricted under our insider trading policy. The current trading plan
- 31 -
covers approximately 1.52 million shares and will run through December 31, 2005.
June 30, 2006.
Our shares repurchased during the first six monthsquarter of 20052006 were as follows (shares in millions): | |
Total Number of Shares Purchased in 2005
| |
Average Price Paid per Share
| | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs |
| | | | | | | | |
January 1-31, 2005 | | | 1.4 | | | | $ | 48.98 | | | | | | | | | |
February 1-28, 2005 | | | 1.3 | | | | | 47.13 | | | | | | | | | |
March 1-31, 2005 | | | 0.5 | | | | | 48.90 | | | | | | | | | |
April 1-30, 2005 | | | 0.1 | | | | | 56.83 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Total | | | 3.3 | | | | | 48.46 | | | | 29.0 | | | | 51.0 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | Total Number of Shares Purchased in 2006 | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | |
January 1-31, 2006 | | | 0.9 | | $ | 88.37 | | | | | | | |
February 1-28, 2006 | | | 0.7 | | | 85.31 | | | | | | | |
March 1-31, 2006 | | | 1.0 | | | 84.24 | | | | | | | |
Total | | | 2.6 | | $ | 85.95 | | | 52 | | | 48 | |
The par value method of accounting is used for common stock repurchases. The excess of the cost of shares acquired over the par value is allocated to additional paid-in capital with the amounts in excess of the estimated original sales price charged to accumulated deficit.
Off-Balance Sheet Arrangements
We have certain contractual arrangements that create
potential risk for Genentech and are not recognized in our
condensed consolidated balance sheets, as prescribed by generally accepted accounting principles.Condensed Consolidated Balance Sheets. Discussed below are those off-balance sheet arrangements that have or are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operation, liquidity, capital expenditures or capital resources.
LeasesOur existing synthetic leases are discussed in Note 6, "Leases, Commitments and Contingencies" and "Off-Balance Sheet Arrangements" in Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2004 (or "Annual Report"). During the six months ended June 30, 2005, there were no significant changes to our synthetic lease arrangements, or our assessment of those arrangements under the provisions of FIN 46R, a revision of Interpretation 46, as discussed in the Annual Report. See also Note 7, "Subsequent Events -- Buyout of a Synthetic Lease," in the Notes to the Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q.
In December 2004, we entered into a Master Lease Agreement with Slough SSF, LLC for the lease of property adjacent to our South San Francisco campus. The property will be developed into eight buildings and two parking structures. The lease of the property will take place in two phases pursuant to separate lease agreements for each building as contemplated by the Master Lease Agreement. Phase I building leases will begin throughout 2006 and Phase II building leases may begin as early as 2008. For accounting purposes, due to the nature of our involvement with the construction of the buildings, subject to the Master Lease Agreement, we are considered to be the owner of the assets during the construction period through the lease commencement date, even though the funds to construct the building shell and some infrastructure costs are paid by the lessor. As such, inIn the first six monthsquarter of 2005,2006, we have capitalized $73.0$27 million of construction costs in property, plant and equipment, andfor a project-to-date capitalized total of $121 million. We have also recognized a corresponding amount as a construction financing obligation in "long-term debt"“long-term debt” in the accompanying condensed consolidated balance sheets.Condensed Consolidated Balance Sheets. We expect at the time of completion of the project, if all the buildings and infrastructure were completed by
the lessor, our construction asset and related obligation
willmay be
in excess of $365.0 million.as much as $365 million, excluding costs related to leasehold improvements. Our aggregate lease payments as contemplated by the Master Lease Agreement through 2020
(if there is no acceleration or delay in the rent commencement date for the second phase of the buildings) will be approximately
$540.1$544 million.
- 32 -
During the first
six monthsquarter of
2005,2006, we believe there
werehave been no significant changes in our payments due under contractual obligations as disclosed in our Annual
Report.On July 18, 2005, we completed a private placement ofReport on Form 10-K for the following debt instruments: $500.0 million principal amount of 4.40% Senior Notes due 2010, $1.0 billion principal amount of 4.75% Senior Notes due 2015 and $500.0 million principal amount of 5.25% Senior Notes due 2035 (collectively, the "Notes"). The Notes are unsecured, non-convertible obligations and will rank equally in right of payment with all of our other unsecured unsubordinated indebtedness. The Notes have not been registered under the Securities Act or any state securities laws, however, we have committed to the buyers of such Notes that we will do so within 240 days of July 18,year ended December 31, 2005.
We are party to various legal proceedings, including patent infringement litigation and licensing and contract disputes, and other matters. See Note
3, "Leases and Contingencies,"4, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements of Part 1, Item 1 of this Form 10-Q for further information.
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. (or
"Roche"“Roche”) at a price of $10.31 per share in cash with funds deposited by Roche for that purpose. We refer to this event as the
"Redemption."“Redemption.” As a result, on that date,
Roche'sRoche’s percentage ownership of our outstanding Common Stock increased from 65% to 100%. Consequently, under GAAP, 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
$1,685.7$1,686 million of goodwill and
$1,499.0$1,499 million of other intangible assets on our balance sheet on June 30, 1999. Refer to Note
2, "Consolidated3, “Condensed Consolidated Financial Statement
Detail -- Detail—Other Intangible Assets,
"” in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for further information about these intangible assets.
Roche's
Roche’s Ability to Maintain Its Percentage Ownership Interest in Our Stock
We
expect from time to time to issue additional shares of
common stockCommon 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 provides, among other things, that
we establish a stock repurchase program designedwith respect to
maintain Roche's percentage ownership interestany issuance of Common Stock by Genentech in
our common stock. The affiliation agreement provides thatthe future, we will repurchase a sufficient number of shares
pursuant to this programso that immediately after such
that, with respect to any issuance
of common stock by Genentech in the future, the percentage of Genentech
common stockCommon 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
"M inimum Percentage."“Minimum Percentage” (as defined below), provided however, as long as Roche’s percentage ownership is greater than 50%, prior to issuing any shares, we will repurchase a sufficient number of shares of our Common Stock such that, immediately after our issuance of shares, Roche’s percentage ownership will be greater than 50%. The Minimum Percentage equals the lowest number of shares of Genentech
common stockCommon Stock owned by Roche since the July 1999 offering (to be adjusted
in the future for dispositions of shares of Genentech
common stockCommon Stock by Roche as well as for stock splits or stock combinations) divided by 1,018,388,704,
(to be adjusted in the future for stock splits or stock combinations), which is the number of shares of Genentech
common stockCommon Stock outstanding at the time of the July 1999 offering, as adjusted for
the two-for-one splits of Genentech common stock
in November 1999, October 2000 and May 2004.splits. We
have repurchased shares of our
common stock in 2005 and 2004Common Stock since 2001 (see discussion above in
"LiquidityLiquidity and Capital
Resources -- Cash Provided by or Used in Financing Activities"). As long as Roche's percentage ownership is greater than 50%, prior to issuing any shares, the affiliation agreement provides that we will repurchase a sufficient number of shares of our common stock such that, immediately after our issuance of shares, Roche's percentage ownership will be greater than 50%Resources). The affiliation agreement also provides that, upon
Roche'sRoche’s request, we will repurchase shares of our
common stockCommon Stock to increase
Roche'sRoche’s ownership to the Minimum
- 33 -
Percentage. In addition, Roche will have a continuing option to buy stock from us at prevailing market prices to maintain its percentage ownership interest. The Minimum Percentage at June 30, 2005March 31, 2006 was 57.7% and, under the terms of the affiliation agreement, Roche's lowestRoche’s ownership percentage is to be no lower than 55.7%. At June 30, 2005, Roche'sMarch 31, 2006, Roche’s ownership percentage was 55.3%55.7%. We expect that future share repurchases under our share repurchase program will increase Roche's ownership percentage.
Related Party Transactions
We enter into transactions with our related parties, Roche and other Roche affiliates (including Hoffmann-La Roche) and Novartis, under existing agreements in the ordinary course of business. The accounting policies we apply to our transactions with our related parties are consistent with those applied in transactions with independent third-parties and all related party agreements are negotiated on an
arm's-lengtharm’s-length basis.
Under our existing arrangements with Hoffmann-La Roche, including our licensing and marketing agreement, we recognized contract revenue from Hoffmann-La Roche, including amounts earned related to ongoing development activities, of $18.5 million in the second quarter of 2005 and $23.7 million in the second quarter of 2004, and $35.0$18 million in the first six monthsquarter of 20052006 and $49.6$16 million in the first six monthsquarter of 2004.2005. All other revenues from Hoffmann-La Roche and their affiliates, principally royalties and product sales, were $133.7 million in the second quarter of 2005 and $111.7 million in the second quarter of 2004, and $289.5$224 million in the first six monthsquarter of 20052006 and $210.6$155 million in the first six monthsquarter of 2004. Cost of sales2005. COS included amounts related to Hoffmann-La Roche of $26.5 million in the second quarter of 2005 and $25.9 million in the second quarter of 2004, and $73.8$49 million in the first six monthsquarter of 20052006 and $48.4$47 million in the first six monthsquarter of 2004.2005. Our reported R&D exp ensesexpenses in each of the first quarters of 2006 and 2005 included amounts$43 million and $34 million, respectively, related to development activities undertaken on projects on which we collaborate with Hoffmann-La RocheRoche.
Novartis
Based on information available to us at the time of
$35.7 million in the second quarter of 2005 and $43.5 million in the second quarter of 2004, and $66.7 million in the first six months of 2005 and $76.4 million in the first six months of 2004.Novartis
We understand thatfiling this Form 10-Q, we believe the Novartis Group holds approximately 33.3% of the outstanding voting shares of Roche Holding Ltd. As a result of this ownership, the Novartis Group is deemed to have an indirect beneficial ownership interest under FAS 57 "Related“Related Party Disclosures"Disclosures” of more than 10% of Genentech'sour voting stock.
Under
We have an arrangementagreement with Novartis a holding companyOphthalmics (now merged into Novartis AG) under which Novartis Ophthalmics has the exclusive right to develop and market Lucentis outside of the U.S. and Canada for indications related to diseases or disorders of the eye. As part of this agreement, the parties share the cost of certain of our ongoing Phase III and related development expenses.
We, along with Novartis
Group,Pharma AG (a wholly owned subsidiary of Novartis AG) and Tanox, Inc.,
are co-developing Xolair in the U.S. We and Novartis are co-promoting Xolair in the U.S. and we
both make certain joint and individual payments to Tanox; Genentech’s joint and individual payments are in the form of royalties. We record all sales and cost of sales in the U.S. and Novartis markets the product and records all sales and cost of sales in Europe. We and Novartis share the resulting U.S. and European operating profits, respectively, according to prescribed profit-sharing percentages. We are currently
supply Xolairsupplying the product and receive cost plus a mark-up similar to other supply arrangements.
On January 20, 2006, Novartis
will be manufacturing all future worldwidereceived FDA approval to manufacture bulk supply of Xolair at their Huningue production facility in
France, upon FDA licensure, expected in early 2006.France. Future production costs of Xolair may initially be higher than those currently reflected in our
cost of salesCOS as a result of
anythe production shift from
Genentechus to Novartis until production economies of scale can be achieved by
that manufacturing party.Novartis.
Contract revenue from Novartis related to manufacturing, commercial and ongoing development activities was $11.9 million in the second quarter of 2005 and $10.2 million in the second quarter of 2004, and $21.9$10 million in the first six monthsquarters of 20052006 and $20.9 million in the first six months of 2004.2005. Revenue from Novartis related to product sales and COS was not material in the secondfirst quarters of 2006 and 2005. Our reported R&D expenses in each of the first six monthsquarters of 2006 and 2005 and 2004. Cost of sales was $12.3included approximately $10 million in the second quarter of 2005 and $15.1related to development activities undertaken on products on which we collaborate with Novartis. Collaboration profit sharing payments from us to Novartis were $43 million in the first six months of 2005, which included a one-time payment in the second quarter of 2005 related to our release from future manufacturing obligations. Cost of sales was not material in the second quarter2006 and first six months on 2004. R&D expenses include amounts related to Novartis of $5.7 million in the second quarter of 2005 and $6.0 million in the second quarter of 2004, and $15.4 $24million in the first six months of 2005 and $12.4 million in the first six months of 200 4. Collaboration profit sharing expenses were $28.7 million in the second quarter of 2005 and $14.8 million in the second quarter of 2004, and $52.4 million in the first six months of 2005 and $26.6 million in the first six months of 2004.- 34 -
2005.
Option Program Description
Our employee stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and to align stockholder and employee interests. Our program primarily consists of our amended and restated 1999 Stock Plan (the "Plan"“Plan”), a broad-based plan under which stock options are granted to employees, directors and other service providers. Substantially all of our employees participate in our stock option program. In the past, we granted options under our amended and restated 1996 Stock Option/Stock Incentive Plan, our amended and restated 1994 Stock Option Plan and our amended and restated 1990 Stock Option/Stock Incentive Plan. Although we no longer grant options under these plans, exercisable options granted under these plans are still outstanding. In addition, our stockholders approved, in April 2004, our 2004 Equity Incentive Plan under which
stock options, restricted stock, stock appreciation rights and performance shares and units may be granted to our employees, directors and consultants in the future.
All stock option grants are made
after a review by, and with the approval of the Compensation Committee of the Board of Directors. See
"The“The Compensation Committee
Report"Report” appearing in our
20052006 Proxy Statement for further information concerning the policies and procedures of the Compensation Committee regarding the use of stock options.
General Option Information
Summary of Option Activity
(Shares in thousands)millions) | | | | Options Outstanding |
| | | | | | |
| | Shares Available for Grant | | Number of Shares
| | Weighted Average Exercise Price |
| | | | | | |
December 31, 2003 | | 40,732 | | 96,126 | | $ | 25.18 | |
Grants | | (20,967) | | 20,967 | | | 53.04 | |
Exercises | | - | | (21,484) | | | 20.81 | |
Cancellations | | 1,843 | | (1,843) | | | 29.92 | |
Additional shares reserved(1) | | 80,000 | | - | | | - | |
| | | | | | | | |
December 31, 2004 | | 101,608 | | 93,766 | | | 32.32 | |
Grants | | (1,645) | | 1,645 | | | 61.08 | |
Exercises | | - | | (17,580) | | | 24.25 | |
Cancellations | | 1,324 | | (1,324) | | | 39.70 | |
| | | | | | | | |
June 30, 2005 (Year to date) | | 101,287 | | 76,507 | | | 34.67 | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
___________
(1)
| Additional shares have been reserved for issuance under the 2004 Equity Incentive Plan approved by stockholders on April 16, 2004. No awards have been made under this Plan.
|
| | | | Options Outstanding | |
| | Shares Available for Grant | | Number of Shares | | Weighted-Average Exercise Price | |
December 31, 2004 | | | 102 | | | 94 | | $ | 32.32 | |
Grants | | | (20 | ) | | 20 | | | 84.01 | |
Exercises | | | - | | | (29 | ) | | 25.88 | |
Cancellations | | | 2 | | | (2 | ) | | 42.16 | |
December 31, 2005 | | | 84 | | | 83 | | $ | 46.64 | |
Grants | | | (1 | ) | | 1 | | | 88.10 | |
Exercises | | | - | | | (2 | ) | | 30.38 | |
Cancellations | | | 1 | | | (1 | ) | | 57.63 | |
March 31, 2006 (Year to date) | | | 84 | | | 81 | | $ | 47.43 | |
In-the-Money and Out-of-the-Money Option Information
(Shares in thousands)millions) | | Exercisable | | Unexercisable | | Total |
| | | | | | | | | |
As of June 30, 2005
| |
Shares
| Wtd. Avg. Exercise Price | |
Shares
| Wtd. Avg. Exercise Price | |
Shares
| Wtd. Avg. Exercise Price |
| | | | | | | | | | | | | | | | | | |
In-the-Money | | 36,528 | | $ | 25.70 | | | 39,689 | | $ | 42.58 | | | 76,217 | | $ | 34.49 | |
Out-of-the-Money(1) | | - | | | - | | | 290 | | | 81.80 | | | 290 | | | 81.80 | |
| | | | | | | | | | | | | | | | | | |
Total Options Outstanding | | 36,528 | | | | | | 39,979 | | | | | | 76,507 | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| | Exercisable | | Unexercisable | | Total | |
As of March 31, 2006 | | Shares | | Weighted-Average Exercise Price | | Shares | | Weighted-Average Exercise Price | | Shares | | Weighted-Average Exercise Price | |
In-the-Money | | | 39 | | $ | 30.06 | | | 24 | | $ | 46.60 | | | 63 | | $ | 36.28 | |
Out-of-the-Money(1) | | | - | | | - | | | 18 | | | 86.33 | | | 18 | | | 86.33 | |
Total Options Outstanding | | | 39 | | | | | | 42 | | | | | | 81 | | | | |
___________
(1) | Out-of-the-money options are those options with an exercise price equal to or greater than the fair market value of Genentech Common Stock, $80.28,$84.51, at the close of business on June 30, 2005. March 31, 2006. |
- 35 -
Distribution and
Dilutive Effect of OptionsEmployee
Net grants, as a percentage of outstanding shares, were 0.02% for the three months ended March 31, 2006, 1.70% for the year ended December 31, 2005 and
Executive Officer Option Grants | | 2005** | | 2004 | | 2003 |
| | | | | | | | | | | | |
Net grants during the year as % of outstanding shares | | | 0.03 | % | | | 1.82 | % | | | 1.69 | % |
Grants to Named Executive Officers* during the year as % of outstanding shares | | | 0.00
| %
| | | 0.19
| %
| | | 0.18
| %
|
Grants to Named Executive Officers during the year as % of total options granted | | | 0.00
| %
| | | 9.63
| %
| | | 8.54
| %
|
___________
*
| "Named Executive Officers" refers to our Chief Executive Officer and our four other most highly compensated executive officers as defined under Item 402(a) (3) of Regulation S-K of the federal securities laws.
|
**
| Reflects year to date activity.
|
1.83% for the year ended December 31, 2004.
Equity Compensation Plan Information
Our stockholders have approved all of our equity compensation plans under which options are outstanding.
******
Our Management's Discussion and Analysis of Financial Condition and Results of Operations
This report contains forward-looking statements regarding achievementour horizon 2010 strategy of our 5x5 goals, including growth in non-GAAP EPS, andbringing 20 new molecules into clinical development, 15 major new products or indications onto the number of products/indications in late stage development; our Horizon 2010 goals, includingmarket, becoming the number one U.S. oncology company by 2010, adding programs intoin sales, achieving compound annual non-GAAP earnings per share growth of 25 percent, and achieving cumulative free cash flow of $12 billion; growth from the use in potential new but unapproved uses of Avastin; Herceptin sales growth; Cabilly related net income; royalty and contract revenues; cost of sales as a
percentage of net product sales; research and
clinical development and
bringing products/indicationsmarketing, general and administrative spending; sales to
market, building a leading immunology business, increasingcollaborators; interest income; annual effective income tax rate; capital expenditures and construction costs; collaboration profit sharing expenses; the level of our
leadership in tissue growthcash, unrestricted cash equivalents, short-term investments and
repair, and achieving non-GAAP growth rates to be considered a growth company; Avastin, Rituxan, Herceptin, Tarceva and Xolair sales growth and growth opportunities, andmarketable securities, our ability to
deliver sustainable growth;meet our foreseeable operating cash requirements; our level of contractual obligations; the
timeframeeffects of
construction or licensurethe Medicare Prescription Drug Improvement and Modernization Act on our revenues; the effect of
manufacturing facilities by us orproduct distribution changes on our
contract manufacturers, a fill line,results of operations; and
yield improvements; FDA action for Tarceva in pancreatic cancer; the impact of Medicare legislation on sales of our products; and sales to collaborators, royalties, contract revenues, cost of sales, R&D and MG&A expenses, collaboration profit-sharing expenses and capital expenditures. Actual results could differ materially.For a discussion of theemployee stock-based compensation expense.
These forward-looking statements involve risks and uncertainties,
associated with achieving our 5x5 and
Horizon 2010 goals of adding programs into researchthe cautionary statements set forth below and
clinical developmentthose contained in “Risk Factors” identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Such factors include, but are not limited to, unexpected safety, efficacy or manufacturing issues, additional time requirements for data analysis, BLA preparation and
bringing products/indications to market, our estimates of our capital expenditures, cost of sales, R&D and MG&A expenses, collaboration profit-sharing expenses, and timeframe of constructiondecision making, FDA actions or
licensure of facilities, a fill line and yield improvements, and FDA action for Tarceva, see "The successful development of biotherapeutics is highly uncertain and requires significant expenditures," "We may be unabledelays, failure to obtain
or maintain regulatory approvalsFDA approval, competition, pricing, the ability to supply product and meet demand for our products,
" "Difficulties or delays in product
manufacturing or in obtaining materials fromwithdrawals and new product approvals and launches, our
suppliers could harm our business and/or negatively impact our financial performance," "Protectingability to protect our proprietary rights,
is difficult and costly," "If there is an adverse outcome in our pendingunanticipated expenses such as litigation or
other legal
actions our business may be harmed," and "We may be unable to retain skilled personnel and maintain key relationships" sections of "Forward-Looking Information and Cautionary Factors That May Affect Future Results" below; for our Horizon 2010 goal of becoming number onesettlement expenses or equity securities write-downs, fluctuations in
U.S. oncology sales and building a leading immunology business, increasing our leadership in tissue growth and repair, Avastin, Rituxan, Hercepti n, Tarceva, and Xolair sales growth and growth opportunities, our ability to deliver sustainable growth, and expected revenues from sales to collaborators, see all of the foregoing and "We may be unable to manufacture certain of our products if there is BSE contamination of our bovine source raw material," "We face competition," "Other factors could affect our product sales," "We may incur material product liability costs," "Insurance coverage is increasingly more difficult to obtain or maintain," and "We are subject to environmental and other risks;" for royalties and contract revenues,
see "Our royaltyincreased costs of sales, research and
contract revenues could decline;" for the impact of Medicare legislation ondevelopment and management, general and administrative expenses, fluctuations in tax and interest rates, increased capital expenditures including greater than expected construction and validation costs, our
product sales, see "Decreasesindebtedness and ability to pay our indebtedness, actions by Roche that are adverse to our interests, decreases in third party reimbursement rates,
may affectreaction to and acceptance by distributors of changes to our
product sales;" for non-GAAP EPS growth, see alldistribution strategy, and the number of
"Forward-Looking Informationoptions granted to employees, Genentech’s stock price and
Cautionary Factors That May Affect Future Results" below.certain valuation assumptions concerning Genentech stock. We disclaim and do not undertake any obligation to update or revise any forward-looking
statementsstatement in
th isthis Form 10-Q.
- 36 -
Our market risks at March 31, 2006 have not changed materially from those discussed in Item 7A of our Form 10-K for the year ended December 31, 2005 on file with the Securities and Exchange Commission. See also Note 1, “Summary of Significant Accounting Policies—Derivative Financial Instruments” section in the Notes to Condensed Consolidated Financial Statements in Part I of this Form 10-Q.
Evaluation of Disclosure Controls and Procedures: The Company’s principal executive and financial officers reviewed and evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Company’s principal executive and financial officers concluded that the Company’s disclosure controls and procedures are effective in timely providing them with material information relating to the Company, as required to be disclosed in the reports the Company files under the Exchange Act.
Changes in Internal Controls over Financial Reporting: There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II—OTHER INFORMATION AND CAUTIONARY FACTORS
THAT MAY AFFECT FUTURE RESULTS
See Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q.
See also Item 3 of our report on Form 10-K for the year ended December 31, 2005.
This Form 10-Q contains forward-looking information based on our current expectations. Because our actual results may differ materially from any forward-looking statements made by or on behalf of Genentech, this section includes a discussion of important factors that could affect our actual future results, including, but not limited to, our product sales, royalties, contract revenues, expenses, net income and earnings per share.
The successful development of biotherapeutics is highly uncertain and requires significant expenditures
Successful development of biotherapeutics is highly
uncertain and is dependent on numerous factors, a number of which are beyond our control.uncertain. Products that appear promising in research or early phases of development may
be delayed or fail to reach later stages of development or the market for several reasons including:
Preclinical tests may show the product to be toxic or lack efficacy in animal models.
Clinical trial results that may show the product to be less effective than desired (e.g., the trial failed to meet its primary or secondary objectives) or to have harmful or problematic side effects.
Failure to receive the necessary regulatory approvals or a delay in receiving such approvals. Among other things, such delays may be caused by slow enrollment in clinical studies, extended length of time to achieve study endpoints, additional time requirements for data analysis or biologic licensing application (or "BLA") preparation, discussions with the U.S. Food and Drug Administration (or "FDA"), an FDA request for additional preclinical or clinical data, or unexpected safety, efficacy or manufacturing issues.
Difficulties formulating the product, scaling the manufacturing process or in getting approval for manufacturing.
Manufacturing costs, pricing or reimbursement issues, or other factors that make the product uneconomical.
The proprietary rights of others and their competing products and technologies that may prevent the product from being developed or commercialized.
· | Preclinical tests may show the product to be toxic or lack efficacy in animal models. |
· | Clinical trial results may show the product to be less effective than desired or to have harmful or problematic side effects. |
· | Failure to receive the necessary regulatory approvals or a delay in receiving such approvals. Among other things, such delays may be caused by slow enrollment in clinical studies, extended length of time to achieve study endpoints, additional time requirements for data analysis or Biologic Licensing Application (or “BLA”) preparation, discussions with the U.S. Food and Drug Administration (or “FDA”), an FDA request for additional preclinical or clinical data, or unexpected safety, efficacy or manufacturing issues. |
· | Difficulties formulating the product, scaling the manufacturing process or in getting approval for manufacturing. |
· | Manufacturing costs, pricing or reimbursement issues, or other factors that make the product uneconomical. |
· | The proprietary rights of others and their competing products and technologies that may prevent the product from being developed or 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. If our large-scale clinical trials are not successful, we will not recover our substantial investments in the product.
Factors affecting our research and development (or
"R&D"“R&D”) productivity and the amount of our R&D expenses include, but are not limited to:
The number of products entering into development from late-stage research. 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, some promising candidates did not yield sufficiently positive preclinical results to meet our stringent development criteria.
- 37 -
In-licensing activities, including the timing and amount of related development funding or milestone payments. For example, we may enter into agreements requiring us to pay a significant upfront fee for the purchase of in-process R&D, which we may record as an R&D expense.
Future levels of revenue.
· | The number of and the outcome of clinical trials currently being conducted by us and/or our collaborators. For example, our R&D expenses may increase based on the number of late-stage clinical trials being conducted by us and/or our collaborators. |
· | The number of products entering into development from late-stage research. 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. |
· | Decisions by F. Hoffmann-La Roche (or “Hoffmann-La Roche”) 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, we may enter into agreements requiring us to pay a significant upfront fee for the purchase of in-process R&D, which we may record as an R&D expense. |
· | Participation in a number of collaborative research arrangements. On many of these collaborations, our share of expenses recorded in our financial statements is subject to volatility based on our collaborators’ spending activities as well as the mix and timing of activities between the parties. |
· | Charges incurred in connection with expanding our product manufacturing capabilities, as described in “Difficulties or delays in product manufacturing or in obtaining materials from our suppliers could harm our business and/or negatively affect our financial performance” below. |
· | Future levels of revenue. |
We may be unable to obtain or maintain regulatory approvals for our products
We are subject to stringent regulation with respect to product safety and efficacy by various international, federal, state and local authorities. Of particular significance are the
FDA'sFDA’s requirements covering R&D, testing, manufacturing, quality control, labeling and promotion of drugs for human use. A biotherapeutic cannot be marketed in the United States (or
"U.S."“U.S.”) until it has been approved by the FDA, and then can only be marketed for the indications approved by the FDA. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical information required for approval of a New Drug Application or a BLA, are substantial and can require a number of years. In addition, even if our products receive regulatory approval, they remain subject to ongoing FDA regulation, including, for example, changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisements to physicians
and/or a product
r ecall.recall.
We may not obtain necessary regulatory approvals on a timely basis, if at all, for any of the products we are developing or manufacturing or maintain necessary regulatory approvals for our existing products, and all of the following could have a material adverse effect on our business:
Loss of, or changes to, previously obtained approvals.
Failure to comply with existing or future regulatory requirements.
· | Significant delays in obtaining or failing to obtain required approvals as described in “The successful development of biotherapeutics is highly uncertain and requires significant expenditures” above. |
· | Loss of, or changes to, previously obtained approvals, including those resulting from post-approval safety or efficacy issues. |
· | Failure to comply with existing or future regulatory requirements. |
· | Changes to manufacturing processes, manufacturing process standards or Good Manufacturing Practices following approval or changing interpretations of these factors. |
In addition, the current regulatory framework could change or additional regulations could arise at any stage during our product development or marketing, which may affect our ability to obtain or maintain approval of our products or require us to make significant expenditures to obtain or maintain such approvals.
Difficulties or delays in product manufacturing or in obtaining materials from our suppliers could harm our business and/or negatively impactaffect our financial performance
Manufacturing biotherapeutics is difficult and complex, and requires facilities specifically designed and validated for this purpose. It can take longer than five years to design, construct, validate, and license a new
biotechbiotechnology manufacturing facility. We currently produce
all of our products
and we produce some products for others at our manufacturing facilities located in South San Francisco,
California,California; Vacaville,
California,California; Porriño,
Spain, orSpain; and increasingly, through
- 38 -
various contract-manufacturing arrangements. Problems with any of our or our contractors'contractors’ manufacturing processes could result in failure to produce adequate product supplies or could result in product defects which could require us to delay shipment of products, recall products previously shipped or be unable to supply products at all. In addition, we may need to record period charges associated with manufacturing or inventory failures or other production-related costs that are not absorbed into inventory or incur costs to secure additional sources of capacity. Furthermore, there are inherent uncertainties associated with forecasting future demand, especially for newly introduced products of ours or of those for whom we produce products, and as a consequence we may have inadequate capacity to meet our own actual demands and/or the actual demands of those for whom we produce product.
In order to maintain adequate supply to keep up with growing demand for our products, we must successfully implement a number of manufacturing capacity enhancement projects on schedule, utilize nearly 100 percent of our production capacity in the next several years and
obtain licensure or maintain a state of regulatory compliance at all
of our production sites. If we,
or any of our contract manufacturers, for any reason fail to obtain licensure for our capacity enhancement projects on schedule, fail to operate at or near
full capacity
utilization, fail to maintain a state of regulatory compliance, or if actual demand significantly exceeds our internal forecasts, we may be unable to maintain an adequate supply of our
productproducts to meet all demand. Key capacity enhancement projects, which we must successfully implement, include the following: (i) licensure of
our Lonza Biologics contract manufacturing facility to produce Rituxan bulk drug substance by late 2005; (ii) licensure of our Porriño, Spain facility to produce Avastin bulk drug subs tance for commercial use by early 2006; (iii) licensure of Novartis' plant in Huningue, France to product Xolair bulk drug substance by early 2006; (iv) licensure of our Wyeth Pharmaceuticals contract manufacturing facility
at Andover, Massachusetts to produce Herceptin bulk drug substance by the end of 2006;
(v)(ii) licensure of additional capacity at our Porriño, Spain facility in 2006 to produce Avastin bulk drug substance; (iii) licensure of yield improvement processes for Rituxan
and Avastin by the end of
2006 and for Avastin by early 2007; (vi)2006; (iv) licensure of our
recently acquired Oceanside, California manufacturing facility during the first half of 2007;
(vii)and (v) construction, qualification and licensure of our new plant in Vacaville, California
by 2009.In the area of fill/finish, we are undertaking efforts to secure additional licensed filling capacity in order to mitigate the current risk associated with having a single licensed filling facility for many of our products. As part of this effort, we expect to begin constructing a new aseptic fill line in our South San Francisco facility in the third quartersecond half of 2005 and anticipate licensure in 2007. We had equipment malfunctions in early 2004 in our filling facility, and consequently, several product lots were not able to be released and a scheduled facility maintenance shut-down was extended. 2009.
If we experience
anothera significant malfunction in our filling facility, we could experience a shortfall or stock out of one or more products, which, if it were to continue for a significant period of time, could result in a material adverse effect on our product sales and our business.
Furthermore, certain of our raw materials and supplies required for the production of our principal products or products we make for others are available only through sole source suppliers (the only recognized supplier available to us) or single source suppliers (the only approved supplier for us among other sources), and
we may not be able to obtain such raw materials
cannot be obtained from other sources without significant delay or at all. If such sole source or single source suppliers were to limit or terminate production or otherwise fail to supply these materials for any reason, such failures could also have a material adverse impact on our products sales and our business.
Any prolonged interruption in the operations of our or our
contractors'contractors’ manufacturing facilities could result in cancellations of shipments, loss of product in the process of being manufactured, or a shortfall or stock-out of available product inventory, any of which could have a material adverse impact on our business. A number of factors could cause prolonged interruptions, including:
the inability of a supplier to provide raw materials used for manufacture of our products;
equipment obsolescence, malfunctions or failures;
product contamination problems;
damage to a facility, including our warehouses and distribution facility, due to natural disasters, including earthquakes as our South San Francisco, Oceanside and Vacaville facilities are located in areas where earthquakes could occur;
- 39 -
· | the inability of a supplier to provide raw materials used for manufacture of our products; equipment obsolescence, malfunctions or failures; |
-40-
changes in FDA regulatory requirements or standards that require modifications to our manufacturing processes;
action by the FDA or by us that results in the halting or slowdown of production of one or more of our products or products we make for others due to regulatory issues;
a contract manufacturer going out of business or failing to produce product as contractually required;
· | product contamination problems; |
· | damage to a facility, including our warehouses and distribution facilities, due to natural disasters, including, but not limited to, earthquakes as our South San Francisco, Oceanside and Vacaville facilities are located in areas where earthquakes could occur; |
· | changes in FDA regulatory requirements or standards that require modifications to our manufacturing processes; |
· | action by the FDA or by us that results in the halting or slowdown of production of one or more of our products or products we make for others due to regulatory issues; |
· | a contract manufacturer going out of business or failing to produce product as contractually required; |
Because our manufacturing processes and those of our contractors are highly complex and are subject to a lengthy FDA approval process, alternative qualified production capacity may not be available on a timely basis or at all. Difficulties or delays in our or our
contractors'contractors’ manufacturing and supply of existing or new products could increase our costs, cause us to lose revenue or market share, damage our reputation and could result in a material adverse effect on our product sales, financial condition and results of operations.
We face competition
We face competition from pharmaceutical companies, pharmaceutical divisions of chemical companies, and biotechnology companies.
The introduction of new competitive products or follow-on biologics or new information about existing products may be unable to manufacture certainresult in lost market share for us, reduced utilization of our products, and/or lower prices, even for products protected by patents.
Avastin: Avastin competes with Erbitux® (Imclone/Bristol-Myers Squibb), which is an EGFR-inhibitor approved for the treatment of irinotecan refractory or intolerant metastatic colorectal cancer patients. While Erbitux® and Avastin are approved for use in different settings (Avastin in front-line and Erbitux® in relapsed patients), physicians use both products across all lines of therapy. In December 2005, the FDA approved Nexavar® (sorafenib Bayer Corporation/Onyx Pharmaceuticals, Inc.) for the treatment of patients with advanced renal cell carcinoma (or “RCC”), or kidney cancer (unapproved uses of Avastin). In January 2006, the FDA approved Sutent® (sunitinib malate, Pfizer, Inc.) for use in advanced RCC and Gleevec-refractory / intolerant gastrointestinal stromal tumor (unapproved uses of Avastin). Avastin could face competition from products in development that currently do not have regulatory approval, including panitumumab and AMG 706 (Amgen). Amgen has announced that it expects panitumumab to be approved for refractory metastatic colorectal cancer in late 2006, and that it will initiate head-to-head clinical trials between AMG 706 and Avastin this year. Additionally, there are more than 30 potential molecules which target VEGF inhibition, and over 130 companies that are developing molecules which, if thereapproved, may compete with Avastin.
Rituxan: Rituxan’s competitors include Bexxar® (GlaxoSmithKline) and Zevalin® (Biogen Idec), both of which are radioimmunotherapies indicated for the treatment of patients with relapsed or refractory low-grade, follicular, or transformed B-cell non-Hodgkin’s lymphoma (or “NHL”). While indicated for the treatment of NHL, both products currently represent limited competition for Rituxan. Other competitors include Campath® (Berlex, Inc.), which is BSE contaminationindicated for B-cell chronic lymphocytic leukemia (an unapproved use of our bovine source raw materialMost biotechnology companies,Rituxan), and Velcade® (Millennium Pharmaceuticals, Inc.) which is indicated for multiple myeloma (an unapproved use of Rituxan).
Rituxan’s current biologic competitors in rheumatoid arthritis include Enbrel® (Amgen/Wyeth), Humira® (Abbott), Remicade® (Johnson & Johnson), Orencia® (Bristol-Myers Squibb), and Kineret® (Amgen). These products are indicated for a broader RA patient population than Rituxan.
Herceptin: Herceptin could face competition in the future from experimental drugs and products in development that do not currently have regulatory approval for any use outside of clinical trials, including Genentech, have historically used bovine source raw materialsTykerb® (lapatinib ditosylate), which is being developed by GlaxoSmithKline. On April 3, 2006, GlaxoSmithKline announced that it halted enrollment in its Phase III clinical trial to support cell growth in cell production processes. Bovine source raw materials from within or outside the U.S. are increasingly subject to greater public and regulatory scrutinyevaluate its drug Tykerb® because of positive results in treating HER2 positive metastatic breast cancer in women whose disease had progressed following treatment with Herceptin and other cancer therapies. GSK said it will file for regulatory approval of Tykerb® in the perceived risksecond half of contaminationthis year.
Tarceva: Tarceva competes with bovine spongiform encephalopathy (or "BSE"the chemotherapeutic products Taxotere® (Sanofi-Aventis) and Alimta® (Eli Lilly and Company), both of which are indicated for the treatment of relapsed NSCLC. Although not FDA approved for use in pancreatic cancer, Xeloda® (Roche) and 5-FU represent competitors in this market. Tarceva could also face competition in the future from products in late-phase development that currently do not have regulatory approval for use in NSCLC or pancreatic cancer. Examples of potential competitors in Phase III NSCLC trials are Erbitux® (Bristol-Myers Squibb), Xyotax® (Cell Therapeutics Inc.), Telcyta® (Telik, Inc.), Nexavar® (sorafenib, Bayer/ Onyx) and Zactima® (Astra Zeneca). Examples of potential competitors in Phase III pancreatic cancer trials, in addition to Xeloda® (Roche), are Erbitux® (Bristol-Myers Squibb) Eloxatin® (oxaliplatin, Sanofi-Aventis) and Avastin.
Xolair: While Xolair has no direct competitors, it faces competition from other asthma therapies, including inhaled corticosteroids, long-acting beta agonists, combination products such as fixed dose inhaled corticosteroids/long-acting beta agonists and leukotriene inhibitors, as well as oral corticosteroids.
Raptiva: Raptiva competes with established therapies for moderate-to-severe psoriasis including oral systemics such as methotrexate and cyclosporin, as well as ultraviolet light therapies. In addition, Raptiva competes with FDA approved biologic agents Amevive® (Biogen Idec) and Enbrel® (Amgen). Raptiva also competes with the unapproved biologic agents Remicade® (Centocor, Inc.) and Humira® (Abbott Laboratories), both of which are currently used in the psoriasis market. In October 2005, Centocor filed with the FDA for approval of Remicade® for the treatment of psoriasis.
Nutropin: In the growth hormone market, we face competition from other companies currently selling growth hormone products. Nutropin’s current competitors are Genotropin® (Pfizer), Norditropin® (Novo Nordisk), Humatrope® (Eli Lilly and Company), Tev-Tropin® (Teva Pharmaceutical Industries Ltd.), and Saizen® (Serono, Inc.). Should BSE contamination occur duringAs a result of multiple competitors, we have experienced, and may continue to experience, a loss of new patient share and increased competition for managed care product placement based on pricing; which may require that we discount our product in the manufacturefuture.
Thrombolytics: We face competition in our acute myocardial infarction market with sales of anyTNKase and Activase affected by the adoption by physicians of our productsmechanical reperfusion strategies. We expect that require the use of bovine source raw materials, it would negatively impactmechanical reperfusion in lieu of thrombolytic therapy for the treatment of acute myocardial infarction will continue to grow. TNKase and Activase for acute myocardial infarction also face competition from aggressive price discounting on Retavase® (reteplase), marketed by ESP Pharma, Inc. (a wholly owned subsidiary of PDL BioPharma, Inc.). Cathflo Activase may face competition in the catheter clearance market from Nuvelo’s Alfimeprase®, currently in ongoing Phase III clinical trials.
Pulmozyme: Pulmozyme faces competition from an emerging, inexpensive approach to clearing the lungs of cystic fibrosis patients. Specifically, the use of hypertonic saline could limit or reduce penetration into specific segments of the cystic fibrosis population. Research continues on new approaches to disease modification of cystic fibrosis which could reduce the number of patients in need of therapy.
Lucentis: We are aware that some retinal specialists are currently using Avastin to treat the wet form of age-related macular degeneration (or “AMD”), an unapproved use, and that there may be continued Avastin use in this setting even after Lucentis has been approved for commercial use. Laser photocoagulation, Macugen® (Pfizer/OSI
Pharmaceuticals), and Visudyne® (Novartis) alone, or in combination with the off-label steroid kenalog, are also currently being used to treat wet AMD.
In addition to the commercial and late stage development products listed above, there are numerous products in earlier stages of development at other biotechnology and pharmaceutical companies that, if successful in clinical trials, may compete with our
ability to manufacture those products for an indefinite period of time (or at least until an alternative process is approved), negatively affect our reputation and could result in a material adverse effect on our product sales, financial condition and results of operations.products.
Decreases in third party reimbursement rates may affect our product sales, results of operations and financial condition
Sales of our products will depend significantly on the extent to which reimbursement for the cost of our products and related treatments will be available to physicians from government health administration authorities, private health insurers and other organizations. Third party payers and governmental health administration authorities are increasingly attempting to limit and/or regulate the price ofreimbursement for medical products and services, especially branded prescription drugs. For example, the Medicare Prescription Drug Improvement and Modernization Act, enacted in December 2003 (or "Medicare Act"), provides for, among other things, a reduction in the Medicare reimbursement rates for many drugs, including our oncology products. The Medicare Act as well as other changesChanges in government legislation or regulation, such as the Medicare Act, or changes in private third-party payers'payers’ policies toward reimbursement for our products may reduce or eliminate reimbursement of our products'products’ costs to physicians. Decreases in third-party reimbursement for o urour products could reduce physician usage of the product and may have a material adverse effect on our product sales, results of operations and financial condition.
Protecting our proprietary rights is difficult and costly
The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. Accordingly, we cannot predict with certainty the breadth of claims allowed in these
companies'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 litigation and other legal proceedings relating to our proprietary rights, such as the
mattersCabilly reexaminations discussed in Note
3, "Leases and Contingencies,"4, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements of Part I, Item
1I of this Form 10-Q. Such litigation and other legal proceedings are costly in their own right and could subject us to significant liabilities to third-parties. An adverse decision could force us to either obtain third-party licenses at a material cost or cease using the technology or commercializing the product in dispute. An adverse decision with respect to
on eone or more of our patents or other
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intellectual property rights could cause us to incur a material loss of royalties and other revenue from licensing arrangements that we have with third-parties, and could significantly interfere with our ability to negotiate future licensing arrangements.
The presence of patents or other proprietary rights belonging to other parties may lead to our termination of the R&D of a particular product, a loss of our entire investment in the product and subject us to infringement claims.
If there is an adverse outcome in our pending litigation or other legal actions our business may be harmed
Litigation to which we are currently or have been subjected relates to, among other things, our patent and other intellectual property rights, licensing arrangements with other persons, product liability and financing activities. We cannot predict with certainty the eventual outcome of pending litigation, which may include an injunction against the manufacture or sale of a product or potential product or a judgment with significant monetary award, including the possibility of punitive damages, or a judgment that certain of our patent or other intellectual property rights are invalid or unenforceable. Furthermore, we may have to incur substantial expense in defending these lawsuits and these lawsuits could divert
management'smanagement’s attention from ongoing business concerns.
Our activities relating to the sale and marketing of our products are subject to regulation under the U.S. Federal Food, Drug and Cosmetic Act and other federal statutes, including those relating to government program fraud and abuse.statutes. Violations of these laws may be punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs (including Medicare and Medicaid). In 1999 we agreed to pay $50 million to settle a federal investigation relating to our past clinical, sales and marketing activities associated with human growth hormone. We are currently being investigated by the Department of Justice with respect to our promotional practices of Rituxan, and may in the future be investigated for our promotional practices relating to any of our products. If the
government were to bring charges against or convict us of violating these laws, or if we were subject to third party litigation relating
t oto the same promotional practices, there could be a material adverse effect on our business, including our financial condition and results of operations.
We are subject to various U.S. federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing some of our practices, it is possible that our practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented for payment to third-party payers (including Medicare and Medicaid) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services. Violations of fraud and abuse laws may be punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs (including Medicare and Medicaid). If a court were to find us liable for violating these laws, or if the government were to allege against or convict us of violating these laws, there could be a material adverse effect on our business, including on our stock price.
We may be unable to manufacture certain of our products if there is BSE contamination of our bovine source raw material
Most biotechnology companies, including Genentech, have historically used bovine source raw materials to support cell growth in our production processes. Bovine source raw materials from within or outside the U.S. are increasingly subject to greater public and regulatory scrutiny because of the perceived risk of contamination with bovine spongiform encephalopathy (or “BSE”). Should BSE contamination occur during the manufacture of any of our products that require the use of bovine source raw materials, it would negatively impact our ability to manufacture those products for an indefinite period of time (or at least until an alternative process is approved), negatively affect our reputation and could result in a material adverse effect on our product sales, financial condition and results of operations.
We may be unable to retain skilled personnel and maintain key relationships
The success of our business depends, in large part, on our continued ability to (i) attract and retain highly qualified management, scientific, manufacturing and sales and marketing personnel, (ii) successfully integrate large
numbernumbers of new employees into our corporate culture, and (iii) develop and maintain important relationships with leading research and medical institutions and key distributors. Competition for these types of personnel and relationships is intense.
Roche has the right
Among other benefits, we use stock options to
maintain its percentage ownership interest in our common stock. Our affiliation agreement with Roche provides that, among other things, we will establish a stock repurchase program designed to maintain Roche's percentage ownership in our common stock if we issue or sell any shares. In addition, changes in stock option accounting rules which will require us to recognize all stock-based compensation costs as expenses could adversely effect theattract and retain personnel. The number of shares management and our board of directors choose to grant under our stock option
plans.plans may be affected by our affiliation agreement with Roche, which provides that we will establish a stock repurchase program designed to maintain Roche’s percentage ownership in our Common Stock if we issue or sell any shares. In addition, stock option accounting rules require us to recognize all employee stock-based compensation costs as expenses. These or other factors could reduce the number of shares management and our board of directors choose to grant. We
therefore cannot
assure yoube sure that we will be able to attract or retain skilled personnel or maintain key relationships or that the costs of retaining such personnel or maintaining such relationships will not materially increase.
We face competition
We face competition from pharmaceutical companies, pharmaceutical divisions of chemical companies, and biotechnology companies of various sizes. Some competitors have greater clinical, regulatory and marketing resources and experience than we do. Many of these companies have commercial arrangements with other companies in the biotechnology industry to supplement their own research capabilities.
The introduction of new products or follow-on biologics or the development of new processes by competitors or new information about existing products may result in price reductions or product replacements, even for products
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protected by patents. Over the longer term, our and our collaborators' abilities to successfully market current products, expand their usage and bring new products to the marketplace will depend on many factors, including but not limited to the effectiveness and safety of the products, FDA and foreign regulatory agencies' approvals of new products and indications, the degree of patent protection afforded to particular products, and the effect of managed care as an important purchaser of pharmaceutical products.
We face competition in certain of our therapeutic markets. In the thrombolytic market, Activase and TNKase have lost market share and could lose additional market share to competing thrombolytic therapies and to the use of mechanical reperfusion therapies to treat acute myocardial infarction. We expect that the use of mechanical reperfusion in lieu of thrombolytic therapy for the treatment of acute myocardial infarction will continue to grow.
In the growth hormone market, we face competition from other companies currently selling growth hormone products and delivery devices. Competitors have also received approval to market their existing growth hormone products for additional indications beyond those that our products are currently are approved. As a result of that competition, we have experienced and may continue to experience a loss in market share.
Raptiva competes with established therapies for moderate-to-severe psoriasis including oral systemics such as methotrexate and cyclosporin, as well as ultraviolet light therapies. In addition, Raptiva competes with FDA-approved biologic agents Amevive® and ENBREL®, which are marketed by Biogen Idec and Amgen Inc., respectively.
Avastin may compete with ImClone/Bristol-Myers Squibb's ERBITUX®; an EGFR-inhibitor approved for the treatment of irinotecan refractory or intolerant metastatic colorectal cancer patients. We are also aware of products in development at other biotechnology or pharmaceutical companies that, if successful in clinical trials, may compete with Avastin for the indication for which we have approval or for indications for which we are seeking, or may seek, approval.
Tarceva faces competition from new and established chemotherapy regimens. Specifically, Tarceva competes with the chemotherapeutic products Taxotere® and Alimta®, both of which are indicated for the treatment of relapsed non-small cell lung cancer.
In addition to the commercial products listed above, there are numerous products in development at other biotech and pharmaceutical company that, if successful in clinical trials, may compete with our products.
Other factors could affect our product sales
Other factors that could affect our product sales include, but are not limited to:
The timing of FDA approval, if any, of competitive products.
Our pricing decisions, including a decision to increase or decrease the price of a product, and the pricing decisions of our competitors.
Government and third-party payer reimbursement and coverage decisions that affect the utilization of our products and competing products.
Negative safety or efficacy data from new clinical studies could cause the utilization and sales of our products to decrease.
Negative safety or efficacy data from post-approval marketing experience could cause sales of our products to decrease or for a product to be recalled.
The degree of patent protection afforded our products by patents granted to us and by the outcome of litigation involving our patents.
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· | The timing of FDA approval, if any, of competitive products. |
· | Our pricing decisions, including a decision to increase or decrease the price of a product, as well as the pricing decisions of our competitors, any of which could affect the utilization of our products. |
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The increasing use and development of alternate therapies.
The rate of market penetration by competing products.
The termination of, or change in, an existing arrangement with any of the wholesalers who supply our products.
· | Government and third-party payer reimbursement and coverage decisions that affect the utilization of our products and competing products. |
· | Negative safety or efficacy data from new clinical studies conducted either in the U.S. or internationally by any party could cause the sales of our products to decrease or a product to be recalled. |
· | Negative safety or efficacy data from post-approval marketing experience could cause sales of our products to decrease or a product to be recalled. |
· | The degree of patent protection afforded our products by patents granted to us and by the outcome of litigation involving our patents. |
· | The outcome of litigation involving patents of other companies concerning our products or processes related to production and formulation of those products or uses of those products. |
· | The increasing use and development of alternate therapies. |
· | The rate of market penetration by competing products. |
· | Our distribution strategy, including the termination of, or change in, an existing arrangement with any major wholesalers who supply our products. |
Any of these factors could have a material adverse effect on our sales and results of operations.
Our results of operations are affected by our royalty and contract revenues
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. |
· | The expiration or termination of existing arrangements with other companies and Hoffmann-La Roche, which may include development and marketing arrangements for our products in the U.S., Europe and other countries outside the U.S. |
· | The timing of non-U.S. approvals, if any, for products licensed to Hoffmann-La Roche and to other licensees. |
· | Fluctuations in foreign currency exchange rates. |
· | The initiation of new contractual arrangements with other companies. |
· | Whether and when contract milestones are achieved. |
· | The failure of or refusal of a licensee to pay royalties. |
· | The expiration or invalidation of our patents or licensed intellectual property. For example, patent litigations, interferences, oppositions, and other proceedings involving our patents often include claims by third-parties that such patents are invalid or unenforceable. If a court, patent office, or other authority were to determine that a patent under which we receive royalties and/or other revenues is invalid or unenforceable, that determination could cause us to suffer a loss of such royalties and/or revenues, and could cause us to incur other monetary damages. |
· | Decreases in licensees’ sales of product due to competition, manufacturing difficulties or other factors that affect the sales of product. |
Our affiliation agreement with Roche Holdings, Inc. could adversely affect our cash position
Our affiliation agreement with Roche provides that we establish a stock repurchase program designed to maintain Roche’s percentage ownership interest in our Common Stock based on an established Minimum Percentage. For more information on our stock repurchase program, see discussion below in “Liquidity and Capital Resources—Cash Used in Financing Activities.” See Note 5, “Relationship with Roche and Related Party Transactions,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for information regarding the Minimum Percentage.
While the dollar amounts associated with future stock repurchase programs cannot currently be determined, future stock repurchases could have a material adverse impact on our liquidity, credit rating and ability to access additional capital in the financial markets.
Our affiliation agreement with Roche could limit our ability to make acquisitions
The affiliation agreement between us and Roche contains provisions that:
· | Require 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. |
· | Require us to establish a stock repurchase program designed to maintain Roche’s percentage ownership interest in our Common Stock based on an established Minimum Percentage. For information regarding Minimum Percentage, see Note 5, “Relationship with Roche and Related Party Transactions,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q. |
These provisions may have the effect of limiting our ability to make acquisitions.
Future sales of our Common Stock by Roche could cause the price of our Common Stock to decline
As of March 31, 2006, Roche owned 587,189,380 shares of our Common Stock, or 55.7% 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
future products in non-U.S. markets and the timing and amountCommon Stock. Sales of
any related development cost reimbursements.Variations in Hoffmann-La Roche's sales and other licensees' salesa substantial number of licensed products.
Roche Holdings, Inc., Europeour controlling stockholder, may seek to influence our business in a manner that is adverse to us or adverse to other stockholders who may be unable to prevent actions by Roche
Roche, as our majority stockholder, controls the outcome of most actions requiring the approval of our stockholders. Our bylaws provide, among other things, that the composition of our board of directors shall consist of at least three
directors designated by Roche, three independent directors nominated by the nomination committee and one Genentech executive officer nominated by the nominations committee. Our bylaws also provide that Roche will have the right to obtain proportional representation on our board until such time that Roche owns less than 5% of our stock. Currently, three of our directors, Mr. William Burns, Dr. Erich Hunziker and Dr. Jonathan K.C. Knowles, also serve as officers and employees of Roche Holding Ltd and its affiliates. As long as Roche owns in excess of 50% of our Common Stock, Roche directors will comprise two of the three members of the nominations committee. Our certificate of incorporation includes provisions relating to competition by Roche affiliates with us, offering of corporate opportunities, transactions with interested parties, intercompany agreements, and provisions limiting the liability of specified employees. We cannot assure you that Roche will not seek to influence our business in a manner that is contrary to our goals or strategies or the interests of other countries outsidestockholders. Moreover, 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.
Additionally, our certificate of incorporation provides that any person purchasing or acquiring an interest in shares of our capital stock shall be deemed to have consented to the
U.S.The timingprovisions in the certificate of non-U.S. approvals, if any, for products licensedincorporation relating to Hoffmann-Lacompetition with Roche, conflicts of interest with Roche, the offer of corporate opportunities to Roche and intercompany agreements with Roche. This deemed consent might restrict the ability to other licensees.
Fluctuationschallenge transactions carried out in foreign currency exchange rates.
The initiation of new contractual arrangementscompliance with other companies.
Whether and when contract benchmarks are achieved.
The failure of or refusal of a licensee to pay royalties.
The expiration or invalidation of our patents or licensed intellectual property. For example, patent litigations, interferences, oppositions, and other proceedings involving our patents often include claims by third-parties that such patents are invalid or unenforceable. If a court, patent office, or other authority were to determine that a patent under which we receive royalties and/or other revenues is invalid or unenforceable, that determination could cause us to suffer a loss of such royalties and/or revenues, and could cause us to incur other monetary damages.
Decreases in licensees' sales of product due to competition, manufacturing difficulties or other factors that affect the sales of product.
these provisions.
We may incur material product liability costs
The testing and marketing of medical products entail an inherent risk of product liability. Liability exposures for biotherapeutics could be extremely large and pose a material risk. Our business may be materially and adversely affected by a successful product liability claim or claims in excess of any insurance coverage that we may have.
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Insurance coverage is increasingly more difficult and costly to obtain or maintain
While we currently have
a certain amount of insurance
forto minimize our
direct exposure to certain business
propertyrisks, premiums are generally increasing and
our products first- and third-party insurancecoverage is
increasingly more costly and narrowernarrowing in
scope, andscope. As a result, we may be required to assume more risk in the future or make significant expenditures to maintain our current levels of insurance. If we are subject to third-party claims or suffer a loss or
damagedamages in excess of our insurance coverage, we
may be required to share that risk in excesswill incur the cost of
our insurance limits.the portion of the retained risk. Furthermore, any
first- or third-party claims made on our insurance
policypolicies may
impactaffect our ability to obtain or maintain insurance coverage at reasonable
costs or at all in the future.costs.
We are subject to environmental and other risks
We use certain hazardous materials in connection with our research and manufacturing activities. In the event such hazardous materials are stored, handled or released into the environment in violation of law or any permit, we could be subject to loss of our permits, government fines or penalties and/or other adverse governmental or private actions. The levy of a substantial fine or penalty, the payment of significant environmental remediation costs or the loss of a permit or other authorization to operate or engage in our ordinary course of business could materially adversely affect our business.
We also have acquired, and may continue to acquire in the future, land and buildings as we expand our operations. Some of these properties are
"brownfields"“brownfields” for which redevelopment or use is complicated by the presence or potential presence of a hazardous substance, pollutant or contaminant. Certain events could occur which may require us to pay significant clean-up or other costs in order to maintain our operations on those properties. Such events include, but are not limited to, changes in environmental laws, discovery of new contamination, or unintended exacerbation of existing contamination. The occurrence of any such event could materially affect our ability to continue our business operations on those properties.
Fluctuations in our operating results could affect the price of our common stockCommon Stock
Our operating results may vary from period to period for several reasons including:
The overall competitive environment for our products as described in "We face competition" above.
The amount and timing of sales to customers in the U.S. For example, sales of a product may increase or decrease due to pricing changes, fluctuations in distributor buying patterns or sales initiatives that we may undertake from time to time.
The timing and volume of bulk shipments to licensees.
The availability and extent of government and private third-party reimbursements for the cost of therapy.
The extent of product discounts extended to customers.
The potential introduction of new products and additional indications for existing products.
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The ability to successfully manufacture sufficient quantities of any particular marketed product.
The number and size of any product price increases we may issue.
· | The overall competitive environment for our products as described in “We face competition” above. |
· | The amount and timing of sales to customers in the U.S. For example, sales of a product may increase or decrease due to pricing changes, fluctuations in distributor buying patterns or sales initiatives that we may undertake from time to time. |
· | The amount and timing of our sales to Hoffmann-La Roche and our other collaborators of products for sale outside of the U.S. and the amount and timing of sales to their respective customers, which directly impacts both our product sales and royalty revenues. |
· | The timing and volume of bulk shipments to licensees. |
· | The availability and extent of government and private third-party reimbursements for the cost of therapy. |
· | The extent of product discounts extended to customers. |
· | 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 the FDA approves it for sale. |
· | The rate of adoption by physicians and use of our products for approved indications and additional indications. Among other things, the rate of adoption by physicians and use of our products may be affected by results of clinical studies reporting on the benefits or risks of a product. |
· | The potential introduction of new products and additional indications for existing products. |
· | The ability to successfully manufacture sufficient quantities of any particular marketed product. |
· | Pricing decisions we may adopt. |
Our integration of new information systems could disrupt our internal operations, which could harm our revenues and increase our expenses
Portions of our information technology infrastructure may experience interruptions, delays or cessations of service or produce errors. As part of our Enterprise Resource Planning efforts, we are
in the process of implementing new
general ledger, financial reporting, order management, procurement and data warehouse systems to replace our currentinformation systems, but we may not be successful in implementing
all of the new systems, and transitioning data and other aspects of the process could be expensive, time consuming, disruptive and resource intensive. Any disruptions that may occur in the implementation of new systems or any future systems could adversely affect our ability to report in an accurate and timely manner the results of our consolidated operations, our financial position and cash flows. Disruptions to these systems also could adversely
impactaffect our ability to fulfill orders and interrupt other operational processes. Delayed sales, lower margins or lost customers resulting from these
disrup tionsdisruptions could adversely affect our financial results.
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, the market price of our
common stockCommon Stock has been and may continue to be
highly volatile.
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.
Publicity regarding actual or potential medical results relating to products under development or being commercialized by us or our competitors.
Developments or outcome of litigation, including litigation regarding proprietary and patent rights.
Regulatory developments or delays concerning our products in the U.S. and foreign countries.
Issues concerning the safety of our products or of biotechnology products generally.
Economic and other external factors or a disaster or crisis.
Period to period fluctuations in our financial results.
Our affiliation agreement with Roche Holdings, Inc. (or "Roche") could adversely affect our cash position
Our affiliation agreement with Roche provides that we establish a stock repurchase program designed to maintain Roche's percentage ownership interest in our common stock based on an established Minimum Percentage. For more information on our stock repurchase program, see discussion above in "Liquidity and Capital Resources -- Cash Provided by or Used in Financing Activities." See Note 4, "Relationship with Roche and Related Party Transactions," in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for information regarding the Minimum Percentage.
While the dollar amounts associated with future stock repurchase programs cannot currently be determined, future stock repurchases could have a material adverse impact on our liquidity, credit rating and ability to access additional capital in the financial markets, and may have the effect of limiting our ability to use our capital stock as consideration for acquisitions.
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Future sales of our common stock by Roche could cause the price of our common stock to decline
As of June 30, 2005, Roche owned 587,189,380 shares of our common stock or 55.3% 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. 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.
Roche Holdings, Inc., our controlling stockholder, may have interests that are adverse to other stockholders
Roche as our majority stockholder controls the outcome of most actions requiring the approval of our stockholders. Our bylaws provide, among other things, that the composition of our board of directors shall consist of at least three directors designated by Roche, three independent directors nominated by the nominating committee and one Genentech executive officer nominated by the nominating committee. Currently, three of our directors, Mr. William Burns, Dr. Erich Hunziker and Dr. Jonathan K.C. Knowles, also serve as officers and employees of Roche Holding Ltd and its affiliates. As long as 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. We cannot assure you that Roche will not seek to influence our business operations in a manner that is contrary to our goals or strategies.
Our affiliation agreement with Roche could limit our ability to make acquisitions and could have a material negative impact on our liquidity
The affiliation agreement between us and Roche contains provisions that:
Require 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.
Require us to establish a stock repurchase program designed to maintain Roche's percentage ownership interest in our common stock based on an established Minimum Percentage. For information regarding Minimum Percentage, see Note 4, "Relationship with Roche and Related Party Transactions," in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q for a discussion of our relationship with Roche and Roche's ability to maintain its percentage ownership interesting our stock. For more information on our stock repurchase program, see discussion above in "Liquidity and Capital Resources -- Cash Provided by or Used in Financing Activities."
These provisions may have the effect of limiting our ability to make acquisitions and while the dollar amounts associated with our future stock repurchases cannot currently be estimated, stock repurchases could have a material adverse impact on our liquidity, credit rating and ability to access additional capital in the financial markets.
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 the following matters:
Competition by Roche affiliates with us.
Offering of corporate opportunities.
Transactions with interested parties.
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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 might restrict the 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 favorable to us but 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. Three of our directors currently serve as officers and employees of Roche Holding Ltd and its affiliates.
Common Stock.
· | Announcements of technological innovations or new commercial products by us or our competitors. |
· | Publicity regarding actual or potential medical results relating to products under development or being commercialized by us or our competitors. |
· | Concerns about the pricing of our products and the potential impact of such on their utilization. |
· | Developments or outcome of litigation, including litigation regarding proprietary and patent rights. |
· | Regulatory developments or delays concerning our products in the U.S. and foreign countries. |
· | Issues concerning the safety of our products or of biotechnology products generally. |
· | Economic and other external factors or a disaster or crisis. |
· | Period to period fluctuations in our financial results. |
Our effective income tax rate may vary significantly
Various internal and external factors may have favorable or unfavorable effects on our future effective
income tax rate. These factors include but are not limited to changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations,
changes in estimates of prior years’ items, past and future levels of R&D spending, and changes in overall levels of
pretax earnings.Recent accounting pronouncements may impact our future financial position and results of operations
Under Financial Accounting Standards Board (or "FASB") Interpretation No. 46R (or "FIN 46R"), a revision to Interpretation 46, "Consolidation of Variable Interest Entities," we are required to assess new business development collaborations as well as to reassess, upon certain events, some of which are outside our control, the accounting treatment of our existing business development collaborations based on the nature and extent of our variable interests in the entities as well as the extent of our ability to exercise influence in the entities with which we have such collaborations. Our continuing compliance with FIN 46R may result in our consolidation of companies or related entities with which we have a collaborative arrangement and this may have a material impact on our financial condition and/or results of operations in future periods.
There may be potential new accounting pronouncements or regulatory rulings, which may have an impact on our future financial position and results of operations. In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or "FAS") No. 123, "Accounting for Stock-Based Compensation." The revision is referred to as "FAS 123R -- Share-Based Payment", which supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee stock plans. We expect to adopt FAS 123R using the modified prospective basis on January 1, 2006. We expect that our adoption of FAS 123R will result in compensation expense comparable,income before the effect of capitalization of manufacturing related compensation expenses, to those disclosed in Note 1, "Summary of Significant Accounting Polici es -- Accounting for Stock-Based Compensation," in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of our Form 10-Q. We are currently evaluating option valuation methodologies and assumptions in light of FAS 123R; the methodologies and assumptions we ultimately use to adopt FAS 123R may be different than those currently used as discussed in Note 1, "Summary of Significant Accounting Policies -- Accounting for Stock-Based Compensation," in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of our Form 10-Q. We currently expect that our adoption of FAS 123R will have a material impact on our consolidated results of operations.
taxes.
To pay our indebtedness will require a significant amount of cash and may adversely affect our operations and financial results
As of March 31, 2006, we had approximately $2.0 billion of long-term debt. Our ability to make payments on and to refinance our indebtedness, including our long-term debt obligations, and to fund planned capital expenditures, R&D, as well as stock repurchases and expansion efforts will depend on our
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ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are and will remain beyond our control. Additionally, our indebtedness may increase our vulnerability to general adverse economic and industry conditions, require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, which would reduce the availability of our cash flow to fund working capital, capital expenditures, R&D, expansion efforts and other general corporate purposes, and limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate.
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Item 3. Quantitative
Accounting pronouncements may affect our future financial position and Qualitative Disclosures About Market RiskOur market risks at June 30, 2005results of operations
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (or “FAS 123R”). As a result, we have
not changed significantly from thoseincluded employee stock-based compensation costs in our results of operations for the quarter ended March 31, 2006, as discussed in
Item 7A of our Form 10-K for the year ended December 31, 2004 on file with the Securities and Exchange Commission. See also Note
1, "Summary of Significant Accounting Policies -- Derivative Financial Instruments" section in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures. The Company's principal executive and financial officers reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Company's principal executive and financial officers concluded that the Company's disclosure controls and procedures are effective in providing them with material information relating to the Company in a timely manner, as required to be disclosed in the reports the Company files under the Exchange Act.
(b) Changes in internal control over financial reporting. There was no change in the Company's internal control over financial reporting that occurred during the period covered by this Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In connection with the Chiron patent infringement lawsuit and interference proceedings relating to United States (or "U.S.") Patent No. 6,054,561, on June 1, 2005, we and Chiron agreed to a settlement of both these interference proceedings and the lawsuit. All pending claims in the lawsuit were dismissed with prejudice, and Chiron has abandoned the contest in the redeclared interferences. The settlement resolves and ends all the patent infringement claims in the lawsuit. The outcome of the interference with respect to our patents and patent applications cannot be determined at this time.
On May 13, 2005, a request was filed by a third party for reexamination of the '415 or Cabilly patent. The request sought reexamination on the basis of non-statutory double patenting over U.S. Patent No. 4,816,567. On July 7, 2005, the U.S. Patent Office ordered reexamination of the '415 patent. Because the reexamination process is ongoing, the final outcome of this matter cannot be determined at this time. The '415 patent, which expires in 2018, relates to methods we and others use to make certain antibodies or antibody fragments, as well as cells and DNA used in these methods. We have licensed the '415 patent to other companies and derive substantial royalties from those licenses.
See also Note 3, "Leases and Contingencies,"2, “Employee Stock-Based Compensation,” in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1I of this Form 10-Q.
See also Item 3 Our adoption of FAS 123R is expected to result in compensation expense that will reduce diluted net income per share by approximately $0.15 to $0.17 per share for 2006. However, our estimate of future employee stock-based compensation expense is affected by our stock price, the number of stock-based awards our board of directors may grant in 2006, as well as a number of complex and subjective valuation assumptions and the related tax effect. These valuation assumptions include, but are not limited to, the volatility of our report on Form 10-K for the year ended December 31, 2004,stock price and Part II, Item 1 of our report on Form 10-Q for the quarter ended March 31, 2005.
employee stock option exercise behaviors.
Under a stock repurchase program approved by our Board of Directors
approved an extensionin December 2003 and most recently extended in April 2006, we are authorized to repurchase up to 100,000,000 shares of our
stock repurchase programCommon Stock for
the repurchasean aggregate amount of up to
an additional $2.0 billion of our common stock for a total of $4.0$6.0 billion through June 30,
2006. The Board also amended the current repurchase program by increasing the maximum number of shares that can be repurchased from 50 million to 80 million shares. Under2007. In this stock repurchase program, purchases may be made in the open market or in privately negotiated transactions from time to time at
management'smanagement’s discretion. Genentech also may engage in transactions in other Genentech securities in conjunction with the repurchase program, including certain derivative securities. Genentech intends to use the repurchased stock to offset dilution caused by the issuance of shares in connection with
Genentech'sGenentech’s employee stock plans. Although there are currently no specific plans for the shares that may be purchased under the program, our goals for the program are (i) to make prudent investments of our cash resources; (ii) to allow for an effective mechanism to provide stock for our employee stock plans; and (iii) to address provisions of our affiliation agreement with Roche relating to maintaining
Roche'sRoche’s minimum ownership percentage. See above in
"Relationship“Relationship with
Roche"Roche” for more information on
Roche'sRoche’s minimum ownership percentage. We have entered into Rule 10b5-1 trading plans to repurchase shares in the open market during those periods each quarter when trading in our stock is restricted under our insider trading policy. The current trading plan covers approximately
1.52 million shares and will run through
December 31, 2005.June 30, 2006.
Our shares repurchased for the three months ended June 30, 2005March 31, 2006 were as follows (shares in millions): | |
Total Number of Shares Purchased in 2005
| |
Average Price Paid per Share
| | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs |
| | | | | | | | |
April 1-30, 2005 | | | 0.1 | | | | $ | 56.83 | | | | | | | | | |
May 1-31, 2005 | | | - | | | | | - | | | | | | | | | |
June 1-30, 2005 | | | - | | | | | - | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
Total | | | 0.1 | | | | | 56.83 | | | | 29.0 | | | | 51.0 | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
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| | Total Number of Shares Purchased in 2006 | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | |
January 1-31, 2006 | | | 0.9 | | $ | 88.37 | | | | | | | |
February 1-28, 2006 | | | 0.7 | | | 85.31 | | | | | | | |
March 1-31, 2006 | | | 1.0 | | | 84.24 | | | | | | | |
Total | | | 2.6 | | $ | 85.95 | | | 52 | | | 48 | |
The par value method of accounting is used for common stock repurchases. The excess of the cost of shares acquired over the par value is allocated to additional paid-in capital with the amounts in excess of the estimated original sales price charged to accumulated deficit.
Item 4. Submission of Matters to a Vote of Security HoldersAt Genentech's Annual Meeting of Stockholders held on April 14, 2005, two matters were voted upon. A description of each matter and a tabulation of the votes for each of the matters follows:
1.
| To elect six director nominees to hold office until the 2006 Annual Meeting of Stockholders or until their successors are duly elected and qualified:
|
| | Votes |
| | |
Nominee | | For | | Withheld |
| | | | |
Herbert W. Boyer, Ph.D. | | 888,986,813 | | 116,574,155 |
William M. Burns | | 889,053,464 | | 116,507,504 |
Erich Hunziker, Ph.D. | | 887,880,218 | | 117,680,750 |
Jonathan K.C. Knowles, Ph.D. | | 887,958,614 | | 117,602,354 |
Arthur D. Levinson, Ph.D. | | 911,755,385 | | 93,805,583 |
Charles A. Sanders, M.D. | | 971,312,485 | | 34,248,483 |
2.
| To ratify Ernst & Young LLP as our independent auditor for 2005.
|
Votes |
|
For | | Against | | Abstain |
| | | | |
997,406,006 | | 7,114,559 | | 1,040,403 |
Item 6. Exhibits
Exhibit No. | (i)
Description | 10.29*
| Purchase and Sale Agreement and Joint Escrow Instruction, dated as of June 16, 2005, between Genentech and Biogen Idec Inc.
Location |
10.1 | Genentech, Inc. Employee Stock Plan, as amended | | Filed on a Current Report on Form 8-K with the U.S. Securities and Exchange Commission on April 25, 2006, and incorporated herein by reference. |
15.1 | (ii)
| 15.1
| Letter regarding Unaudited Interim Financial Information. | Filed herewith |
31.1 | | | | |
| (iii)
| 31.1
| Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. amended | Filed herewith |
31.2 | | | | |
| (iv)
| 31.2
| Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. amended | Filed herewith |
32.1 | | | | |
| (v)
| 32.1
| Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 2002 | Furnished herewith |
___________
*
| | Pursuant to a request for confidential treatment, portions of this Exhibit have been redacted from the publicly filed document and have been furnished separately to the Securities and Exchange Commission as required by Rule 24b-2 under the Securities Exchange Act of 1934.
|
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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: | August 2, 2005 May 1, 2006 | | /s/ARTHUR D. LEVINSON |
| | | |
| | | Arthur D. Levinson, Ph.D.
Chairman and Chief Executive Officer |
| | | |
| | | |
Date: | August 2, 2005 May 1, 2006 | | /s/DAVID A. EBERSMAN |
| | | |
| | | David A. Ebersman
Senior Executive Vice President and
Chief Financial Officer |
| | | |
| | | |
Date: | August 2, 2005 May 1, 2006 | | /s/JOHN M. WHITING |
| | | |
| | | John M. Whiting
Vice President, Controller and
Chief Accounting Officer |
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