Genentech, Inc. Form 10-Q For the Period Ending 03/31/2007
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
________________________
FORM
10-Q
________________________
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(Mark
One)
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þ
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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 March 31, 2007
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or
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o
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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 .
Commission
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’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 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):
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Large
accelerated filer þ
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Accelerated
filer o
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Non-accelerated
filer o
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
Indicate
the number of shares outstanding of each of the issuer’s classes of Common
Stock, as of the latest practicable date.
|
Class
|
Number
of Shares Outstanding
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Common
Stock $0.02 par value
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1,053,169,937 Outstanding
at April 27, 2007
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GENENTECH,
INC.
TABLE
OF CONTENTS
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Page
No.
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Item
1.
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3
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3
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4
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5
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6-13
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14
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Item
2.
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15-36
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Item
3.
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37
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Item
4.
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37
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Item
1.
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38
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Item
1A.
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38-49
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Item
2.
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49
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Item
6.
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50
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51
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In
this report, “Genentech,” “we,” “us” and “our” refer to Genentech, Inc. “Common
Stock” refers to Genentech’s Common Stock, par value $0.02 per share, “Special
Common Stock” refers to Genentech’s callable putable 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® (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; Omnitarg™ (pertuzumab) HER dimerization
inhibitor; Pulmozyme® (dornase alfa, recombinant) inhalation solution; Raptiva®
(efalizumab) anti-CD11a antibody; and TNKase® (tenecteplase) single-bolus
thrombolytic agent. Rituxan® (rituximab) anti-CD20 antibody is a registered
trademark of Biogen Idec Inc.; Tarceva® (erlotinib) is a 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.
GENENTECH,
INC.
(In
millions, except per share amounts)
(Unaudited)
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Revenues
|
|
|
|
|
|
|
Product
sales (including amounts from related parties: 2007-$266;
2006-$59)
|
|
$
|
2,329
|
|
$
|
1,644
|
|
|
Royalties
(including amounts from related parties: 2007-$260;
2006-$167)
|
|
|
419
|
|
|
286
|
|
|
Contract
revenue (including amounts from related parties: 2007-$70;
2006-$28)
|
|
|
95
|
|
|
56
|
|
|
Total
operating revenues
|
|
|
2,843
|
|
|
1,986
|
|
| |
|
|
|
|
|
|
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Costs
and expenses
|
|
|
|
|
|
|
|
|
Cost
of sales (including amounts for related parties: 2007-$124;
2006-$50)
|
|
|
392
|
|
|
262
|
|
|
Research
and development (including amounts for related parties: 2007-$68;
2006-$53)
(including
contract related: 2007-$46; 2006-$36)
|
|
|
610
|
|
|
374
|
|
|
Marketing,
general and administrative
|
|
|
491
|
|
|
441
|
|
|
Collaboration
profit sharing (including amounts for a related party: 2007-$47;
2006-$43)
|
|
|
252
|
|
|
226
|
|
|
Recurring
charges related to redemption
|
|
|
26
|
|
|
26
|
|
|
Special
items: litigation-related
|
|
|
13
|
|
|
13
|
|
|
Total
costs and expenses
|
|
|
1,784
|
|
|
1,342
|
|
| |
|
|
|
|
|
|
|
|
Operating
income
|
|
|
1,059
|
|
|
644
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
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Interest
and other income (expense), net
|
|
|
74
|
|
|
53
|
|
|
Interest
expense
|
|
|
(18
|
)
|
|
(19
|
)
|
|
Total
other income, net
|
|
|
56
|
|
|
34
|
|
|
Income
before taxes
|
|
|
1,115
|
|
|
678
|
|
|
Income
tax provision
|
|
|
409
|
|
|
257
|
|
|
Net
income
|
|
$
|
706
|
|
$
|
421
|
|
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|
|
|
|
|
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Earnings
per share
|
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Basic
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$
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0.67
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$
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0.40
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Diluted
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|
$
|
0.66
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$
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0.39
|
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| |
|
|
|
|
|
|
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Shares
used to compute basic earnings per share
|
|
|
1,053
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|
1,054
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|
Shares
used to compute diluted earnings per share
|
|
|
1,071
|
|
|
1,075
|
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(In
millions)
(Unaudited)
| |
|
Three
Months
Ended
March 31,
|
|
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|
2007
|
|
2006
|
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
Net
income
|
|
$
|
706
|
|
$
|
421
|
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
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Depreciation
and amortization
|
|
|
106
|
|
|
96
|
|
|
Employee
stock-based compensation
|
|
|
100
|
|
|
74
|
|
|
Deferred
income taxes
|
|
|
(81
|
)
|
|
(50
|
)
|
|
Deferred
revenue
|
|
|
(15
|
)
|
|
10
|
|
|
Litigation-related
liabilities
|
|
|
13
|
|
|
13
|
|
|
Excess
tax benefit from stock-based compensation arrangements
|
|
|
(99
|
)
|
|
(49
|
)
|
|
Gain
on sales of securities available-for-sale and other, net
|
|
|
(8
|
)
|
|
(3
|
)
|
|
Write-down
of securities available-for-sale and other
|
|
|
3
|
|
|
-
|
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Loss
on property and equipment dispositions
|
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11
|
|
|
-
|
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
and other current assets
|
|
|
(31
|
)
|
|
(96
|
)
|
|
Inventories
|
|
|
(115
|
)
|
|
(86
|
)
|
|
Investments
in trading securities
|
|
|
(9
|
)
|
|
(7
|
)
|
|
Accounts
payable, other accrued liabilities, and other long-term
liabilities
|
|
|
179
|
|
|
139
|
|
|
Net
cash provided by operating activities
|
|
|
760
|
|
|
462
|
|
| |
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
Purchases
of securities available-for-sale
|
|
|
(122
|
)
|
|
(454
|
)
|
|
Proceeds
from sales of securities available-for-sale
|
|
|
37
|
|
|
75
|
|
|
Proceeds
from maturities of securities available-for-sale
|
|
|
126
|
|
|
118
|
|
|
Capital
expenditures
|
|
|
(209
|
)
|
|
(253
|
)
|
|
Change
in other intangible and long-term assets
|
|
|
31
|
|
|
(13
|
)
|
|
Net
cash used in investing activities
|
|
|
(137
|
)
|
|
(527
|
)
|
| |
|
|
|
|
|
|
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
Stock
issuances
|
|
|
174
|
|
|
89
|
|
|
Stock
repurchases
|
|
|
(392
|
)
|
|
(227
|
)
|
|
Excess
tax benefit from stock-based compensation arrangements
|
|
|
99
|
|
|
49
|
|
|
Net
cash used in financing activities
|
|
|
(119
|
)
|
|
(89
|
)
|
|
Net
increase (decrease) in cash and cash equivalents
|
|
|
504
|
|
|
(154
|
)
|
|
Cash
and cash equivalents at beginning of period
|
|
|
1,250
|
|
|
1,225
|
|
|
Cash
and cash equivalents at end of period
|
|
$
|
1,754
|
|
$
|
1,071
|
|
| |
|
|
|
|
|
|
|
|
Supplemental
cash flow data
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
Interest
|
|
$
|
42
|
|
$
|
42
|
|
|
Income
taxes
|
|
|
163
|
|
|
6
|
|
|
Non-cash
investing and financing activities
|
|
|
|
|
|
|
|
|
Capitalization
of construction in progress related to financing lease
transactions
|
|
|
57
|
|
|
27
|
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(In
millions)
(Unaudited)
| |
|
March
31,
2007
|
|
December
31,
2006
|
|
|
Assets
|
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
1,754
|
|
$
|
1,250
|
|
|
Short-term
investments
|
|
|
1,149
|
|
|
1,243
|
|
|
Accounts
receivable—product sales (net of allowances: 2007-$94;
2006-$92; including amounts from related parties: 2007-$113;
2006-$56)
|
|
|
1,077
|
|
|
965
|
|
|
Accounts
receivable—royalties (including amounts from related parties:
2007-$340;
2006-$316)
|
|
|
481
|
|
|
453
|
|
|
Accounts
receivable—other (including amounts from related parties: 2007-$56;
2006-$150)
|
|
|
134
|
|
|
248
|
|
|
Inventories
|
|
|
1,297
|
|
|
1,178
|
|
|
Deferred
tax assets
|
|
|
293
|
|
|
278
|
|
|
Prepaid
expenses and other current assets
|
|
|
100
|
|
|
89
|
|
|
Total
current assets
|
|
|
6,285
|
|
|
5,704
|
|
|
Long-term
marketable debt and equity securities
|
|
|
1,889
|
|
|
1,832
|
|
|
Property,
plant and equipment, net
|
|
|
4,353
|
|
|
4,173
|
|
|
Goodwill
|
|
|
1,315
|
|
|
1,315
|
|
|
Other
intangible assets
|
|
|
449
|
|
|
476
|
|
|
Restricted
cash and investments
|
|
|
788
|
|
|
788
|
|
|
Other
long-term assets
|
|
|
609
|
|
|
554
|
|
|
Total
assets
|
|
$
|
15,688
|
|
$
|
14,842
|
|
| |
|
|
|
|
|
|
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
|
Accounts
payable (including amounts to related parties: 2007-$15;
2006-$7)
|
|
$
|
420
|
|
$
|
346
|
|
|
Deferred
revenue
|
|
|
57
|
|
|
62
|
|
|
Taxes
payable
|
|
|
338
|
|
|
111
|
|
|
Other
accrued liabilities (including amounts to related parties:
2007-$126;
2006-$136)
|
|
|
1,263
|
|
|
1,491
|
|
|
Total
current liabilities
|
|
|
2,078
|
|
|
2,010
|
|
|
Long-term
debt
|
|
|
2,267
|
|
|
2,204
|
|
|
Deferred
revenue
|
|
|
189
|
|
|
199
|
|
|
Litigation-related
and other long-term liabilities
|
|
|
1,006
|
|
|
951
|
|
|
Total
liabilities
|
|
|
5,540
|
|
|
5,364
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
Stockholders’
equity
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
21
|
|
|
21
|
|
|
Additional
paid-in capital
|
|
|
10,422
|
|
|
10,091
|
|
|
Accumulated
other comprehensive income
|
|
|
212
|
|
|
204
|
|
|
Accumulated
deficit, since June 30, 1999
|
|
|
(507
|
)
|
|
(838
|
)
|
|
Total
stockholders’ equity
|
|
|
10,148
|
|
|
9,478
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
15,688
|
|
$
|
14,842
|
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(Unaudited)
|
Note
1.
|
Summary
of Significant Accounting
Policies
|
Basis
of Presentation
We
prepared the Condensed 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 U.S. generally accepted accounting principles
(or
“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 Statements and accompanying notes included in our Annual Report on
Form 10-K for the year ended December 31, 2006. In the opinion of management,
the financial statements include all adjustments, consisting only of normal
and
recurring adjustments, 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
consolidated financial statements include the accounts of Genentech and all
wholly owned subsidiaries. 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 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 statements to conform to the current period
presentation.
Recent
Accounting Pronouncements
On
January 1, 2007, we adopted Emerging Issues Task Force (or “EITF”) Issue No.
06-2, “Accounting
for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement
No.
43, Accounting for Compensated Absences”
(or “EITF 06-2”). Prior to the adoption of EITF 06-2, we recorded a liability
for a sabbatical leave when the employee vested in the benefit, which was only
at the end of a six-year service period. Under EITF 06-2, we accrue an estimated
liability for a sabbatical leave over the requisite six-year service period,
as
the employee’s services are rendered. Upon our adoption of EITF 06-2 we recorded
an adjustment to accumulated deficit of $26 million, net of tax, as a cumulative
effect of a change in accounting principle.
On
January 1, 2007, we adopted the provisions of FASB Interpretation No. 48,
“Accounting
for Uncertainty in Income Taxes”
(or “Interpretation 48”). Implementation of Interpretation 48 did not result in
a cumulative adjustment to accumulated deficit. The total amount of unrecognized
tax benefits as of the date of adoption was $147 million. Of this total, $112
million represents the amount of unrecognized tax benefits that, if recognized,
would favorably affect our effective income tax rate in future periods. As
a
result of the implementation of Interpretation 48, we reclassified $147 million
of unrecognized tax benefits from current liabilities to long-term liabilities
as of January 1, 2007 and we also reclassified the balance as of December 31,
2006, for consistency, in the accompanying Condensed Consolidated Balance
Sheets.
We
file income tax returns in the U.S. federal jurisdiction and various state
and
foreign jurisdictions. Substantially all U.S. federal income tax and all
material state and local tax matters have been concluded for all years ended
through December 31, 2000. The Internal Revenue Service (or “IRS”) is currently
examining our U.S. federal income tax returns for the years ended December
31,
2002 through 2004. As of March 31, 2007, the IRS has not proposed any
adjustments. We are also currently under examination by several state
jurisdictions. As of March 31, 2007, no material adjustments related to these
examinations have been proposed.
We
accrue tax-related interest expenses and include such expenses with income
taxes
in our condensed consolidated statements of income and financial position.
We
recognized approximately $2 million in tax-related interest expense during
the
three months ended March 31, 2007 and had approximately $10 million of
tax-related interest accrued at January 1, 2007. Interest amounts are net of
tax
benefit. No penalties have been accrued.
Revenue
Recognition
We
recognize revenue from the sale of our products, royalties earned and contract
arrangements. Our revenue arrangements that contain 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.
The
Avastin Patient Assistance Program is a voluntary program that enables eligible
patients who have received 10,000 milligrams of Avastin in a 12-month period
to
receive free Avastin in excess of the 10,000 milligrams during the remainder
of
the 12-month period. Based on the current wholesale acquisition cost, the 10,000
milligrams is valued at $55,000 in gross revenue. We defer a portion of our
gross Avastin product sales revenue to reflect our estimate of the commitment
to
supply free Avastin to those patients who elect to enroll in the program. To
calculate our deferred revenue, we estimate the number of patients who will
receive free Avastin and the amount of free Avastin that we expect them to
receive. Based on these estimates, we defer a portion of Avastin revenue on
product vials sold through normal commercial channels. The deferred revenue
will
be recognized as free Avastin vials are delivered.
Earnings
Per Share
Basic
earnings per share (or “EPS”) are computed based on the weighted-average number
of shares of our Common Stock outstanding. Diluted earnings per share are
computed based on the weighted-average number of shares of our Common Stock
and
other dilutive securities.
The
following is a reconciliation of the numerators and denominators of the basic
and diluted earnings per share computations (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Numerator:
|
|
|
|
|
|
|
Net
income
|
|
$
|
706
|
|
$
|
421
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding used to compute basic earnings per
share
|
|
|
1,053
|
|
|
1,054
|
|
|
Effect
of dilutive stock options
|
|
|
18
|
|
|
21
|
|
|
Weighted-average
shares outstanding and dilutive securities used to compute diluted
earnings per share
|
|
|
1,071
|
|
|
1,075
|
|
Outstanding
employee stock options to purchase approximately 35 million shares of our Common
Stock were excluded from the computation of diluted EPS for the first quarter
of
2007 because the effect would have been anti-dilutive.
Comprehensive
Income
Comprehensive
income is comprised of net income and other comprehensive income (or “OCI”). OCI
includes certain changes in 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. In accordance with our adoption
of
FAS 158 in 2006, the gains or losses and prior service costs or credits that
arise during the period, but are not recognized as components of net periodic
benefit cost, have been recognized in other comprehensive income.
The
components of accumulated other comprehensive income, net of taxes, were as
follows (in
millions):
| |
|
March
31, 2007
|
|
December
31, 2006
|
|
|
Net
unrealized gains on securities available-for-sale
|
|
$
|
219
|
|
$
|
214
|
|
|
Net
unrealized losses on cash flow hedges
|
|
|
(1
|
)
|
|
(4
|
)
|
|
Post-retirement
benefit obligation
|
|
|
(6
|
)
|
|
(6
|
)
|
|
Accumulated
other comprehensive income
|
|
$
|
212
|
|
$
|
204
|
|
The
activity in comprehensive income, net of income taxes, was as follows
(in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Net
income
|
|
$
|
706
|
|
$
|
421
|
|
|
Increase
in unrealized gains on securities available-for-sale
|
|
|
5
|
|
|
3
|
|
|
Increase
(decrease) in unrealized gains on cash flow hedges
|
|
|
3
|
|
|
(1
|
)
|
|
Comprehensive
income, net of income taxes
|
|
$
|
714
|
|
$
|
423
|
|
Derivative
Instruments
Our
derivative instruments, designated as cash flow hedges, consist of foreign
currency exchange options and marketable equity collars. At March 31, 2007,
estimated net gains expected to be reclassified from accumulated OCI to “other
income, net” during the next twelve months are $3 million.
|
Note
2.
|
Employee
Stock-Based Compensation
|
Stock-based
Compensation Expense under FAS 123R
Employee
stock-based compensation expense recognized in the first quarters of 2007 and
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 123R was as follows
(in
millions, except for per share data):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Cost
of sales (or “COS”)
|
|
$
|
16
|
|
$
|
-
|
|
|
Research
and development
|
|
|
38
|
|
|
33
|
|
|
Marketing,
general and administrative
|
|
|
46
|
|
|
41
|
|
|
Total
employee stock-based compensation expense
|
|
$
|
100
|
|
$
|
74
|
|
As
of March 31, 2007, total compensation cost related to unvested stock options
not
yet recognized was $751
million, which is expected to be allocated to expense and production costs
over
a weighted-average period of 26 months.
The
carrying value of inventory on our Condensed Consolidated Balance Sheets as
of
March 31, 2007 and 2006 includes employee stock-based compensation costs of
$71
million and $16 million, respectively. During the first quarter of 2007, $16
million of previously capitalized employee stock-based compensation costs were
recognized in COS. Substantially all of the products sold during the first
quarter of 2006 were manufactured in previous periods when we did not include
employee stock-based compensation expense in our production costs.
Valuation
Assumptions
The
employee stock-based compensation expense recognized under FAS 123R 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,
|
|
| |
|
2007
|
|
2006
|
|
|
Risk-free
interest rate
|
|
|
4.6
|
%
|
|
4.6
|
%
|
|
Dividend
yield
|
|
|
0.0
|
%
|
|
0.0
|
%
|
|
Expected
volatility
|
|
|
27.0
|
%
|
|
29.0
|
%
|
|
Expected
term (years)
|
|
|
4.6
|
|
|
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.
|
Note
3.
|
Condensed
Consolidated Financial Statement
Detail
|
Inventories
The
components of inventories were as follows (in
millions):
| |
|
March
31, 2007
|
|
December
31, 2006
|
|
|
Raw
materials and supplies
|
|
$
|
117
|
|
$
|
116
|
|
|
Work
in process
|
|
|
889
|
|
|
818
|
|
|
Finished
goods
|
|
|
291
|
|
|
244
|
|
|
Total
|
|
$
|
1,297
|
|
$
|
1,178
|
|
Included
in work in process at March 31, 2007 and December 31, 2006 are approximately
$210 million and $81 million, respectively, of Avastin inventories that were
manufactured through manufacturing processes or at facilities awaiting
regulatory licensure. The majority of these inventories were manufactured at
our
Oceanside facility for which we received U.S. Food and Drug Administration
licensure on April 27, 2007.
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 U.S. Department of Justice,
requesting documents related to the promotion of Rituxan, a prescription
treatment now approved for five indications: (1) the treatment of relapsed
or refractory, low-grade or follicular, CD20-positive, B-cell non-Hodgkin’s
lymphoma, (2) the first-line treatment of diffuse large B-cell, CD20-positive,
non-Hodgkin’s lymphoma in combination with CHOP (cyclophosphamide, doxorubicin,
vincristine and prednisone) or other anthracycline-based chemotherapy regimens,
(3) the first-line treatment of previously untreated patients with follicular,
CD20-positive, B-cell non-Hodgkin’s lymphoma in combination with
cyclophosphamide, vincristine, prednisone (or “CVP”) chemotherapy, (4) the
treatment of low-grade, CD20-positive, B-cell non-Hodgkin’s lymphoma in patients
with stable disease or who achieve a partial or complete response following
first-line treatment with CVP chemotherapy, and (5) 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 tumor necrosis factor antagonist therapies. We are cooperating with
the
associated investigation, which we have been advised is both civil and criminal
in nature. The government has called, and may continue 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. Genentech filed a motion to dismiss the complaint
and
on December 14, 2006, the Magistrate Judge assigned to the case issued a
Recommended Decision on that motion, which is subject to review by the District
Court Judge. The Magistrate Judge recommended that the False Claims Act portion
of the complaint be dismissed, leaving as the only remaining claim against
Genentech the plaintiff’s retaliatory discharge claim. Plaintiff, Biogen Idec,
and Genentech each subsequently filed objections with the District Court Judge
concerning certain aspects of the Magistrate Judge’s Recommended Decision. We
are awaiting the District Court’s decision on the Recommended Decision and the
objections. The outcome of this matter cannot be determined at this time.
We
and the City of Hope National Medical Center (or “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/Itakura Patents.” Since that time, we 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 2002 and are
included in the accompanying Condensed Consolidated Balance Sheets in
“litigation-related and other long-term liabilities” at March 31, 2007 and
December 31, 2006. 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’s request for rehearing. On November 24, 2004,
we filed a petition seeking review by the California Supreme Court. On February
2, 2005, the California Supreme Court granted that petition. The appeal to
the
California Supreme Court has been fully briefed and we are waiting to be
assigned an oral argument date. 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’s review of the matter. It may take longer than one
year to resolve the matter.
We
recorded $13 million of accrued interest and bond costs related to the COH
trial
judgment in the first quarters of 2007 and 2006. In conjunction with the COH
judgment, we posted a surety bond and were required to pledge cash and
investments of $788 million at March 31, 2007 and December 31, 2006 to secure
the bond. These amounts are reflected in “restricted cash and investments” in
the accompanying 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
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” or “Cabilly patent”) that we co-own with COH
and under which MedImmune and other companies have been licensed and are paying
royalties to us. The lawsuit includes claims for violation of antitrust, patent,
and unfair competition laws. MedImmune is seeking a ruling that the ‘415 patent
is invalid and/or unenforceable, a determination that MedImmune does not owe
royalties under the ‘415 patent on sales of its Synagis® antibody product, an
injunction to prevent us from enforcing the ‘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 our favor
on all of MedImmune’s antitrust and unfair competition claims. On April 23,
2004, the District Court granted our motion to dismiss all remaining claims
in
the case. On October 18, 2005, the U.S. Court of Appeals for the Federal Circuit
affirmed the judgment of the 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 and the oral argument of this case
before the Supreme Court occurred on October 4, 2006. On January 9, 2007, the
Supreme Court issued a decision reversing the Federal Circuit’s decision and
remanding the case to the lower courts for further proceedings in connection
with the patent and contract claims. The case is currently set for a status
conference on June 4, 2007 in the District Court. 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
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. On September
13, 2005, the Patent Office mailed 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. On December 23, 2005, a second request for reexamination
of
the ‘415 patent was filed by another third party, and on January 23, 2006, the
Patent Office granted that request. On June 6, 2006, the two reexaminations
were
merged into one proceeding. On August 16, 2006, the Patent Office mailed a
non-final Office action in the merged proceeding, rejecting the claims of the
‘415 patent based on issues raised in the two reexamination requests. We filed
our response to the Office action on October 30, 2006. On February 16, 2007,
the
Patent Office mailed a final Office action rejecting all thirty-six claims
of
the ‘415 patent. We intend to respond to the final Office action, to request
continued reexamination, and, if necessary, to appeal the decision. 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
significant royalties from those licenses. The claims of the ‘415 patent remain
valid and enforceable throughout the reexamination and appeals processes.
Because the above-described proceeding is ongoing, the outcome of this matter
cannot be determined at this time.
In
2006, we made development decisions involving our humanized anti-CD20 program,
and our collaborator Biogen Idec disagrees with certain of our development
decisions relating to humanized anti-CD20 products. Under our 2003 collaboration
agreement with Biogen Idec, we believe that we are permitted under the agreement
to proceed with further trials of certain humanized anti-CD20 antibodies, and
Biogen Idec disagrees with our position. We continue to pursue a resolution
of
our differences, and the disputed issues have been submitted to arbitration.
In
the arbitration, Biogen Idec filed motions for a preliminary injunction and
summary judgment seeking to stop us from proceeding with certain development
activities, including planned clinical trials. On April 20, 2007, the
arbitration panel denied both Biogen Idec’s motion for a preliminary injunction
and Biogen Idec’s motion for summary judgment. Resolution of the arbitration
could require that both parties agree to certain development decisions before
moving forward with humanized anti-CD20 antibody clinical trials, and possibly
clinical trials of other collaboration products, including Rituxan, in which
case we may have to alter or cancel planned trials in order to obtain Biogen
Idec’s approval. The outcome of this matter cannot be determined at this
time.
On
March 24, 2004, Dr. Kourosh Dastgheib filed a lawsuit against Genentech in
the
U.S. District Court for the Eastern District of Pennsylvania. The lawsuit stems
from Dastgheib’s claim that, based on a purported relationship with Genentech in
the mid-1990’s, he is entitled to profits or proceeds from Genentech’s Lucentis
product. Dastgheib has asserted multiple claims for monetary damages, including
a claim under an unjust enrichment theory that he is entitled to the entire
net
present value of projected Lucentis sales, which he claims is between
approximately $1.4 billion and $4.1 billion. On November 8, 2006, a jury ruled
unanimously against Dastgheib and in favor of Genentech on all claims, and
final
judgment was entered in Genentech’s favor. On January 30, 2007,
Dastgheib’s
motion for a new trial was denied in its entirety. Dastgheib did not appeal
the
judgment to the court of appeals, and accordingly the case is
closed.
|
Note
5.
|
Relationship
with Roche and Related Party
Transactions
|
Roche’s
Ability to Maintain Its Percentage Ownership Interest in Our
Stock
We
issue additional shares of Common Stock in connection with our stock option
and
stock purchase plans, and we may issue additional shares for other purposes.
Our
affiliation agreement with Roche provides, among other things, that with respect
to any issuance of our Common Stock in the future, we will repurchase a
sufficient number of shares so that immediately after such issuance, the
percentage of our Common Stock owned by Roche will be no lower than 2% below
the
“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 Stock owned by Roche since the July 1999 offering (to be
adjusted in the future for dispositions of shares of Genentech Common Stock
by
Roche 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 Stock
outstanding at the time of the July 1999 offering, as adjusted for stock splits.
We have repurchased shares of our Common Stock since 2001. The affiliation
agreement also provides that, upon Roche’s request, we will repurchase shares of
our Common Stock to increase Roche’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. Under the terms
of
the affiliation agreement, Roche’s Minimum Percentage is 57.7% and Roche’s
ownership percentage is to be no lower than 55.7%. At March 31, 2007, Roche’s
ownership percentage was 55.7%.
Related
Party Transactions
We
enter into transactions with our related parties, Roche Holdings AG and
affiliates (or “Hoffmann-La Roche”) and Novartis AG and other Novartis
affiliates (or “Novartis”). The accounting policies we apply to our transactions
with our related parties are consistent with those applied in transactions
with
independent third-parties.
In
our royalty and supply arrangements with related parties, we are the principal,
as defined under EITF Issue No. 99-19, “Reporting
Revenue Gross as a Principal versus Net as an Agent”
(or “EITF 99-19”), because we bear the manufacturing risk, general inventory
risk, and the risk to defend our intellectual property. In circumstances where
we are the principal in the transaction, we record the transaction on a gross
basis in accordance with EITF 99-19. Otherwise, our transactions are recorded
on
a net basis.
Hoffmann-La
Roche
We
currently have no active profit sharing arrangements with Hoffmann-La
Roche.
Under
our existing arrangements with Hoffmann-La Roche, including our licensing and
marketing agreements, we recognized the following amounts (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Ex-U.S.
product sales to Hoffmann-La Roche
|
|
$
|
264
|
|
$
|
58
|
|
| |
|
|
|
|
|
|
|
|
Royalties
earned from Hoffmann-La Roche
|
|
$
|
255
|
|
$
|
167
|
|
| |
|
|
|
|
|
|
|
|
Cost
of sales on ex-U.S. product sales to Hoffmann-La Roche
|
|
$
|
121
|
|
$
|
49
|
|
| |
|
|
|
|
|
|
|
|
Contract
revenue from Hoffmann-La Roche
|
|
$
|
30
|
|
$
|
18
|
|
R&D
expenses incurred
on
joint development projects
with Hoffmann-La Roche were $58 million in the first quarter of 2007 and $43
million in the first quarter of 2006. These
expenses are partially reimbursable to us by Hoffmann-La Roche. In addition,
these amounts include R&D expenses resulting from the net settlement of
amounts owed to Hoffmann-La Roche on R&D development expenses it incurred on
joint development projects, less amounts reimbursable by us on these respective
projects.
Novartis
Based
on information available to us at the time of filing this Form 10-Q, we believe
Novartis holds approximately 33.3% of the outstanding voting shares of Roche
Holding AG. As a result of this ownership, Novartis is deemed to have an
indirect beneficial ownership interest under FAS 57, “Related Party
Disclosures,” of more than 10% of our voting stock.
We
have an agreement with Novartis Pharma AG (a wholly-owned subsidiary of Novartis
AG) under which Novartis Pharma AG has the exclusive right to develop and market
Lucentis outside of the U.S. for indications related to diseases or disorders
of
the eye. As part of this agreement, the parties will share the cost of certain
of our ongoing development expenses for Lucentis.
We,
along with Novartis Pharma AG and Tanox, Inc., are co-developing Xolair in
the
U.S. and we and Novartis are co-promoting Xolair in the U.S. and both make
certain joint and individual payments to Tanox; our 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 in 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,
and
our U.S. and European profit sharing expenses are recorded as collaboration
profit sharing expense.
Under
our existing arrangements with Novartis, we recognized the following amounts
from Novartis (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Ex-U.S.
product sales to Novartis
|
|
$
|
2
|
|
$
|
1
|
|
| |
|
|
|
|
|
|
|
|
Royalties
earned from Novartis
|
|
$
|
5
|
|
$
|
-
|
|
| |
|
|
|
|
|
|
|
|
Cost
of sales on ex-U.S. product sales to Novartis
|
|
$
|
3
|
|
$
|
1
|
|
| |
|
|
|
|
|
|
|
|
Contract
revenue from Novartis
|
|
$
|
40
|
|
$
|
10
|
|
| |
|
|
|
|
|
|
|
|
Collaboration
profit sharing expense to Novartis
|
|
$
|
47
|
|
$
|
43
|
|
Contract
revenue in the first quarter of 2007 includes a $30 million milestone payment
from Novartis Pharma AG for European Union approval of Lucentis for the
treatment of neovascular (wet) age-related macular degeneration.
R&D
expenses incurred
on
joint development projects
with Novartis were $10 million in the first quarters of 2007 and 2006.
The
effective income tax rate was 37% in the first quarter of 2007, as compared
to
38% in the first quarter of 2006. The decrease in the income tax rate is
primarily due to the extension of the federal R&D tax credit and an increase
in the domestic manufacturing deduction in 2007.
The
Board of Directors and Stockholders of Genentech, Inc.
We
have reviewed the condensed consolidated balance sheet of Genentech, Inc. as
of
March 31, 2007, and the related condensed consolidated statements of income
and
cash flows for the three-month periods ended March 31, 2007 and 2006. These
financial statements are the responsibility of the Company’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 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, 2006, and the related consolidated statements
of income, stockholders’ equity, and cash flows for the year then ended, not
presented herein, and in our report dated February 5, 2007, 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, 2006, is fairly stated, in all material respects,
in
relation to the consolidated balance sheet from which it has been
derived.
Palo
Alto, California
April
16, 2007
GENENTECH,
INC.
FINANCIAL
REVIEW
Overview
The
information included in this Quarterly Report on Form 10-Q should be read in
conjunction with the Consolidated Financial Statements and accompanying notes
included in our Annual Report on Form 10-K for the year ended December 31,
2006.
The
Company
Genentech
is a leading biotechnology company that discovers, develops, manufactures,
and
commercializes biotherapeutics for significant unmet medical needs. We
commercialize multiple biotechnology products, and also receive royalties from
companies that are licensed to market products based on our
technology.
Major
Developments in the First Quarter of 2007
We
primarily earn revenues and income and generate cash from product sales and
royalty revenues. In the first quarter of 2007, our total operating revenues
were $2,843 million, an increase of 43% from $1,986 million in the first quarter
of 2006. Our net income was $706 million, an increase of 68% from $421 million
in the first quarter of 2006.
During
the first quarter of 2007, we established three major new collaborations giving
us access to novel early stage drug products being developed as potential
treatments for cancer, cardiovascular disease, and human growth hormone
disorders. We entered into: (i) an exclusive worldwide license agreement with
Seattle Genetics, Inc. for the development and commercialization of a humanized
monoclonal antibody currently in Phase I clinical trials for multiple myeloma,
chronic lymphocytic leukemia and non-Hodgkin’s lymphoma, and a Phase II clinical
trial for diffuse large B-cell lymphoma, (ii) a collaboration with BioInvent
to
co-develop and commercialize a monoclonal antibody currently in pre-clinical
development for the potential treatment of cardiovascular disease, and (iii)
a
collaboration agreement with Altus to develop, manufacture and commercialize
a
subcutaneously administered, once-per-week formulation of human growth hormone,
currently preparing for Phase II and Phase III clinical trials for patients
with
growth hormone deficiencies. We believe that these collaborations are an
important complement to our internal R&D efforts.
On
November 9, 2006, we and Tanox, Inc. announced that we entered into an agreement
to acquire Tanox. On January 29, 2007, we and Tanox announced that we
received a request for additional information from the U.S. Federal Trade
Commission (or “FTC”) in connection with the proposed acquisition. The second
request extends the waiting period imposed by the Hart-Scott-Rodino Improvements
Act of 1976. Assuming a successful and timely outcome from our interactions
with
the FTC, the absence of a material adverse effect, and the satisfaction of
other closing conditions, we are now planning for the transaction to be
completed within the third quarter of 2007.
Our
Strategy and Goals
As
announced in 2006, our business objectives for the years 2006 through 2010
include bringing at least 20 new molecules into clinical development, bringing
at least 15 major new products or indications onto the market, becoming the
number one U.S. oncology company in sales, and achieving certain financial
growth measures. These objectives are reflected in our revised Horizon 2010
strategy and goals summarized on our website at
http://www.gene.com.
Economic,
Industry-wide, and Other Factors
Our
strategy and goals are challenged by economic and industry-wide factors that
affect our business. Key factors that affect our future growth are discussed
below:
-
We
face significant competition in the diseases of interest to us from
pharmaceutical companies and biotechnology companies. The introduction
of new
competitive products or follow-on biologics, and/or new information about
existing products or pricing decisions by us or our competitors, may result
in
lost market share for us, reduced utilization of our products, lower prices,
and/or reduced product sales, even for products protected by
patents.
- Our
near-term growth will depend on our ability to execute on recent product
approvals, including Lucentis for the treatment of neovascular (wet)
age-related macular degeneration (or “AMD”) and Avastin for the treatment of
non-small cell lung cancer, and to successfully obtain U.S. Food and Drug
Administration (or “FDA”) approvals for potential new indications for our
existing products such as Avastin for the treatment of metastatic breast
cancer and Rituxan for the treatment of immunological disorders.
-
Our
long-term business growth depends upon our ability to continue to successfully
develop and commercialize important novel therapeutics to treat unmet
medical
needs, such as cancer. We recognize that the successful development of
biotherapeutics is highly difficult and uncertain and that it will be
challenging for us to continue to discover and develop innovative treatments.
Our business requires significant investment in R&D over many years, often
for products that fail during the R&D process. Once a product receives FDA
approval, it remains 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 or
withdrawals.
-
We
believe our business model is only sustainable with appropriate pricing
and
reimbursement for our products to offset the costs and risks of drug
development. The pricing of our products has received negative press
coverage
and public scrutiny. We will continue to meet with patient groups,
payers and
other stakeholders in the healthcare system to understand their issues
and
concerns. The future reimbursement environment for our products is
uncertain.
-
As
the Medicare and Medicaid programs are the largest payers for our
products,
rules relating to coverage and reimbursement continue to represent
an
important area of focus. New regulations relating to hospital and
physician
payment continue to be implemented annually. 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 2007.
-
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.
-
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. 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.
-
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.
Marketed
Products
We
commercialize in the United States (or “U.S.”) the biotechnology products listed
below:
Avastin
(bevacizumab) is an anti-VEGF humanized antibody approved for use in combination
with intravenous 5-fluorouracil based chemotherapy as a treatment for patients
with first- or second-line metastatic cancer of the colon or rectum. It is
also
approved for use in combination with carboplatin and paclitaxel chemotherapy
for
the first-line treatment of unresectable, locally advanced, recurrent or
metastatic non-squamous non-small cell lung cancer.
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;
-
The
first-line treatment of patients with diffuse large B-cell, CD20-positive,
non-Hodgkin’s lymphoma in combination with CHOP (cyclophosphamide,
doxorubicin, vincristine and prednisone) or other anthracycline-based
chemotherapy;
-
The
first-line treatment of previously untreated patients with follicular,
CD20-positive, B-cell non-Hodgkin’s lymphoma in combination with CVP
(cyclophosphamide, vincristine and prednisone) chemotherapy
regimens;
-
The
treatment of patients with low-grade, CD20-positive, B-cell non-Hodgkin’s
lymphoma in patients with stable disease or who achieve a partial or complete
response following first-line treatment with CVP chemotherapy;
and
-
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
antagonist therapies.
Herceptin
(trastuzumab)
is a humanized anti-HER2 antibody approved for use as an adjuvant treatment
of
node-positive breast cancer as part of a treatment regimen containing
doxorubicin, cyclophosphamide, and paclitaxel for patients who have tumors
that
overexpress the human epidermal growth factor receptor 2 (or “HER2”) protein. It
is also approved for use as a first-line therapy in combination with paclitaxel
and as a single agent in second- and third-line therapy for patients with
HER2-positive metastatic breast cancer.
Lucentis
(ranibizumab) is an anti-VEGF antibody fragment approved for the treatment
of
neovascular (wet) age-related macular degeneration.
Xolair
(omalizumab) is a humanized anti-IgE antibody, which we commercialize with
Novartis Pharma AG (or “Novartis”). Xolair is approved for adults and
adolescents (12 years of age and above) with moderate to severe persistent
asthma who have a positive skin test or in vitro reactivity to a perennial
aeroallergen and whose symptoms are inadequately controlled with inhaled
corticosteroids.
Tarceva
(erlotinib),
which we commercialize with OSI Pharmaceuticals, Inc., is a small-molecule
tyrosine kinase inhibitor of the HER1/epidermal growth factor receptor (or
“EGFR”) signaling pathway. Tarceva is approved for the treatment of patients
with locally advanced or metastatic non-small cell lung cancer after failure
of
at least one prior chemotherapy regimen. It is also approved, in combination
with gemcitabine chemotherapy, for the first-line treatment of patients with
locally advanced, unresectable or metastatic pancreatic cancer.
Nutropin
(somatropin
[rDNA origin] for injection) and 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.
Activase
(alteplase,
recombinant) is a tissue plasminogen activator (or “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 (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.
Pulmozyme
(dornase
alfa, recombinant) is an inhalation solution of deoxyribonuclease (rhDNase) I,
approved for the treatment of cystic fibrosis.
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.
Licensed
Products
We
receive royalty revenue from various licensees, including significant royalty
revenue from Roche Holding AG and affiliates (or “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 and TNKase in Canada.
Refer
to Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements of Part I, Item 1 of this Form 10-Q for information regarding certain
patent litigation matters.
Available
Information
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 CEO, CFO and senior financial
officials; and
-
the
charters of the Audit Committee and the Compensation 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 Statements and
the related disclosures, which have been prepared in accordance with U.S.
generally accepted accounting principles (or “GAAP”). The preparation of these
Condensed Consolidated Financial Statements requires management to make
estimates, assumptions and judgments that affect the reported amounts in our
Condensed 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, 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 critical to understanding our financial
condition, results of operations, and our expectations for 2007 because these
policies require management to make significant estimates, assumptions and
judgments about matters that are inherently uncertain.
Contingencies
We
are currently, and have been, involved in certain legal proceedings, including
patent infringement litigation. We are also involved in licensing and contract
disputes, and other matters. Refer to Note 4, “Contingencies,” in the Notes to
Condensed Consolidated Financial Statements of Part I, Item 1 of this Form
10-Q
for further information on these matters. We assess the likelihood of any
adverse judgments or outcomes for these legal matters as well as potential
ranges of probable losses. We record an estimated loss as a charge to income
if
we determine that, based on information available at the time, the loss is
probable and the amount of loss can be reasonably estimated. Included
in “litigation-related and other long-term liabilities” in the accompanying
Condensed Consolidated Balance Sheets at March 31, 2007 is $739 million, which
represents our estimate of the costs for the current resolution of the City
of
Hope National Medical Center (or “COH”) matter. 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 have a material effect on our financial position or our results of
operations in any one quarter.
Revenue
Recognition - Avastin U.S. Product Sales
In
February 2007, we launched the Avastin Patient Assistance Program, which is
a
voluntary program that enables eligible patients who have received 10,000
milligrams of Avastin in a 12-month period to receive free Avastin in excess
of
the 10,000 milligrams during the remainder of the 12-month period. Based on
the
current wholesale acquisition cost, the 10,000 milligrams is valued at $55,000
in gross revenue. Eligible patients include those who are being treated for
an
FDA-approved indication and who meet the household income criteria for this
program. The program is available for eligible patients who enroll regardless
of
whether they are insured. We defer a portion of our gross Avastin product sales
revenue to reflect our estimate of the commitment to supply free Avastin to
those patients who elect to enroll in the program.
In
order to make our estimate of the amount of free Avastin to be provided to
patients under the program, we need to estimate several factors, most notably:
the number of patients who are currently being treated for FDA-approved
indications and the start date for their treatment regimen, the extent to which
doctors and patients may elect to enroll in the program, the number of patients
who will meet the financial eligibility requirements of the program, and the
duration and extent of treatment for the FDA-approved indications, among other
factors. We have based our enrollment assumptions on physician surveys and
other
information that we consider relevant. We will continue to update our estimates
in each reporting period as new information becomes available. If the actual
results underlying this deferred revenue accounting vary significantly from
our
estimates, we will need to make adjustments to these estimates, which could
have
a material effect on revenue and earnings in the period of adjustment. Based
on
these estimates, we defer a portion of Avastin revenue on product vials sold
through normal commercial channels. The deferred revenue will be recognized
as
free Avastin vials are delivered. In the first quarter of 2007, we deferred
a
net amount of $3 million of our Avastin sales, resulting in a total deferred
revenue liability in connection with the Avastin Patient Assistance Program
of
$12 million in our Condensed Consolidated Balance Sheets at March 31,
2007.
Product
Sales Allowances
Revenues
from U.S. product sales are recorded net of allowances and accruals for rebates,
healthcare provider contractual chargebacks, prompt pay sales discounts, product
returns, and wholesaler inventory management allowances, all of which are
established at the time of sale. Sales allowances and accruals are based on
estimates of the amounts earned or to be claimed on the related sales. The
amounts reflected in our Condensed Consolidated
Statements
of Income as total product sales allowances have been relatively consistent
at
approximately six to eight percent of gross sales. 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.
Definitions
for the product sales allowance types are as follows:
-
Rebate
allowances and accruals are comprised of both direct and indirect rebates.
Direct rebates are contractual price adjustments payable to direct customers,
mainly to wholesalers and specialty pharmacies, that purchase products
directly from us. Indirect rebates are contractual price adjustments payable
to healthcare providers and organizations such as clinics, hospitals,
pharmacies, Medicaid and group purchasing organizations that do not purchase
products directly from us;
-
Prompt
pay sales discounts are credits granted to wholesalers for remitting payment
on their purchases within established cash payment incentive
periods;
-
Product
return allowances are established in accordance with our Product Returns
Policy. Our returns policy allows product returns within the period beginning
two months prior to and six months following product expiration;
-
Wholesaler
inventory management allowances are credits granted to wholesalers for
compliance with various contractually-defined inventory management programs.
These programs were created to align purchases with underlying demand for
our
products and to maintain consistent inventory levels, typically at two
to
three weeks of sales depending on the product; and
-
Healthcare
provider contractual chargebacks are the result of contractual commitments
by
us to provide products to healthcare providers at specified prices or
discounts.
We
believe that our estimates related to product returns allowances and wholesaler
inventory management payments are not material amounts, based upon the
historical levels of credits and allowances as a percentage of product sales.
We
believe our estimates related to healthcare provider contractual chargebacks
and
prompt pay sales discounts do not have a high degree of estimation complexity
or
uncertainty as the related amounts are settled within a short period of time.
We
consider rebate allowances and accruals to be the only estimation that involves
both material amounts and requires a higher degree of subjectivity and judgment
necessary to account for the rebate allowances or accruals. As a result of
the
uncertainties involved in estimating rebate allowances and accruals, there
is a
likelihood that materially different amounts could be reported under different
conditions or using different assumptions.
Our
rebates are based upon definitive agreements or legal requirements (such as
Medicaid). These rebates are primarily estimated using historical and other
data, including patient usage, customer buying patterns, applicable contractual
rebate rates and contract performance by the benefit providers. Direct rebates
are accrued at the time of sale and recorded as allowances against trade
accounts receivable; indirect (including Medicaid) rebates are accrued at the
time of sale and recorded as liabilities. Rebate estimates are evaluated
quarterly and may require changes to better align our estimates with actual
results. As part of this evaluation, we review changes to Medicaid legislation,
changes to state rebate contracts, changes in the level of discounts, and
significant changes in product sales trends. Although rebates are accrued at
the
time of sale, rebates are typically paid out, on average, up to six months
after
the sale. We believe our rebate allowances and accruals estimation process
provides a high degree of confidence in the amounts established and that the
annual allowance amounts provided for would not vary by more than approximately
3% based on our estimate that our changes in rebate allowances and accruals
estimates related to prior years have not exceeded 3%. To illustrate our
sensitivity to changes in the rebate allowances and accruals process, as much
as
a 10% change in our annualized rebate allowances and accruals provision
experienced to date in 2007 (which is in excess of three times the level of
variability we have recently observed for rebates) would have an approximate
$18
million effect on our income before taxes (or approximately $0.01 per share,
after tax). The total rebate allowances and accruals recorded in our Condensed
Consolidated Balance Sheets were $61 million as of March 31, 2007.
All
of the aforementioned categories of allowances and accruals are evaluated
quarterly and adjusted when trends or significant events indicate that a change
in estimate is appropriate. Such changes in estimate could materially affect
our
results of operations or financial position; however, to date they have not
been
material. It is possible that we
may
need to adjust our estimates in future periods. As of March 31, 2007, our
Condensed Consolidated Balance Sheets reflected estimated product sales
allowance reserves and accruals totaling approximately $149
million.
Royalties
For
substantially all of our agreements with licensees, we estimate royalty revenue
and royalty receivables in the period the royalties are earned, which is in
advance of collection. Our estimate of royalty revenue and receivables in those
instances is based upon communication with some licensees, historical
information, forecasted sales trends and collectibility. Differences between
actual royalty revenues and estimated royalty revenues are adjusted for in
the
period in which they become known, typically the following quarter. If the
collectibility of a royalty amount is doubtful, royalty revenue is not recorded.
In the case of receivables related to previously recognized royalty revenue
which is subsequently determined to be uncollectible, the receivable is reserved
for in the period in which the circumstances that make collectibility doubtful
are determined. Historically, adjustments to our royalty receivables have not
been material to our consolidated financial condition or results of
operations.
We
have confidential licensing agreements with a number of companies on U.S. Patent
No. 6,331,415 (or “the ‘415 patent” or “Cabilly patent”), under which we receive
royalty revenue on sales of products that are covered by the patent. 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. The U.S. Patent office is performing a reexamination of the patent
and
on February 16, 2007 issued a final Office action rejecting all thirty-six
claims of the ‘415 patent. We intend to respond to the final Office action, to
request continued reexamination, and, if necessary, to appeal the decision.
The
claims of the patent remain valid and enforceable throughout the reexamination
and appeals processes. See also Note 4, “Contingencies,” in the Notes to
Condensed Consolidated Financial Statements of Part I, Item 1 of this Form
10-Q
for further information on our Cabilly patent reexamination. Cabilly patent
royalties are generally due 60 days after quarter-end. Additionally, we pay
COH
a percentage of our ‘415 patent royalty revenue 60 days after the quarter in
which we receive payments from our licensees. As of March 31, 2007, our
Condensed Consolidated Balance Sheets included Cabilly patent receivables
totaling approximately $62 million and the related COH payable totaling
approximately $12 million.
Income
Taxes
Income
tax expense is based on income before 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 tax rates projected to be 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, acquisitions, and changes in overall
levels of income before taxes.
On
January 1, 2007, we adopted the provisions of FASB Interpretation No. 48,
“Accounting
for Uncertainty in Income Taxes”
(or “Interpretation 48”). As a result of the implementation of Interpretation
48, we evaluated our income tax position and reclassified $147 million of
unrecognized tax benefits from current liabilities to long-term liabilities
as
of January 1, 2007 and we also reclassified the balance as of December 31,
2006,
for consistency, in the accompanying Condensed Consolidated Balance
Sheets.
Inventories
Inventories
include currently marketed products manufactured under a new process or at
facilities awaiting regulatory approval. These inventories are capitalized
based
on management’s judgment of probable near-term regulatory approval. The
valuation of inventory requires us to estimate the value of inventory that
may
become expired prior to use or that may fail to be released for commercial
sale.
The determination of obsolete inventory requires us to estimate the future
demands for our products, and in the case of pre-approval inventories, to
estimate the regulatory approval date for the product or for the licensure
of
either the manufacturing facility or the new manufacturing process. We may
be
required to expense previously capitalized inventory costs upon a change in
our
estimate,
due to, among other potential factors, a denial or delay of approval of a
product or the licensure of either a manufacturing facility or a new
manufacturing process by the necessary regulatory bodies, or new information
that suggests that the inventory will not be saleable.
Employee
Stock-Based Compensation
On
January 1, 2006, we began accounting for employee stock-based compensation
in
accordance with FAS 123R. Under the provisions of FAS 123R, employee
stock-based compensation is estimated at the date of grant based on the employee
stock award’s fair value using the Black-Scholes option-pricing model and is
recognized as expense ratably over the requisite service period in a manner
similar to other forms of compensation paid to employees. The Black-Scholes
option-pricing model 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 recent 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, our valuation assumptions used to value employee stock-based awards
granted in future periods may change. See also Note 2, “Employee Stock-Based
Compensation,” in the Notes to Condensed Consolidated Financial Statements of
Part I, Item 1 of this Form 10-Q for further information.
Results
of Operations
(In
millions)
| |
|
Three
Months
Ended
March 31,
|
|
|
|
| |
|
2007
|
|
2006
|
|
%
Change
|
|
|
Product
sales
|
|
$
|
2,329
|
|
$
|
1,644
|
|
|
42
|
%
|
|
Royalties
|
|
|
419
|
|
|
286
|
|
|
47
|
|
|
Contract
revenue
|
|
|
95
|
|
|
56
|
|
|
70
|
|
|
Total
operating revenues
|
|
|
2,843
|
|
|
1,986
|
|
|
43
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
392
|
|
|
262
|
|
|
50
|
|
|
Research
and development
|
|
|
610
|
|
|
374
|
|
|
63
|
|
|
Marketing,
general and administrative
|
|
|
491
|
|
|
441
|
|
|
11
|
|
|
Collaboration
profit sharing
|
|
|
252
|
|
|
226
|
|
|
12
|
|
|
Recurring
charges related to redemption
|
|
|
26
|
|
|
26
|
|
|
-
|
|
|
Special
items: litigation-related
|
|
|
13
|
|
|
13
|
|
|
-
|
|
|
Total
costs and expenses
|
|
|
1,784
|
|
|
1,342
|
|
|
33
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
1,059
|
|
|
644
|
|
|
64
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income, net
|
|
|
74
|
|
|
53
|
|
|
40
|
|
|
Interest
expense
|
|
|
(18
|
)
|
|
(19
|
)
|
|
(5
|
)
|
|
Total
other income, net
|
|
|
56
|
|
|
34
|
|
|
65
|
|
|
Income
before taxes
|
|
|
1,115
|
|
|
678
|
|
|
64
|
|
|
Income
tax provision
|
|
|
409
|
|
|
257
|
|
|
59
|
|
|
Net
income
|
|
$
|
706
|
|
$
|
421
|
|
|
68
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.67
|
|
$
|
0.40
|
|
|
68
|
|
|
Diluted
|
|
$
|
0.66
|
|
$
|
0.39
|
|
|
69
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales as a % of product sales
|
|
|
17
|
%
|
|
16
|
%
|
|
|
|
|
Research
and development as a % of operating revenues
|
|
|
21
|
|
|
19
|
|
|
|
|
|
Marketing,
general and administrative as a % of operating revenues
|
|
|
17
|
|
|
22
|
|
|
|
|
|
Pretax
operating margin
|
|
|
37
|
|
|
32
|
|
|
|
|
|
Tax
rate
|
|
|
37
|
|
|
38
|
|
|
|
|
________________________
|
Percentages
in this table and throughout management’s discussion and analysis of
financial condition and results of operations may reflect rounding
adjustments.
|
Total
Operating Revenues
Total
operating revenues increased 43% in the first quarter of 2007 from the
comparable period in 2006. These increases were primarily due to higher product
sales and royalty income, and are further discussed below.
Total
Product Sales
(In
millions)
| |
|
Three
Months
Ended
March 31,
|
|
|
|
| |
|
2007
|
|
2006
|
|
%
Change
|
|
|
Net
U.S. Product Sales
|
|
|
|
|
|
|
|
|
Avastin
|
|
$
|
533
|
|
$
|
398
|
|
|
34
|
%
|
|
Rituxan
|
|
|
535
|
|
|
477
|
|
|
12
|
|
|
Herceptin
|
|
|
311
|
|
|
290
|
|
|
7
|
|
|
Lucentis
|
|
|
211
|
|
|
-
|
|
|
*
|
|
|
Xolair
|
|
|
111
|
|
|
95
|
|
|
17
|
|
|
Tarceva
|
|
|
102
|
|
|
93
|
|
|
10
|
|
|
Nutropin
products
|
|
|
91
|
|
|
87
|
|
|
5
|
|
|
Thrombolytics
|
|
|
68
|
|
|
59
|
|
|
15
|
|
|
Pulmozyme
|
|
|
52
|
|
|
49
|
|
|
6
|
|
|
Raptiva
|
|
|
24
|
|
|
21
|
|
|
14
|
|
|
Total
U.S. product sales(1)
|
|
$
|
2,037
|
|
$
|
1,569
|
|
|
30
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
Net
product sales to collaborators
|
|
|
292
|
|
|
75
|
|
|
289
|
|
|
Total
product sales
|
|
$
|
2,329
|
|
$
|
1,644
|
|
|
42
|
|
______________________
|
*
|
Calculation
not meaningful.
|
|
(1)
|
The
totals may not appear to sum due to
rounding.
|
Total
product sales increased 42% from the comparable period in 2006. Total U.S.
product sales increased 30% to $2,037 million
in the first quarter of 2007 from the comparable period in 2006. This increase
in U.S. sales over the comparable period was due to higher sales across all
products, in particular higher sales of our oncology products and sales of
Lucentis. Increased U.S. sales volume accounted for 88%, or $417 million,
of the increase in U.S. net product sales in the first quarter of 2007. Changes
in net U.S. sales prices across the portfolio accounted for most of the
remaining increase in net U.S. product sales in the first quarter of
2007.
Our
references below to market adoption and penetration are derived from our
analyses of market tracking studies and surveys we undertake with physicians.
We
consider these tracking studies and surveys as indicative of trends and
information with respect to our direct customers’ buying patterns. We use
statistical analyses to extrapolate the data we obtain and, as such, the
adoption and penetration data presented herein represents estimates. Limitations
in sample size and the timeliness in receiving and analyzing this data results
in inherent margins of error, thus we have rounded our percentage estimates
to
the nearest five percent.
Avastin
Net
U.S. sales of Avastin increased 34% to $533 million
in the first quarter of 2007 from the comparable period in 2006. Net U.S. sales
in the first quarter of 2007 excluded $3 million of revenue we deferred in
connection with our Avastin Patient Assistance Program. Net U.S. sales in the
first quarter of 2006 included a $3 million reimbursement for a shipment that
was destroyed while in transit to a wholesaler. There have been no price
increases on Avastin.
The
increase in sales in the first quarter of 2007 from the first quarter of 2006
was primarily a result of increased use of Avastin in metastatic non-small
cell
lung cancer (or “NSCLC”), approved on October 11, 2006, and in metastatic breast
cancer, an unapproved use of Avastin. Growth in metastatic NSCLC was due to
greater post-launch penetration rates, and increased duration of treatment
and
higher dosing in the first quarter of 2007 as compared to the first quarter
of
2006. We estimate that Avastin penetration was approximately 25% among
first-line metastatic NSCLC patients in the first quarter of 2007, an increase
from the adoption rate in the first quarter of 2006, and essentially flat
compared to the fourth quarter of 2006. In first-line metastatic colorectal
cancer (or “CRC”) we estimate that penetration, duration of treatment and dosing
remained flat in the first quarter of 2007 as compared to the first and fourth
quarters of 2006. In second-line CRC we estimate that Avastin penetration was
approximately 35% in the first quarter of 2007, essentially flat compared to
the
first quarter of 2006 and a decrease from
approximately
50% in the fourth quarter of 2006 due to increased competition. We anticipate
that the major driver of Avastin growth for 2007 will continue to come from
use
in the first-line treatment of metastatic NSCLC.
On
February 21, 2007, we and Hoffmann-La Roche announced the results of a
Hoffmann-La Roche-sponsored Phase III study (BO17704) in NSCLC evaluating two
different doses of Avastin in combination with gemcitabine and cisplatin
chemotherapy compared to chemotherapy alone in patients with previously
untreated, advanced NSCLC. This study evaluated a 15 mg/kg/every 3 weeks dose
of
Avastin (the dose approved in the U.S. for use in combination with carboplatin
and paclitaxel) and a 7.5 mg/kg/every 3 weeks dose of Avastin (a dose not
approved for use in the U.S.). Both doses met the primary endpoint of prolonging
progression-free survival (or “PFS”) compared to chemotherapy alone.
Although the study was not designed to compare the Avastin doses, a similar
treatment effect in PFS was observed between the two arms. In the first quarter
of 2007, we estimate that approximately 75% of first-line NSCLC patients treated
with Avastin received the approved dosage of Avastin. Once the BO17704 data
is
presented at the American Society of Clinical Oncology (or “ASCO”) in June 2007,
we may see an increase in the number of physicians who treat certain patients
with lower doses. Efficacy data from BO17704 or other clinical studies conducted
by any party in the U.S. or internationally (such as AVADO, Hoffmann-La Roche’s
study evaluating two doses of Avastin in first-line metastatic breast cancer
patients), showing or perceiving to show a similar or an improved treatment
benefit at a lower dose or shorter duration of therapy could negatively affect
future sales of Avastin.
Rituxan
Net
U.S. sales of Rituxan increased 12% to $535 million
in the first quarter of 2007 from the comparable period in 2006. The sales
growth resulted from increased use of Rituxan in rheumatoid arthritis, approved
on February 28, 2006, and use of Rituxan following first-line therapy in
indolent non-Hodgkin’s lymphoma (or “NHL”), including areas of unapproved uses.
Also contributing to the increase in product sales were price increases
effective on March 29, 2006 and October 5, 2006. It remains difficult to
precisely determine the sales split between Rituxan use in oncology and
immunology settings since many treatment centers treat both types of patients.
We estimate that Rituxan’s overall adoption rate in combined markets of NHL,
including areas of unapproved use, and chronic lymphocytic leukemia (or “CLL”),
an unapproved use, remained flat in the first quarter of 2007 and throughout
2006.
Net
U.S. sales of Rituxan decreased 4% in the first quarter of 2007 from the fourth
quarter of 2006. Rituxan’s channel inventory finished the 2006 year at the upper
level of our distributors’ target range, adding approximately $10 million to $12
million to 2006 sales. At the end of the first quarter of 2007, Rituxan’s
channel inventory was at the mid level of our distributors’ target
range.
Herceptin
Net
U.S. sales of Herceptin increased 7% to $311 million in the first quarter of
2007 from the comparable period in 2006. The sales growth resulted from
increased use of Herceptin in the treatment of early stage HER2-positive breast
cancer, approved on November 16, 2006. In early stage HER2-positive breast
cancer patients we estimate that Herceptin penetration was approximately 65%
in
the first quarter of 2007, a slight increase from the adoption rate in the
first
quarter of 2006. In first-line HER2-positive metastatic breast cancer we
estimate that penetration and duration of treatment remained flat in the first
quarter of 2007 as compared to the first and fourth quarters of
2006. Contributing to the increase in product sales were price increases
effective on March 29, 2006 and October 3, 2006. 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.
We
expect the U.S. sales growth rate for Herceptin to be lower in 2007 relative
to
2006 now that the large pool of patients who were put on therapy in the months
after the adjuvant data were released have completed therapy. We believe that
Herceptin sales growth will depend on increased penetration in the adjuvant
setting and increased duration of treatment.
Lucentis
Lucentis
was approved by the FDA for the treatment of neovascular (wet) age-related
macular degeneration (or “AMD”) on June 30, 2006. Net U.S. sales were $211
million in the first quarter of 2007, as compared to $217 million in the fourth
quarter of 2006. We believe the decrease in the first quarter of 2007 as
compared to the fourth quarter of 2006 was the result of less frequent dosing
of
newly diagnosed and existing Lucentis patients. We believe that sales growth
will depend on increased penetration in newly diagnosed patients (including
gains against the unapproved use of Avastin in this setting). Growth may also
be
affected by frequency of dosing and duration of treatment.
Xolair
Net
U.S. sales of Xolair increased 17% to $111 million in the first quarter of
2007
from the comparable period in 2006. The sales growth was primarily driven by
increased penetration in the asthma market and, to a lesser extent, price
increases effective on April 4, 2006 and October 17, 2006. We believe that
first
quarter 2007 sales were modestly affected by the FDA’s request that we
strengthen the existing warning on the potential risk for anaphylaxis in
patients receiving Xolair by adding a boxed warning to the product label and
implementing a Risk Minimization Action Plan (or “RiskMAP”), including providing
a medication guide for patients. We and Novartis, our co-promotion collaborator,
are continuing to work with the FDA on the final wording and placement of the
information in the Xolair label and the terms of the RiskMAP.
Tarceva
Net
U.S. sales of Tarceva increased 10% to $102 million in the first quarter of
2007
from the comparable period in 2006. The growth was primarily due to a price
increase effective on November 14, 2006, and to a lesser extent, an increase
in
duration of treatment in second-line NSCLC. In first- and second-line pancreatic
cancer, we observed that penetration decreased at the end of the first quarter
of 2007 as compared to the end of the first and fourth quarters of 2006. In
second-line NSCLC we observed that penetration decreased at the end of the
first
quarter of 2007 as compared to the end of first quarter of 2006 and remained
flat compared to the fourth quarter of 2006. Future sales growth in NSCLC will
depend on an increase in duration of therapy and in penetration, particularly
against chemotherapy within select second-line NSCLC patient
subsets.
Nutropin
Products
Combined
net U.S. sales of our Nutropin products increased 5% to $91 million in the
first
quarter of 2007 from the comparable period in 2006. The increase primarily
resulted from favorable product distribution agreements that resulted in lower
rebate reserves rates and, to a lesser extent, price increases effective January
10, 2006 and March 1, 2007.
Net
U.S. sales of Nutropin products decreased 10% in the first quarter of 2007
from
the fourth quarter of 2006, due to declining new patient market share and
the loss of managed care product placement due to price discounting by
competitors.
Thrombolytics
Combined
net U.S. sales of our three thrombolytic products, Activase, Cathflo Activase,
and TNKase, increased 15% to $68 million in the first quarter of 2007 from
the
comparable period in 2006. The increase was primarily due to growth in Cathflo
Activase sales in the catheter clearance market and increased Activase sales
in
the acute ischemic stroke market, partially offset by lower sales of TNKase.
Also contributing to the increase in product sales were price increases
effective on February 14, 2006, July 6, 2006, and January 18, 2007.
Pulmozyme
Net
U.S. sales of Pulmozyme increased 6% to $52 million in the first quarter of
2007
from the comparable period in 2006. The increase primarily reflected a price
increase effective on June 29, 2006, and, to a lesser extent, increased
penetration in certain patient segments.
Raptiva
Net
U.S. sales of Raptiva increased 14% to $24 million in the first quarter of
2007
from the comparable period in 2006. The growth was primarily due to a price
increase effective on August 10, 2006.
Sales
to Collaborators
Product
sales to collaborators, predominantly for use in non-U.S. markets,
increased 289% to $292 million in the first quarter of 2007 from the comparable
period in 2006. The increase was primarily due to more favorable Herceptin
pricing terms that were part of the new Hoffmann-La Roche supply agreement
signed in the third quarter of 2006 and higher sales of Herceptin, Avastin
and
Rituxan to Hoffmann-La Roche. The favorable Hoffmann-La Roche Herceptin pricing
terms will continue through the end of 2008.
For
the full year 2007, we expect sales to collaborators to approximately double
relative to 2006 levels.
Royalties
Royalty
revenues increased 47% to $419 million in the first quarter of 2007 from the
comparable period in 2006. The increase was primarily due to higher sales by
F.
Hoffmann-La Roche of our Herceptin, Avastin and Rituxan products. Of the overall
royalties received, royalties from F. Hoffmann-La Roche represented
approximately 61% in the first quarter of 2007 as compared to 58% in the first
quarter of 2006. Royalties from other licensees include royalty revenue on
our
patent licenses, including our Cabilly patents noted below.
We
have confidential licensing agreements with a number of companies on U.S. Patent
No. 6,331,415 and No. 4,816,567 (or 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 affect 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 COH a percentage of our royalty revenue and these
payments to COH are recorded with our marketing, general and administrative
(or
“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. The overall net pre-tax
contribution from revenues and expenses related to the Cabilly patents was
approximately $32 million in the first quarter of 2007 or approximately $0.02
per diluted share. See also Note 4, “Contingencies,” in the Notes to Condensed
Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q for
further information on 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”)
and forwards to hedge these foreign currency cash flows. These options and
forwards are due to expire throughout 2007 and 2008.
For
the full year 2007, we expect royalty revenue to increase approximately 25%
over
2006 levels of $1,354 million; however, royalties are difficult to forecast
because of the number of licensees and products involved, and potential
licensing and intellectual property disputes.
Contract
Revenues
Contract
revenues increased 70% to $95 million in the first quarter of 2007 from the
comparable period in 2006. The increase was primarily due to recognition of
a
$30 million milestone payment from Novartis Pharma AG for European Union
approval
of Lucentis for the treatment of patients with AMD and higher reimbursements
from Hoffmann-La Roche related to R&D development efforts on Avastin. See
“Related Party Transactions” below for more information on contract revenue from
Hoffmann-La Roche and Novartis.
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 2007, we expect contract revenues to be relatively flat as compared
to
$290 million in 2006.
Cost
of Sales
Cost
of sales (or “COS”) as a percentage of product sales was 17% in the first
quarter of 2007 compared to 16% in the first quarter of 2006. The increase
was
due to the recognition of $16 million of employee stock-based compensation
expense related to products sold for which employee stock-based compensation
expense was previously capitalized as part of inventory costs upon adoption
of
FAS 123R on January 1, 2006, and to higher volume of lower margin sales to
collaborators. COS as a percentage of product sales was favorably affected
by
improved manufacturing performance, favorable U.S. product sales mix (increased
sales of our higher margin products, primarily Lucentis, Avastin, and Herceptin
in the first quarter of 2007) and price increase on sales of Herceptin to
Roche.
Research
and Development
Research
and development (or “R&D”) expenses increased 63% to $610 million in the
first quarter of 2007 from the comparable period in 2006. A significant portion
of the increase in R&D expenses was due to $110 million of in-licensing
expense for new collaborations with Seattle Genetics, BioInvent, and Altus.
The
higher levels of expenses also reflected increased development activity across
our entire product portfolio, including increased spending on clinical trials
(notably Avastin, Rituxan Immunology, and humanized anti-CD20) and early stage
projects, higher clinical manufacturing expenses in support of early development
and development pipeline, as well as higher research expenses due to increased
headcount and headcount related expenses.
R&D
as a percentage of operating revenues was 21% in
the first quarter of 2007 as compared to 19% in the first quarter of
2006.
The
major components of R&D expenses were as follows (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
|
|
|
Research
and Development
|
|
2007
|
|
2006
|
|
%
Change
|
|
|
Product
development (including post-marketing)
|
|
$
|
390
|
|
$
|
283
|
|
|
38
|
%
|
|
Research
|
|
|
89
|
|
|
74
|
|
|
20
|
|
|
In-licensing
|
|
|
131
|
|
|
17
|
|
|
671
|
|
|
Total
R&D
|
|
$
|
610
|
|
$
|
374
|
|
|
63
|
|
Marketing,
General and Administrative
Marketing,
general and administrative (or “MG&A”) expenses increased 11% to $491
million in the first quarter of 2007 from the comparable period in 2006. The
increase was primarily due to: (i) an increase in royalty expense, primarily
to
Biogen Idec resulting from higher Hoffmann-La Roche sales of Rituxan, (ii)
an
increase in corporate expenses, including charitable donations and losses on
fixed asset disposals, and (iii) an increase in marketing and sales expense
primarily in support of post-launch activities related to Lucentis, Rituxan
Immunology, and Herceptin (adjuvant setting).
MG&A
as a percentage of operating revenues was 17% in the first quarter of 2007
as
compared to 22% from the comparable period in 2006.
Collaboration
Profit Sharing
Collaboration
profit sharing expenses increased 12% to $252 million in the first quarter
of
2007 from the comparable period in 2006 due to higher sales of Tarceva, Xolair
and Rituxan and the related profit sharing expenses.
The
following table summarizes the amounts resulting from the respective profit
sharing collaborations, for the periods presented (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
|
|
| |
|
2007
|
|
2006
|
|
%
Change
|
|
|
U.S.
Rituxan profit sharing expense
|
|
$
|
166
|
|
$
|
151
|
|
|
10
|
%
|
|
U.S.
Tarceva profit sharing expense
|
|
|
39
|
|
|
32
|
|
|
22
|
|
|
U.S.
and ex-U.S. Xolair profit sharing expense
|
|
|
47
|
|
|
43
|
|
|
9
|
|
|
Total
collaboration profit sharing expense
|
|
$
|
252
|
|
$
|
226
|
|
|
12
|
|
Currently,
our most significant collaboration profit sharing agreement is with Biogen
Idec,
with whom we co-promote Rituxan in the U.S. Under the collaboration agreement,
Biogen Idec granted us a worldwide license to develop, commercialize and market
Rituxan in multiple indications. In exchange for these worldwide rights, Biogen
Idec has co-promotion rights in the U.S. and a contractual arrangement under
which we share a portion of the pretax U.S. co-promotion profits of Rituxan
and
royalty revenue on sales of Rituxan by collaborators. In June 2003, we amended
and restated the collaboration agreement with Biogen Idec to include the
development and commercialization of one or more anti-CD20 antibodies targeting
B-cell disorders, in addition to Rituxan, for a broad range of indications.
Under
the amended and restated collaboration agreement, our share of the current
pretax U.S. co-promotion profit sharing formula is approximately 60% of
operating profits and Biogen Idec’s share is approximately 40% of operating
profits. For each calendar year or portion thereof following the approval date
of the first new anti-CD20 product, after a period of transition, our share
of
the pretax U.S. co-promotion profits will change to approximately 70% of
operating profits and Biogen Idec’s share will be approximately 30% of operating
profits.
Collaboration
profit sharing expense, exclusive of research and development expenses, related
to Biogen Idec for the periods ended March 31, 2007 and 2006, consisted of
the
following (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
|
|
| |
|
2007
|
|
2006
|
|
%
Change
|
|
|
Product
sales, net
|
|
$
|
535
|
|
$
|
477
|
|
|
12
|
%
|
|
Combined
commercial and manufacturing costs and expenses
|
|
|
130
|
|
|
115
|
|
|
13
|
|
|
Combined
co-promotion profits
|
|
$
|
405
|
|
$
|
362
|
|
|
12
|
|
|
Amount
due to Biogen Idec for their share of co-promotion profits - included
in
collaboration profit sharing expense
|
|
$
|
166
|
|
$
|
151
|
|
|
10
|
|
Biogen
Idec’s relative share of combined commercial costs determines the amount shown
as collaboration profit sharing expense, exclusive of research and development
expenses.
Revenue
and expenses related to our collaboration with Biogen Idec separately included
the following (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
|
|
| |
|
2007
|
|
2006
|
|
%
Change
|
|
|
Contract
revenue from Biogen Idec (R&D reimbursement)
|
|
$
|
21
|
|
$
|
17
|
|
|
24
|
%
|
| |
|
|
|
|
|
|
|
|
|
|
|
Royalty
expense on ex-U.S. sales of Rituxan and other patent costs - included
in
MG&A expense
|
|
$
|
56
|
|
$
|
35
|
|
|
60
|
|
Recurring
Charges Related to Redemption
We
recorded recurring charges related to the June 1999 redemption of our Special
Common Stock and push-down accounting. These charges were $26 million in the
first quarters of 2007 and 2006, and were comprised of the amortization of
Redemption-related other intangible assets in the periods
presented.
On
June 30, 1999, Roche Holdings Inc., (a wholly owned subsidiary of Roche Holding
AG) exercised its option to cause us to redeem all of our Special Common Stock
held by stockholders other than Roche. The Redemption was reflected as a
purchase of a business, which under U.S. generally accepted accounting
principles required push-down accounting to reflect in our financial statements
the amounts paid for our stock in excess of our net book value.
Special
Items: Litigation-Related
We
recorded $13 million of accrued interest and bond costs related to the COH
trial
judgment in the first quarters of 2007 and 2006. 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 to be 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’s review
of the matter. It may take longer than one year to resolve this matter. See
Note
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 $1,059 million in the first quarter of 2007, a 64% increase from
the
first quarter of 2006. Our operating income as a percentage of operating
revenues (or “pretax operating margin”) was 37% in
the first quarter of 2007 and 32% in the first quarter of 2006.
Other
Income (Expense)
The
components of “other income (expense)” are as follows (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
|
|
|
Other
Income, Net
|
|
2007
|
|
2006
|
|
%
Change
|
|
|
Gains
on sales of biotechnology equity securities and other
|
|
$
|
8
|
|
$
|
3
|
|
|
167
|
%
|
|
Write-downs
of biotechnology debt, equity securities and other
|
|
|
(3
|
)
|
|
-
|
|
|
-
|
|
|
Interest
income
|
|
|
69
|
|
|
49
|
|
|
41
|
|
|
Interest
expense
|
|
|
(18
|
)
|
|
(19
|
)
|
|
(5
|
)
|
|
Other
miscellaneous income
|
|
|
-
|
|
|
1
|
|
|
(100
|
)
|
|
Total
other income, net
|
|
$
|
56
|
|
$
|
34
|
|
|
65
|
|
Other
income, net, increased 65% to $56 million in the first quarter of 2007 over
the
comparable period in 2006. Interest income increased primarily due to higher
yields and higher average cash balances in the first quarter of 2007 from the
comparable period in 2006.
Income
Tax Provision
The
effective income tax rate was 37% in the first quarter of 2007, as compared
to
38% in the first quarter of 2006. The decrease in the income tax rate was
primarily due to the extension of the federal R&D tax credit and an increase
in the domestic manufacturing deduction in 2007.
We
adopted the provisions of Interpretation 48 on January 1, 2007. Implementation
of Interpretation 48 did not result in any adjustment to our condensed
consolidated statements of income or a cumulative adjustment to accumulated
deficit. As a result of the implementation of Interpretation 48, we reclassified
$147 million of unrecognized tax benefits from current liabilities to long-term
liabilities as of January 1, 2007 and we also reclassified the balance as of
December 31, 2006, for consistency, in the accompanying Condensed Consolidated
Balance
Sheets, none of which would have been considered as due in 2007 in the
presentation of our Contractual Obligations table in our Annual Report on Form
10-K for the year ended December 31, 2006.
Liquidity
and Capital Resources
(In
millions)
| |
|
March 31,
2007
|
|
December 31,
2006
|
|
|
Unrestricted
cash, cash equivalents, short-term investments and long-term marketable
debt and equity securities
|
|
$
|
4,792
|
|
$
|
4,325
|
|
|
Net
receivable - equity hedge instruments
|
|
|
64
|
|
|
50
|
|
|
Total
unrestricted cash, cash equivalents, short-term investments, long-term
marketable debt and equity securities, and equity hedge
instruments
|
|
$
|
4,856
|
|
$
|
4,375
|
|
|
Working
capital
|
|
$
|
4,207
|
|
$
|
3,694
|
|
|
Current
ratio
|
|
|
3.0:1
|
|
|
2.8:1
|
|
Total
unrestricted cash, cash equivalents, short-term investments and long-term
marketable securities, including the fair value of the equity hedge instruments,
were approximately $4.9 billion at March 31, 2007, an increase of approximately
$480 million from December 31, 2006. This increase primarily reflects cash
generated from operations and cash increases from stock option exercises;
partially offset by cash used for repurchases of our Common Stock and capital
expenditures. 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. See Note 1, “Summary of
Significant Accounting 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.
See
“Our affiliation agreement with Roche Holdings, Inc. could adversely affect
our
cash position” among other risk factors below in Part II, Item 1A “Risk Factors”
of this Form 10-Q, and “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—product sales” was $1,077 million at March 31, 2007, an
increase of $112 million from December 31, 2006. The increase is primarily
due
to higher product sales of Avastin and higher sales of Herceptin and Avastin
to
Hoffmann-La Roche. The average collection period of our “accounts
receivable—product sales” as measured in days sales outstanding (or “DSO”) was
42 days for the first quarter 2007, compared to 34 days in the first quarter
of
2006. The increase from the first quarter of 2006 is primarily due to the
extended payment terms we offered to certain wholesalers in conjunction with
the
launch of Lucentis on June 30, 2006. This program is planned to be in effect
for
12 months following the launch date; therefore, we currently expect our DSO
to
decrease during the second half of 2007.
Our
inventory balance was $1,297 million at March 31, 2007, an increase of $119
million from December 31, 2006. The increase was primarily due to bulk campaign
production of our Avastin and Herceptin products.
Accounts
payable, other accrued liabilities and other long-term liabilities increased
$179 million in the first quarter of 2007. This increase is mainly due to
increases in taxes payable, accrued royalties and accrued marketing expenses,
which are mainly due to the growth in the business; partially offset by
decreases in accrued compensation and other liabilities due to payments made
during the first quarter of 2007.
Cash
Used in Investing Activities
Cash
used in investing activities was primarily related to purchases, sales and
maturities of investments and capital expenditures. Capital expenditures were
$209 million during the first quarter of 2007 compared to $253 million during
the first quarter of 2006. Capital expenditures in the first quarter of 2007
included ongoing construction of our second manufacturing facility in Vacaville,
California, validation costs at our manufacturing facility in Oceanside,
California, purchase of equipment and information systems, and ongoing
expenditures to support our corporate infrastructure needs.
Cash
Used in Financing Activities
Cash
used in financing activities was primarily related to activities under our
employee stock plans and our stock repurchase program. We used cash for stock
repurchases of $392 million during the first quarter of 2007 and $227 million
during the first quarter of 2006 pursuant to our stock repurchase program
approved by our Board of Directors. We also received $174 million during the
first quarter of 2007 and $89 million during the first quarter of 2006 related
to stock option exercises and stock issuances under our employee stock plans.
The excess tax benefits from stock-based compensation arrangements were $99
million in the first quarter of 2007 and $49 million in the first quarter of
2006.
Under
a stock repurchase program approved by our Board of Directors in December 2003
and most recently extended in April 2007, we are authorized to repurchase up
to
100,000,000 shares of our Common Stock for an aggregate price of up to $8.0
billion through June 30, 2008. In this program, as in previous stock repurchase
programs, purchases may be made in the open market or in privately negotiated
transactions from time to time at management’s discretion. We also may engage in
transactions in other Genentech securities in conjunction with the repurchase
program, including certain derivative securities. As of March 31, 2007, we
have
not engaged in any such transactions. We intend to use the repurchased stock
to
offset dilution caused by the issuance of shares in connection with our 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 address
provisions of our affiliation agreement with Roche relating to maintaining
Roche’s minimum ownership percentage; (ii) to make prudent investments of our
cash resources; and (iii) to allow for an effective mechanism to provide stock
for our employee stock plans. See below in “Relationship with Roche” for more
information on Roche’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
four million shares and is effective through June 30, 2007.
Our
shares repurchased during the first quarter of 2007 were as follows
(shares in millions):
| |
|
Total
Number of Shares Purchased
|
|
Average
Price Paid per Share
|
|
|
January
1-31, 2007
|
|
|
3.0
|
|
$
|
87.33
|
|
|
February
1-28, 2007
|
|
|
0.9
|
|
|
86.54
|
|
|
March
1-31, 2007
|
|
|
0.6
|
|
|
82.33
|
|
|
Total
|
|
|
4.5
|
|
$
|
86.47
|
|
As
of March 31, 2007, 67 million shares have been purchased under our stock
repurchase program for $4.8 billion, and a maximum of 33 million additional
shares may be purchased under the program through June 30, 2008.
Off-Balance
Sheet Arrangements
We
have certain contractual arrangements that create potential risk for us and
are
not recognized in our Condensed Consolidated Balance Sheets. We believe there
have been no significant changes in the off-balance sheet arrangements disclosed
in our Annual Report on Form 10-K for the year ended December 31, 2006 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.
Contractual
Obligations
During
the first quarter of 2007, we believe there have been no significant changes
in
our payments due under contractual obligations as disclosed in our Annual Report
on Form 10-K for the year ended December 31, 2006, except as noted above in
Income Tax Provision.
Contingencies
We
are party to various legal proceedings, including patent infringement litigation
and licensing and contract disputes, and other matters. See Note 4,
“Contingencies,” in the Notes to Condensed Consolidated Financial Statements of
Part 1, Item 1 of this Form 10-Q for further information.
Relationship
with Roche
Roche’s
Ability to Maintain Its Percentage Ownership Interest in Our
Stock
We
issue additional shares of Common Stock in connection with our stock option
and
stock purchase plans, and we may issue additional shares for other purposes.
Our
affiliation agreement with Roche provides, among other things, that with respect
to any issuance of our Common Stock in the future, we will repurchase a
sufficient number of shares so that immediately after such issuance, the
percentage of our Common Stock owned by Roche will be no lower than 2% below
the
“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 Stock owned by Roche since the July 1999 offering (to be
adjusted in the future for dispositions of shares of Genentech Common Stock
by
Roche 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 Stock
outstanding at the time of the July 1999 offering, as adjusted for stock splits.
We have repurchased shares of our Common Stock since 2001 (see discussion above
in Liquidity and Capital Resources). The affiliation agreement also provides
that, upon Roche’s request, we will repurchase shares of our Common Stock to
increase Roche’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. Under the terms of the affiliation
agreement, Roche’s Minimum Percentage is 57.7% and Roche’s ownership percentage
is to be no lower than 55.7%. At March 31, 2007, Roche’s ownership percentage
was 55.7%.
Related
Party Transactions
We
enter into transactions with our related parties, Roche Holding AG and
affiliates (or “Hoffmann-La Roche”) and Novartis AG and other Novartis
affiliates (or “Novartis”). 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.
In
our royalty and supply arrangements with related parties, we are the principal,
as defined under Emerging Issues Task Force Issue No. 99-19, “Reporting
Revenue Gross as a Principal Versus Net as an Agent”
(or “EITF 99-19”), because we bear the manufacturing risk, general inventory
risk, and the risk to defend our intellectual property. In circumstances where
we are the principal in the transaction, we record the transaction on a gross
basis in accordance with EITF 99-19. Otherwise our transactions are recorded
on
a net basis.
Hoffmann-La
Roche
We
currently have no active profit sharing arrangements with Hoffmann-La
Roche.
Under
our existing arrangements with Hoffmann-La Roche, including our licensing and
marketing agreement, we recognized the following amounts (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Ex-U.S.
product sales to Hoffmann-La Roche
|
|
$
|
264
|
|
$
|
58
|
|
| |
|
|
|
|
|
|
|
|
Royalties
earned from Hoffmann-La Roche
|
|
$
|
255
|
|
$
|
167
|
|
| |
|
|
|
|
|
|
|
|
Cost
of sales on ex-U.S. product sales to Hoffmann-La Roche
|
|
$
|
121
|
|
$
|
49
|
|
| |
|
|
|
|
|
|
|
|
Contract
revenue from Hoffmann-La Roche
|
|
$
|
30
|
|
$
|
18
|
|
R&D
expenses incurred
on
joint development projects
with Hoffmann-La Roche were $58 million in the first quarter of 2007 and $43
million in the first quarter of 2006. These expenses are partially reimbursable
to us by Hoffmann-La Roche. In addition, these amounts include R&D expenses
resulting from the net settlement of amounts owed to Hoffmann-La Roche on
R&D development expenses it incurred on joint development projects, less
amounts reimbursable by us on these respective projects.
Novartis
Based
on information available to us at the time of filing this Form 10-Q, we believe
Novartis holds approximately 33.3% of the outstanding voting shares of Roche
Holding AG. As a result of this ownership, Novartis is deemed to have an
indirect beneficial ownership interest under FAS 57 “Related Party Disclosures”
of more than 10% of our voting stock.
We
have an agreement with Novartis Pharma AG (a wholly-owned subsidiary of Novartis
AG) under which Novartis Pharma AG has the exclusive right to develop and market
Lucentis outside of the U.S. for indications related to diseases or disorders
of
the eye. As part of this agreement, the parties will share the cost of certain
of our ongoing development expenses for Lucentis.
We,
along with Novartis Pharma AG and Tanox, Inc., are co-developing Xolair in
the
U.S., and we and Novartis are co-promoting Xolair in the U.S. and both make
certain joint and individual payments to Tanox; our 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 in 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,
and
our U.S. and European profit sharing expenses are recorded as collaboration
profit sharing expense.
Under
our existing arrangements with Novartis, we recognized the following amounts
from Novartis (in
millions):
| |
|
Three
Months
Ended
March 31,
|
|
| |
|
2007
|
|
2006
|
|
|
Ex-U.S.
product sales to Novartis
|
|
$
|
2
|
|
$
|
1
|
|
| |
|
|
|
|
|
|
|
|
Royalties
earned from Novartis
|
|
$
|
5
|
|
$
|
-
|
|
| |
|
|
|
|
|
|
|
|
Cost
of sales on ex-U.S. product sales to Novartis
|
|
$
|
3
|
|
$
|
1
|
|
| |
|
|
|
|
|
|
|
|
Contract
revenue from Novartis
|
|
$
|
40
|
|
$
|
10
|
|
| |
|
|
|
|
|
|
|
|
Collaboration
profit sharing expense to Novartis
|
|
$
|
47
|
|
$
|
43
|
|
Contract
revenue in the first quarter of 2007 includes a $30 million milestone payment
from Novartis Pharma AG for European Union approval of Lucentis for the
treatment of AMD.
R&D
expenses incurred
on
joint development projects
with Novartis were $10 million in the first quarters of 2007 and
2006.
Stock
Options
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 2004 Equity
Incentive Plan (the “Plan”), a broad-based plan under which stock options,
restricted stock, stock appreciation rights and performance shares and units
may
be 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 1999 Stock Plan, 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.
All
stock option grants are made with the approval of the Compensation Committee
of
the Board of Directors or an authorized delegate.
General
Option Information
Summary
of Option Activity
(Shares
in millions)
| |
|
|
|
Options
Outstanding
|
|
| |
|
Shares
Available
for
Grant
|
|
Number
of
Shares
|
|
Weighted-Average
Exercise
Price
|
|
|
December 31,
2005
|
|
|
83.7
|
|
|
82.8
|
|
$
|
46.64
|
|
|
Grants
|
|
|
(17.5
|
)
|
|
17.5
|
|
|
79.85
|
|
|
Exercises
|
|
|
-
|
|
|
(9.5
|
)
|
|
30.42
|
|
|
Cancellations
|
|
|
2.5
|
|
|
(2.5
|
)
|
|
62.09
|
|
|
December 31,
2006
|
|
|
68.7
|
|
|
88.3
|
|
$
|
54.53
|
|
|
Grants
|
|
|
(0.3
|
)
|
|
0.3
|
|
|
84.72
|
|
|
Exercises
|
|
|
-
|
|
|
(4.8
|
)
|
|
30.75
|
|
|
Cancellations
|
|
|
0.6
|
|
|
(0.6
|
)
|
|
71.63
|
|
|
March 31,
2007 (Year to date)
|
|
|
69.0
|
|
|
83.2
|
|
$
|
55.88
|
|
In-the-Money
and Out-of-the-Money Option Information
(Shares
in millions)
| |
|
Exercisable
|
|
Unexercisable
|
|
Total
|
|
|
As
of March 31, 2007
|
|
Shares
|
|
Weighted-Average
Exercise
Price
|
|
Shares
|
|
Weighted-Average
Exercise
Price
|
|
Shares
|
|
Weighted-Average
Exercise
Price
|
|
|
In-the-Money
|
|
|
40
|
|
$
|
33.70
|
|
|
25
|
|
$
|
68.91
|
|
|
65
|
|
$
|
47.42
|
|
|
Out-of-the-Money(1)
|
|
|
6
|
|
$
|
86.25
|
|
|
12
|
|
$
|
86.16
|
|
|
18
|
|
$
|
86.19
|
|
|
Total
Options Outstanding
|
|
|
46
|
|
|
|
|
|
37
|
|
|
|
|
|
83
|
|
|
|
|
___________
|
(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, $82.12, at the close
of
business on March 30, 2007.
|
Dilutive
Effect of Options
Grants,
net of cancellations, as a percentage of outstanding shares, were
(0.03)% for
the first quarter of 2007, 1.43% for
the year ended December 31, 2006 and 1.70% for the year ended December 31,
2005.
Equity
Compensation Plan Information
Our
stockholders have approved all of our equity compensation plans under which
options are outstanding.
******
This
report contains forward-looking statements regarding our Horizon 2010 strategy
of bringing 20 new molecules into clinical development, bringing at least 15
major new products or indications onto the market, becoming the number one
U.S.
oncology company in sales, and achieving certain financial growth measures;
Avastin, Herceptin, Lucentis and Tarceva sales growth; sales to collaborators;
royalty and contract revenue; the effects of the Medicare Prescription Drug
Improvement and Modernization Act on our revenues; days of sales outstanding;
and the acquisition of Tanox.
These
forward-looking statements involve risks and uncertainties, and the cautionary
statements set forth below and those contained in “Risk Factors” in this Form
10-Q 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, additional time requirements for data
analysis; BLA preparation and decision making; FDA actions or delays; failure
to
obtain FDA approval; difficulty in obtaining materials from suppliers;
unexpected safety, efficacy or manufacturing issues for us or our
contract/collaborator manufacturers; the ability to supply product; product
withdrawals; competition; pricing decisions by us or our competitors; our
ability to protect our proprietary rights; the outcome of, and expenses
associated with, litigation or legal settlements; increased cost of sales;
variations in collaborator sales and expenses; actions by Roche that are adverse
to our interests; decreases in third party reimbursement rates; and the extent
to which all closing conditions are met for our proposed acquisition of Tanox
including the absence of a material adverse effect with respect to the
transaction and the expiration of any waiting periods under antitrust laws.
We
disclaim and do not undertake any obligation to update or revise any
forward-looking statement in this Form 10-Q.
Our
market risks at March 31, 2007 have not changed materially from those discussed
in Item 7A of our Form 10-K for the year ended December 31, 2006 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.
See
Note 4, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements of Part I, Item 1 of this Form 10-Q for a description of legal
proceedings as well as certain other matters.
See
also Item 3 of our report on Form 10-K for the year ended December 31,
2006.
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 we make or that are made on our behalf, 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 and time
Successful
development of biotherapeutics is highly uncertain. Products that appear
promising in research or 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 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 License Application
(or “BLA”) preparation, discussions with the U.S. Food and Drug Administration
(or “FDA”), FDA requests for additional preclinical or clinical data, analyses
or changes to study design, 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.
-
The
contractual rights of our collaborators or others 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”) productivity and the
amount of our R&D expenses include, but are not limited to:
-
The
number of and the outcome of clinical trials currently being conducted
by us
and/or our collaborators. For example, 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 a sufficient number of candidate products that are ready to
move
into development or that product candidates will be available for in-licensing
on terms acceptable to us and permitted under the anti-trust
laws.
-
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.
-
Our
ability to in-license projects of interest to us and the timing and amount
of
related development funding or milestone payments for such licenses. 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’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.”) 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 BLA or NDA, 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 recall or withdrawal.
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 we may not maintain
necessary regulatory approvals for our existing products, and all of the
following could have a material adverse effect on our business:
-
Significant
delays in obtaining or failing to obtain approvals as described in “The
successful development of biotherapeutics is highly uncertain and requires
significant expenditures and time” 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.
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.
We
face competition
We
face competition from pharmaceutical companies and biotechnology
companies.
The
introduction of new competitive products or follow-on biologics, and/or new
information about existing products or pricing decisions by us or our
competitors, may result in lost market share for us, reduced utilization of
our
products, lower prices, and/or reduced product sales, even for products
protected by patents.
Avastin: Avastin
competes in metastatic colorectal cancer (or “CRC”) with Erbitux®
(Imclone/Bristol-Myers Squibb), which is an EGFR-inhibitor approved for the
treatment of irinotecan refractory or intolerant metastatic CRC patients and
Vectibix™ (Amgen) which is indicated for the treatment of patients with
EGFr-expressing metastatic CRC who have disease progression, on or following
fluoropyrimidine-, oxaliplatin- and irinotecan- containing regimens. In addition
Avastin competes with: Nexavar® (sorafenib, Bayer Corporation/Onyx
Pharmaceuticals, Inc.) and Sutent® (sunitinib malate, Pfizer, Inc.) for the
treatment of patients with advanced renal cell carcinoma (or “RCC”) (an
unapproved use of Avastin).
Avastin
could face competition from products in development that currently do not have
regulatory approval. Amgen has stated that it will initiate head-to-head
clinical trials comparing AMG 706 and Avastin. There
are also head-to-head clinical trials that have recently begun comparing both
Sutent and AZD2171 (AstraZeneca) to Avastin. Additionally,
there are more than 65 molecules that target VEGF inhibition, and over 130
companies that are developing molecules that, if approved, may compete with
Avastin.
Rituxan: Rituxan’s
current competitors in hematology-oncology include Bexxar® (GlaxoSmithKline (or
“GSK”)) 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”). Other
potential competitors include Campath® (Bayer Corporation/Genzyme) in relapsed
CLL (an unapproved use of Rituxan), Velcade® (Millennium Pharmaceuticals, Inc.)
which is indicated for multiple myeloma and more recently, mantle cell lymphoma
(both unapproved uses of Rituxan).
Rituxan’s
current biologic competitors in rheumatoid arthritis (or “RA”) include Enbrel®
(Amgen/Wyeth), Humira® (Abbott), Remicade® (Johnson & Johnson), Orencia®
(Bristol-Myers Squibb), and Kineret® (Amgen). These products are approved for
use in a broader RA patient population than the approved population for Rituxan.
In addition, molecules in development that, if successful in clinical trials,
may compete with Rituxan in RA include: Actemra, an anti-interleukin-6
antibody being developed by Chugai and Roche, certolizumab pegol (Cimzia™), an
anti-TNF antibody being developed by UCB, and golimumab (CNTO 148), an anti-TNF
antibody being developed by Centocor.
Rituxan
may face future competition in both hematology-oncology and rheumatoid arthritis
from Ofatumumab (Humax CD20™), an anti-CD20 antibody being co-developed by
Genmab and GSK; Ofatumumab is in late-stage development for refractory CLL
and
NHL. In addition we are aware of other anti-CD20 molecules in development that,
if successful in clinical trials, may compete with Rituxan.
Herceptin: Herceptin
faces competition in the relapsed metastatic setting from lapatinib ditosylate
(Tykerb®), manufactured by GlaxoSmithKline (or “GSK”). On March 13, 2007, the
FDA approved Tykerb®, in combination with capecitabine, for the treatment of
patients with advanced or metastatic breast cancer whose tumors overexpress
HER2
and who have received prior therapy including an anthracycline, a taxane, or
Herceptin.
Lucentis: We
are aware that retinal specialists are currently using Avastin to treat the
wet
form of age-related macular degeneration (or “AMD”), an unapproved use for
Avastin, which results in significantly less revenue to us per treatment as
compared to Lucentis. We expect Avastin use to continue in this setting.
Additionally, the National Eye Institute and National Institute of Health
announced plans to initiate a head-to-head trial of Avastin and Lucentis in
this
setting. Lucentis also competes with Macugen® (Pfizer/OSI Pharmaceuticals), and
Visudyne® (Novartis) alone, in combination with Lucentis, or in combination with
the off-label steroid triamcinolone in wet AMD. In addition, if successful
in
clinical trials, VEGF-Trap-Eye, a vascular endothelial growth factor blocker
being developed by Bayer Corporation and Regeneron, may compete with
Lucentis.
Xolair: Xolair
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 and immunotherapy.
Tarceva: Tarceva
competes with the chemotherapy agents Taxotere® (Sanofi-Aventis) and Alimta®
(Eli Lilly and Company), both of which are indicated for the treatment of
relapsed non-small cell lung cancer (or “NSCLC”). Recent increases in the
off-label use of Avastin in combination with chemotherapy in second-line NSCLC
have also had an impact in this setting. In front-line pancreatic cancer,
Tarceva primarily competes with Gemzar® (Eli Lilly) monotherapy and Gemzar® in
combination with other chemotherapeutic agents. Tarceva could also face
competition in the future from products in late-phase development, such as
Erbitux® (Bristol-Myers Squibb), and Xeloda® (Roche), that currently do not have
regulatory approval for use in NSCLC or pancreatic cancer.
Nutropin: Nutropin
faces competition in the growth hormone market, 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.).
In addition, follow-on biologics that are not therapeutically equivalent (not
substitutable) for current growth hormone products are beginning to enter the
market. In May 2006, the FDA approved the first follow-on version of a protein
product, Omnitrope® (Sandoz), as a biologic similar to Genotropin® (Pfizer);
Omnitrope launched in January of 2007. Cangene received an approvable letter
from the FDA for its growth hormone Accretropin in March 2007 as a biologic
similar to Humatrope®. Furthermore, as a result of multiple competitors, we have
experienced, and may continue to experience, a loss of patient share and
increased competition for managed care product placement. Obtaining placement
on
the preferred product lists of managed care companies may require that we
further discount the price of Nutropin.
Thrombolytics: Our
thrombolytic products face competition in the acute myocardial infarction
market, with sales of TNKase and Activase affected by the adoption by physicians
of mechanical reperfusion strategies. We expect that the use of mechanical
reperfusion in lieu of thrombolytic therapy for the treatment of acute
myocardial infarction will continue to grow. TNKase, for acute myocardial
infarction, also faces competition from Retavase® (PDL BioPharma Inc.), which
engages in competitive price discounting.
Pulmozyme: Pulmozyme
faces competition from the use of hypertonic saline, an inexpensive approach
to
clearing the lungs of cystic fibrosis patients.
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 biologic agents Amevive®
(Astellas), Enbrel® (Amgen), and Remicade® (Centocor, Inc.). Raptiva also
competes with the biologic agent Humira® (Abbott Laboratories), which is
currently used off-label in the psoriasis market.
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 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 increasingly attempt to limit and/or regulate the
reimbursement for medical products and services, including branded prescription
drugs. Changes in government legislation or regulation, such as the Medicare
Act, or changes in private third-party payers’ policies toward reimbursement for
our products may reduce reimbursement of our products’ costs to physicians.
Decreases in third-party reimbursement for our 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.
Difficulties
or delays in product manufacturing or in obtaining materials from our suppliers
could harm our business and/or negatively affect 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 biotechnology manufacturing
facility. We currently produce our products at our manufacturing facilities
located in South San Francisco, Vacaville, and Oceanside, California and through
various contract-manufacturing arrangements. Maintaining an adequate supply
to
meet demand for our products depends on our ability to execute on our production
plan. Any significant problem in the operations of our or our contractors’
manufacturing facilities could result in cancellations of shipments, loss of
product in the process of being manufactured, a shortfall or stock-out or recall
of available product inventory, or unplanned increases in production costs,
any
of which could have a material adverse effect on our business. A number of
factors could cause significant production problems or interruptions,
including:
-
the
inability of a supplier to provide raw materials used for manufacture of
our
products;
-
equipment
obsolescence, malfunctions or failures;
-
product
quality or 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 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;
-
a
contract manufacturer going out of business or failing to produce product
as
contractually required;
-
failure
to maintain an adequate state of GMP compliance; and
-
implementation
and integration of our new enterprise resource planning system, including
the
portions relating to manufacturing and distribution.
In
addition, 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. Alternatively, we may have an excess of available capacity which could
lead to an idling of a portion of our manufacturing facilities and incurring
unabsorbed or idle plant charges, resulting in an increase in our costs of
sales.
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 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 effect on our product sales
and
our business.
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’ 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.
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’
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 Cabilly reexaminations discussed in Note 4,
“Contingencies,” in the Notes to Condensed Consolidated Financial Statements of
Part I, Item 1 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 one or more of our
patents or other 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, or to 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
or other legal actions to which we are currently or have been subjected relates
to, among other things, our patent and other intellectual property rights,
licensing arrangements and other contracts with third parties, and product
liability. We cannot predict with certainty the eventual outcome of pending
proceedings, which may include an injunction against the development,
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 these proceedings and such matters could divert management’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. 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, 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
to 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 affect 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 numbers 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. We cannot be 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.
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, the pricing decisions of our competitors, as well as our Avastin
Patient Assistance Program, which is a voluntary program that enables eligible
patients who have received 10,000 milligrams of Avastin in a 12-month period
to receive free Avastin in excess of the 10,000 milligrams during the
remainder of the 12-month period.
-
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 or withdrawn.
-
Negative
safety or efficacy data from post-approval marketing experience or production
quality problems could cause sales of our products to decrease or a product
to
be recalled.
-
Efficacy
data from clinical studies conducted by any party in the U.S. or
internationally, showing or perceived to show, a similar or an improved
treatment benefit at a lower dose or shorter duration of therapy could
cause
the sales of our products to decrease.
-
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, and
sales to collaborators
Royalty
and contract revenues, and sales to collaborators 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.
-
Government
and third-party payer reimbursement and coverage decisions that affect
the
utilization of our products and competing products.
-
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, unenforceable, or unpatentable. If a court, patent
office, or other authority were to determine that a patent (including,
for
example, the Cabilly patent) under which we receive royalties and/or other
revenues is invalid, unenforceable, or unpatentable, 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 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.
Roche’s
ownership percentage is diluted by the exercise of stock options to purchase
shares of our Common Stock by our employees and the purchase of shares of our
Common Stock through our employee stock purchase plan. See Note 2, “Employee
Stock-Based Compensation,” in the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this Form 10-Q for information regarding
employee stock plans. In order to maintain Roche’s Minimum Percentage, we
repurchase shares of our Common Stock under the stock repurchase program. While
the dollar amounts associated with future stock repurchase programs cannot
currently be determined, future stock repurchases could have a material adverse
effect on our liquidity, credit rating and ability to access additional capital
in the financial markets.
Our
affiliation agreement with Roche Holdings, Inc. 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, 2007, 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 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 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
As
our majority stockholder, Roche 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
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 stockholders. 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 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.
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.
Insurance
coverage is increasingly more difficult and costly to obtain or
maintain
While
we currently have a certain amount of insurance to minimize our direct exposure
to certain business risks, premiums are generally increasing and coverage is
narrowing in scope. 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 damages
in excess of our insurance coverage, we will incur the cost of the portion
of
the retained risk. Furthermore, any claims made on our insurance policies may
affect our ability to obtain or maintain insurance coverage at reasonable
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” for which redevelopment or use is complicated by the presence or
potential presence of a hazardous substance, pollutant or contaminant. Certain
events which could occur 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
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
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 affects 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
efficacy 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 that we or our competitors have adopted or may adopt, as well
as our
Avastin Patient Assistance Program.
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 implementing new information 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 affect our ability to fulfill orders and
interrupt other operational processes. Delayed sales, lower margins or lost
customers resulting from these disruptions could adversely affect our financial
results.
Our
stock price, like that of many biotechnology companies, is
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 Stock has been and may continue to
be
volatile.
The
following factors may have a significant effect 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.
-
Concerns
about the pricing of our products, or our pricing initiatives (including
our
Avastin Patient Assistance Program), and the potential effect of such on
their
utilization or our product sales.
-
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, acquisitions, and changes in overall
levels of income before 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, 2007, 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 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.
Accounting
pronouncements may affect our future financial position and results of
operations
Under
Financial Accounting Standards Board 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 over 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 effect on our financial
condition and/or results of operations in future periods.
Under
a stock repurchase program approved by our Board of Directors in December 2003
and most recently extended in April 2007, we are authorized to repurchase up
to
100,000,000 shares of our Common Stock for an aggregate price of up to $8.0
billion through June 30, 2008. In this program, as in previous stock repurchase
programs, purchases may be made in the open market or in privately negotiated
transactions from time to time at management’s discretion. We also may engage in
transactions in other Genentech securities in conjunction with the repurchase
program, including certain derivative securities. As of March 31, 2007, we
have
not engaged in any such transactions. We intend to use the repurchased stock
to
offset dilution caused by the issuance of shares in connection with our 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 address
provisions of our affiliation agreement with Roche relating to maintaining
Roche’s minimum ownership percentage; (ii) to make prudent investments of our
cash resources; and (iii) to allow for an effective mechanism to provide stock
for our employee stock plans. See above in “Relationship with Roche” for more
information on Roche’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
four million shares and is effective through June 30, 2007.
Our
shares repurchased for the three months ended March 31, 2007 were as
follows
(shares in millions):
| |
|
Total
Number of
Shares
Purchased
|
|
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, 2007
|
|
|
3.0
|
|
$
|
87.33
|
|
|
|
|
|
|
|
|
February
1-28, 2007
|
|
|
0.9
|
|
|
86.54
|
|
|
|
|
|
|
|
|
March
1-31, 2007
|
|
|
0.6
|
|
|
82.33
|
|
|
|
|
|
|
|
|
Total
|
|
|
4.5
|
|
$
|
86.47
|
|
|
67
|
|
|
33
|
|
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.
|
Exhibit
No.
|
Description
|
Location
|
|
10.1
|
Fourth
Amendment to the Manufacturing and Supply Agreement between Genentech
and
Lonza Biologics PLC, dated as of 2 February 2007.*
|
Filed
herewith
|
|
10.2
|
Amendment
No. 1 to the Genentech, Inc. Tax Reduction Investment Plan, as amended
and
restated.
|
Filed
herewith
|
|
10.3
|
Amendment
No. 2 to the Genentech, Inc. Tax Reduction Investment Plan, as amended
and
restated.
|
Filed
herewith
|
|
15.1
|
Letter
regarding Unaudited Interim Financial Information.
|
Filed
herewith
|
|
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
|
Filed
herewith
|
|
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
|
Filed
herewith
|
|
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
|
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.
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.
| |
|
|
GENENTECH,
INC.
|
|
Date:
|
May
3, 2007
|
|
/s/ARTHUR
D. LEVINSON
|
| |
|
|
Arthur
D. Levinson, Ph.D.
Chairman
and Chief Executive Officer
|
| |
|
|
|
| |
|
|
|
|
Date:
|
May
3, 2007
|
|
/s/DAVID
A. EBERSMAN
|
| |
|
|
David
A. Ebersman
Executive
Vice President and
Chief
Financial Officer
|
| |
|
|
|
| |
|
|
|
|
Date:
|
May
3, 2007
|
|
/s/ROBERT
ANDREATTA
|
| |
|
|
Robert
Andreatta
Controller
and Chief Accounting Officer
|