(dollars in millions, except per share amounts)
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(1) Based on Pro Forma amounts, which exclude the special charges in 1999 related to the Redemption and legal settlements, recurring charges related to the Redemption in 2000 and 1999, costs in 2000 and 1999 related to the sale of inventory that was written up at the Redemption, and their related tax effects. In addition, Pro Forma excludes the cumulative effect of an accounting change, net of tax, in 2000. See the Special Charges, Recurring Charges Related to Redemption, Cost of Sales, Income Tax and Staff Accounting Bulletin No. 101 discussions in the Financial Review section of this annual report for further information on these charges. |
Genentech is a leading biotechnology company using human genetic information to discover, develop, manufacture and market human pharmaceuticals that address significant unmet medical needs. Fourteen of the approved products of biotechnology stem from our science. We manufacture and market nine protein-based pharmaceuticals listed below, and license several additional products to other companies.
- Herceptin (trastuzumab) antibody for the treatment of certain patients with metastatic breast cancer whose tumors overexpress the human epidermal growth factor receptor2, or HER2, protein;
- Rituxan (rituximab) antibody which we market together with IDEC Pharmaceuticals Corporation, commonly known as IDEC, for the treatment of patients with relapsed or refractory low-grade or follicular, CD20-positive B-cell non-Hodgkin's lymphoma;
- TNKase (tenecteplase) single-bolus thrombolytic agent for the treatment of acute myocardial infarction;
- Activase (alteplase, recombinant) tissue plasminogen activator, or t-PA, for the treatment of acute myocardial infarction, acute ischemic stroke within three hours of the onset of symptoms and acute massive pulmonary embolism;
- Nutropin Depot [somatropin (rDNA origin) for injectable suspension] long-acting growth hormone for the treatment of growth failure associated with pediatric growth hormone deficiency;
- Nutropin AQ [somatropin (rDNA origin) injection] liquid formulation growth hormone for the same indications as Nutropin;
- Nutropin [somatropin (rDNA origin) for injection] growth hormone for the treatment of growth hormone deficiency in children and adults, growth failure associated with chronic renal insufficiency prior to kidney transplantation and short stature associated with Turner syndrome;
- Protropin (somatrem for injection) growth hormone for the treatment of inadequate endogenous growth hormone secretion, or growth hormone deficiency, in children; and
- Pulmozyme (dornase alfa, recombinant) inhalation solution for the treatment of cystic fibrosis.
We receive royalties on sales of rituximab outside of the United States (excluding Japan), on sales of Pulmozyme and Herceptin outside of the United States and on sales of certain products in Canada from F. Hoffmann-La Roche Ltd, an affiliate of Roche Holdings, Inc., that is commonly known as Hoffmann-La Roche. We receive royalties on sales of growth hormone products and t-PA outside of the United States and Canada, and we will receive royalties on sales of rituximab in Japan through other licensees. We also receive worldwide royalties on seven additional licensed products that are marketed by other companies. Six of these products originated from our technology.
On June 30, 1999, we redeemed all of our outstanding Special Common Stock held by stockholders other than Roche Holdings, Inc., commonly known as Roche, at a price of $20.63 per share in cash with funds deposited by Roche for that purpose. We refer to this event as the "Redemption." As a result, on that date, Roche's percentage ownership of our outstanding Common Stock increased from 65% to 100%. Consequently, under U.S. generally accepted accounting principles, we were required to use push-down accounting to reflect in our financial statements the amounts paid for our stock in excess of our net book value. Push-down accounting required us to record $1,685.7 million of goodwill and $1,499.0 million of other intangible assets onto our balance sheet on June 30, 1999. Also, as a result of push-down accounting, we recorded special charges related to the Redemption of $1,207.7 million on June 30, 1999. For more information about special charges and push-down accounting, you should read "Special Charges" below and the "Redemption of Our Special Common Stock" note in the Notes to Consolidated Financial Statements. Roche subsequently made public offerings of our Common Stock as described below.
On October 24, 2000, we effected a two-for-one stock split of our Common Stock in the form of a dividend of one share of Genentech Common Stock for each share held at the close of business on October 17, 2000. Our stock began trading on a split-adjusted basis on October 25, 2000. On November 2, 1999, we effected a two-for-one stock split of our Common Stock in the form of a dividend of one share of Genentech Common Stock for each share held at the close of business on October 29, 1999. Our stock began trading on a split-adjusted basis on November 3, 1999. All information in this annual report relating to the number of shares, price per share and per share amounts of Common Stock, Special Common Stock and Redeemable Common Stock give effect to these splits.
On July 23, 1999, October 26, 1999, and March 29, 2000, Roche completed public offerings of our Common Stock. We did not receive any of the net proceeds from these offerings. On January 19, 2000, Roche completed an offering of zero-coupon notes that are exchangeable for an aggregate of 13,034,618 shares of our Common Stock held by Roche. Roche's percentage ownership of our outstanding Common Stock is approximately 58.4% at December 31, 2000.
(dollars in millions, except per share amounts)
As discussed in the "Basis of Presentation and Restatement" note in the Notes to Consolidated Financial Statements, our 1999 financial statements have been restated to reflect: (a) our results of operations prior to the Redemption (Old Basis) separately from our results of operations subsequent to the Redemption (New Basis) and (b) revised accounting related to the write up of the valuation allowance pertaining to unrealized gains on certain marketable equity securities resulting from the Redemption. Information for 1999 in this Financial Review for 1999 reflects the combined Old Basis and New Basis presentation from the Consolidated Financial Statements.
Total Revenues
Total Revenues
Total revenues for 2000 reached $1,736.4 million, a 24% increase from 1999. Revenues for 1999 increased 22% from 1998 primarily due to higher product sales. These increases are further discussed below.
Total Product Sales
Total Product Sales
Total product sales were $1,278.3 million in 2000, an increase of 23% from 1999 reflecting the effect of strong Rituxan and Herceptin sales. Total product sales were $1,039.1 million in 1999, an increase of 45% from 1998 also reflecting the effect of strong Rituxan sales, a full year of Herceptin sales and higher Activase sales. Product sales in connection with our licensing agreement with Hoffmann-La Roche were $67.4 million in 2000, $41.3 million in 1999 and $28.7 million in 1998. See "Relationship With Roche" below for further information about our licensing agreement with Hoffmann-La Roche.
Herceptin
Herceptin
Sales of Herceptin were $275.9 million, a 46% increase from 1999. In 1999 sales of Herceptin were $188.4 million. We recorded $30.5 million of initial sales of Herceptin in the fourth quarter of 1998. Herceptin was first marketed in September 1998 and is the first humanized monoclonal antibody for the treatment of HER2 overexpressing metastatic breast cancer. Since the launch of Herceptin, an increase in penetration into the breast cancer market has contributed to a positive sales trend. We have granted Hoffmann-La Roche exclusive marketing rights to Herceptin outside of the United States.
During the third quarter of 2000, Hoffmann-La Roche received approval from the European Commission to market Herceptin for the treatment of HER2-positive metastatic breast cancer in Europe. We receive royalties from Hoffmann-La Roche for these European Herceptin product sales.
On May 3, 2000, we sent a letter to physicians advising them of some serious adverse events that have been reported related to the use of Herceptin in certain patients and that have occurred subsequent to its approval. In 15 patients who experienced such serious adverse events following Herceptin therapy, death ensued. Nine of these patients died within 24 hours after Herceptin administration. Most of these patients had significant pre-existing pulmonary compromise as a consequence of lung disease or malignancies that had spread to the lung. On October 6, 2000, we issued a follow-up letter to physicians which included an amended package insert for Herceptin including this information.
Rituxan
Rituxan
Sales of Rituxan were $444.1 million in 2000, an increase of 59% from 1999. Sales of Rituxan were $279.4 million in 1999, an increase of 72% from 1998. These increases were primarily due to increased market penetration for the treatment of B-cell non-Hodgkin's lymphoma. Sales of Rituxan were $162.6 million in 1998, the first full year of sales. Rituxan was approved for marketing by the Food and Drug Administration, or FDA, in late November 1997 and we launched Rituxan in December 1997. We co-developed Rituxan with IDEC, from which we license Rituxan. IDEC and Genentech jointly promote Rituxan in the U.S. We shared responsibility with IDEC for manufacturing the product until the end of the third quarter of 1999, when IDEC finished transferring all bulk manufacturing responsibilities for Rituxan to us. Our partner Hoffmann-La Roche received permission from the European Commission in 1997 to market rituximab under the tradename MabThera® in the European Union. Hoffmann-La Roche holds marketing rights for MabThera outside of the U.S., excluding Japan, and has agreed to pay us royalties and a mark-up on the supply of MabThera.
In December 1998, a letter was sent to physicians advising them of some deaths associated with administration of Rituxan. As a result, Genentech and IDEC updated the warning section of the package insert to include information on infusion-related reactions and cardiovascular events.
Activase/TNKase
Activase/TNKase
Sales of our two cardiovascular products, Activase and TNKase, were $206.2 million in 2000, a decrease of 13% from 1999. TNKase received FDA approval in early June 2000 and was launched in late June 2000. The decrease from the prior year was due primarily to increased competition from Centocor, Inc.'s Retavase® (reteplase), and a decline in the overall size of the thrombolytic market as a result of increasing use of mechanical reperfusion as well as early intervention with other therapies in the treatment of acute myocardial infarction. In 1999, sales of Activase were $236.0 million, an increase of 11% from 1998. This increase was largely due to the usage of Activase in peripheral vascular occlusive disease in lieu of another company's thrombolytic that was unavailable. This increase was offset in part by a continued decline in the overall size of the thrombolytic therapy market due to increasing use of mechanical reperfusion and competition from Centocor's Retavase.
Growth Hormone
Growth Hormone
Sales of our four growth hormone products, Nutropin Depot, Nutropin AQ, Nutropin and Protropin, increased slightly in 2000 compared to 1999. This increase was largely due to fluctuations in customer ordering patterns and the introduction of Nutropin Depot. In December 1999, we received FDA approval for Nutropin Depot, a long-acting dosage form of recombinant growth hormone for pediatric growth hormone deficiency. Nutropin Depot was launched in late June 2000. In 1999, Protropin, Nutropin and Nutropin AQ sales were $221.2 million, a slight increase from 1998. This increase primarily reflects fluctuations in customer ordering patterns.
Pulmozyme
Pulmozyme
Pulmozyme sales were $121.8 million in 2000, a 9% increase from 1999. This increase was attributable to increased market penetration in the early and mild patient populations for the treatment of cystic fibrosis. Sales of Pulmozyme were $111.4 million in 1999, an increase of 19% over 1998. This increase was due to our continued market penetration for the treatment of cystic fibrosis in the early and mild patient populations.
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Actimmune
In the second quarter of 1998, in return for a royalty on net sales, we licensed U.S. marketing and development rights to interferon gamma, including Actimmune, to Connetics Corporation. Thereafter, Connetics sublicensed all of its rights to InterMune Pharmaceuticals, Inc., or InterMune. As of January 1999, we no longer sell Actimmune directly in the United States. We have agreed to sell packaged drug product to InterMune at cost plus a mark-up.
Royalties
Royalties
Royalty income was $207.2 million, an increase of 9% from 1999. This increase was due to higher third-party sales from various licensees. Royalty income was $189.3 million in 1999, a decrease of 18% from 1998. This decrease was primarily related to the expiration of royalties from Eli Lilly and Company for sales of Humulin® (human insulin) which expired in August 1998. The decrease in 1999 was partly offset by higher royalties from various licensees, and new royalties from Immunex Corporation under a licensing agreement for Enbrel® (etanercept) biologic response modifier. Cash flows from royalty income include revenues denominated in foreign currency. We currently purchase simple foreign currency put option contracts (options) to hedge these royalty cash flows. All options expire within the next two years. See "Forward-Looking Information and Cautionary Factors That May Affect Future Results" below for a discussion of market risks related to these financial instruments.
Contract and Other Revenues
Contract and Other Revenues
Contract and other revenues were $160.4 million in 2000, an increase of 93% over 1999. This increase was primarily due to higher gains from the sale of biotechnology equity securities and the recognition of $8.6 million of deferred revenues (see "Staff Accounting Bulletin No. 101" below for further discussion), offset in part by lower contract revenues from our strategic alliances with third-party collaborators. Contract and other revenues were $83.2 million in 1999, a decrease of 28% from 1998. This decrease resulted primarily from higher revenues in 1998 related to payments from Hoffmann-La Roche for Herceptin marketing rights and from Novo Nordisk A/S, commonly known as Novo, for the patent infringement litigation settlement, as discussed below. These decreases were partially offset by higher revenues in 1999 from our strategic alliances, including initial license fees from Immunex for Enbrel and from Schwarz Pharma AG for Nutropin AQ and Nutropin Depot and by higher gains from the sale of biotechnology equity securities.
In July 1998, we settled a lawsuit brought by us against Novo relating to our patents for human growth hormone and insulin and a lawsuit brought by Novo alleging infringement of a patent held by Novo relating to our manufacture, use and sale of our Nutropin human growth hormone products. Under the settlement agreement, we agreed with Novo to cross-license worldwide certain patents relating to human growth hormone. In August 1998, Novo received a worldwide license under our patents relating to insulin, and we received certain payments from Novo that were recorded in contract revenues.
We recorded contract revenues from Hoffmann-La Roche of $40.0 million in 1998 for Herceptin marketing rights outside of the U.S. All other contract revenue from Hoffmann-La Roche, including reimbursement for ongoing development expenses after the option exercise date, totaled $3.5 million in 2000, $17.2 million in 1999 and $21.6 million in 1998.
Interest Income
Interest Income
Interest income in 2000 and 1999 were comparable to previous years. In our fixed income portfolio (cash, short-term and long-term investment portfolio, excluding marketable equity securities), at December 31, 2000, lower portfolio returns were offset by higher average balances. Year end balances were also higher in 2000 compared to 1999.
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Cost of Sales
Cost of Sales
Cost of sales, or COS, was $364.9 million in 2000, an increase of 28% from 1999. COS as a percent of product sales was 29%, an increase from 1999. This increase primarily reflects a change in the product mix, an increase in provisions established for nonuseable inventory and higher sales to Hoffmann-La Roche. COS was $285.6 million in 1999, an increase of 106% from 1998. COS as a percent of net sales increased to 27% in 1999. This increase reflects the six months of costs related to the sale of inventory that was written up at the Redemption due to push-down accounting, offset in part by efficiencies in production and a more favorable product mix. As a result of push-down accounting, $92.8 million and $93.4 million of expense was recognized in 2000 and 1999, respectively, through the sale of inventory that was written up as a result of the Redemption. All inventory written up as a result of the Redemption has been sold as of December 31, 2000.
Research and Development
Research and Development
Research and development, or R&D, expenses in 2000 were $489.9 million, up 33% from 1999. This increase was due to higher clinical costs related to later-stage clinical trials and higher in-licensing and collaboration expenses. In-licensing expenses in 2000 included a $15.0 million payment for the purchase of in-process research and development, or IPR&D, during the first quarter of 2000 under an agreement with Actelion Ltd., for the rights to develop and co-promote tezosentan in the United States for the potential treatment of acute heart failure. Actelion is leading the development effort of tezosentan and the project is currently in Phase III clinical trials. In addition, we made a $35.0 million payment to Actelion for the purchase of IPR&D for the rights to develop and co-promote Actelion's endothelin receptor antagonist Tracleer (bosentan) in the United States for the potential treatment of acute and chronic heart failure. Actelion is leading the development efforts and commercialization of Tracleer. We determined that the above acquired IPR&D was not yet technologically feasible and that the acquired IPR&D had no future alternative uses. R&D expenses were $367.3 million in 1999, down 7% from 1998 as a result of reduced spending as products progressed through late-stage clinical trials. R&D as a percentage of revenues was 28% in 2000, 26% in 1999 and 34% in 1998.
To gain additional access to potential new products and technologies, and to utilize other companies to help develop potential new products, we establish strategic alliances with various companies. These companies are developing technologies that may fall outside our research focus and through technology exchanges and investments with these companies we may have the potential to generate new products. As part of these strategic alliances, we have acquired equity and convertible debt securities of such companies. We have also entered into product-specific collaborations to acquire development and marketing rights for products.
Marketing, General and Administrative
Marketing, General and Administrative
Marketing, general and administrative, or MG&A, expenses in 2000 increased 6% from 1999. This increase resulted from higher marketing and sales expenses while general and administrative expenses decreased. The marketing and sales increase was driven by the continued support of our growing bio-oncology business, including the Rituxan profit-sharing expense with IDEC, the launch of TNKase, and the prelaunch support of Xolair for the potential treatment of allergic asthma and seasonal allergic rhinitis. The decrease in general and administrative expenses was mostly due to the write down of certain biotechnology investments as a result of other than temporary impairment and higher legal expenses in 1999. In 1999, MG&A expenses increased 30% from 1998. The increase was primarily in support of the growth of our bio-oncology products including the Rituxan profit-sharing with IDEC, and competitive conditions with other marketed products. Additional increases came from higher royalty, legal and corporate expenses.
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Special Charges
During 1999, we had special charges of $1,437.7 million related to the Redemption and the application of push-down accounting, and legal settlements. The Redemption related charge of $1,207.7 million primarily included: (1) a non-cash charge of $752.5 million for IPR&D, (2) $284.5 million of compensation expense related to early cash settlement of certain employee stock options and (3) an aggregate of approximately $160.1 million as a non-cash charge for the remeasurement of the value of continuing employee stock options. See "In-Process Research and Development" below and the "Redemption of Our Special Common Stock" note in the Notes to Consolidated Financial Statements for further information regarding these special charges.
The legal settlements charge included: (1) a $50.0 million settlement related to a federal investigation of our past clinical, sales and marketing activities associated with human growth hormone; and (2) a $180.0 million charge for the settlement of the patent infringement lawsuits brought by the University of California relating to our human growth hormone products. See the "Leases, Commitments and Contingencies" note in the Notes to Consolidated Financial Statements for further information regarding these special charges.
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Recurring Charges Related to Redemption
We began recording recurring charges related to the Redemption and push-down accounting in the third quarter of 1999. These charges were $375.3 million in 2000 and $197.7 million in 1999. These charges were comprised of $364.2 million in 2000 and $190.4 million in 1999 related to the amortization of other intangible assets and goodwill, and $11.1 million in 2000 and $7.3 million in 1999 of compensation expense related to alternative arrangements provided at the time of the Redemption for certain holders of some of the unvested options.
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Interest Expense
Interest expense will fluctuate depending on the amount of capitalized interest related to the amount of construction projects. Interest expense, net of amounts capitalized, relates to interest on our 5% convertible subordinated debentures.
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Staff Accounting Bulletin No. 101
In the fourth quarter of 2000, we adopted the Securities and Exchange Commission's Staff Accounting Bulletin No. 101 on revenue recognition effective January 1, 2000 and recorded a $57.8 million charge, net of tax, as a cumulative effect of a change in accounting principle related to contract revenues recognized in prior periods. The related deferred revenue is being recognized over the term of the agreements. In 2000, we recognized $8.6 million of this deferred revenue in contract and other income. (See the "Change in Accounting Principle" section of the "Description of Business and Significant Accounting Policies" note in the Notes to Consolidated Financial Statements for further information on our adoption of Staff Accounting Bulletin No. 101.)
Income Tax
The tax provision of $20.4 million for 2000 increased over the 1999 tax benefit of $203.1 million primarily due to increased pretax income and non-deductible goodwill amortization related to the Redemption. The increase was partially offset by the increased benefit of R&D tax credits. The 1999 tax benefit differed from the 1998 tax provision primarily because of the charges related to the Redemption and legal settlements. The tax provision and tax benefit in 2000 and 1999, respectively, reflect the adverse impact of non-deductible in-process R&D charges and amortization of goodwill.
The tax rate of 31% in 2000 on pretax income excluding charges related to the Redemption and cumulative effect of accounting change is lower than the comparable tax rate of 33% in 1999 primarily due to increased R&D tax credits. The 1999 tax rate increased from 28% in 1998 primarily due to reduced research credits and realization of foreign losses.
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Net Income (Loss)
The net loss of $74.2 million, or a loss of $0.14 per share in 2000 primarily reflects a full year of recurring charges for the amortization of goodwill and other intangible assets related to the Redemption and push-down accounting, the cumulative effect of a change in accounting principle, costs related to the sale of inventory that was written up at the Redemption and higher R&D expenses; offset in part by higher product sales. The net loss in 1999 of $1,157.5 million, or a loss of $2.26 per share, is attributable to the Redemption and related push-down accounting, and legal settlements, net of their related tax effects. To a lesser extent, the loss in 1999 was also due to higher MG&A expenses, COS and income taxes, and lower royalty and contract and other revenues, partly offset by higher product sales and lower R&D spending.
In-Process Research and Development
At June 30, 1999, the Redemption date, we determined that the acquired in-process technology was not technologically feasible and that the in-process technology had no future alternative uses. In 1990 and 1991 through 1997, Roche purchased 60% and 5%, respectively, of our outstanding common stock. The push-down effect of Roche's aggregate purchase price is allocated based on Roche's ownership percentages as if the purchases had occurred at the original purchase dates for the 1990 and 1991 through 1997 purchases. Therefore, 65% of the purchase price allocated to IPR&D as of September 7, 1990, or 65% of $770.0 million ($500.5 million) was recorded as an adjustment to additional paid-in capital related to the 1990-1997 acquisitions. The remaining 35% of our outstanding common stock not owned by Roche was purchased in 1999. Accordingly, 35% of $2,150.0 million of total fair value at the Redemption date, or $752.5 million, was expensed on June 30, 1999.
The amounts of IPR&D were determined based on an analysis using the risk-adjusted cash flows expected to be generated by the products that result from the in-process projects. The analysis included forecasted future cash flows that were expected to result from the progress made on each of the in-process projects prior to the purchase dates. These cash flows were estimated by first forecasting, on a product-by-product basis, total revenues expected from sales of the first generation of each in-process product. A portion of the gross in-process product revenues was then removed to account for the contribution provided by any core technology, which was considered to benefit the in-process products. The net in-process revenue was then multiplied by the project's estimated percentage of completion as of the purchase dates to determine a forecast of net IPR&D revenues attributable to projects completed prior to the purchase dates. Appropriate operating expenses, cash flow adjustments and contributory asset returns were deducted from the forecast to establish a forecast of net returns on the completed portion of the in-process technology. Finally, these net returns were discounted to a present value at discount rates that incorporate both the weighted-average cost of capital (relative to the biotech industry and us) as well as the product-specific risk associated with the purchased IPR&D products. The product-specific risk factors included each product in each phase of development, type of molecule under development, likelihood of regulatory approval, manufacturing process capability, scientific rationale, pre-clinical safety and efficacy data, target product profile and development plan. The discount rates ranged from 16% to 19% for the 1999 valuation and 20% to 28% for the 1990 purchase valuation, all of which represent a significant risk premium to our weighted-average cost of capital.
The forecast data in the analysis was based on internal product level forecast information maintained by our management in the ordinary course of managing the business. The inputs used by us in analyzing IPR&D were based on assumptions, which we believed to be reasonable but which were inherently uncertain and unpredictable. These assumptions may be incomplete or inaccurate, and no assurance can be given that unanticipated events and circumstances will not occur.
A brief description of projects that were included in the IPR&D charge is set forth below, including an estimated percentage of completion as of the Redemption date. Projects subsequently added to the research and development pipeline are not included. Except as otherwise noted below, since the Redemption date there have been no significant changes to the phase of development for the projects listed. We do not track all costs associated with research and development on a project-by-project basis. Therefore, we believe a calculation of cost incurred as a percentage of total incurred project cost as of FDA approval is not possible. We estimated, however, that the R&D expenditures that will be required to complete the in-process projects will total at least $640.0 million as of December 31, 2000, as compared to $700.0 million as of the Redemption date. This estimate reflects costs incurred since the Redemption date, discontinued projects and decreases in cost to complete estimates for other projects, partially offset by an increase in certain cost estimates related to early stage projects and changes in expected completion dates.
The foregoing discussion of our IPR&D projects, and in particular the following table and subsequent paragraphs regarding the future of these projects, our additional product programs and our process technology program include forward-looking statements that involve risks and uncertainties, and actual results may vary materially. For a discussion of risk factors that may affect projected completion dates and the progress of research and development, see "Forward-Looking Information and Cautionary Factors That May Affect Future Results."
At the Redemption date, we estimated percentage complete data for each project based on weighting of three indicators, as follows:
PTS: Probability of technical success, or PTS, is a project level statistic maintained by us on an ongoing basis, which is intended to represent the current likelihood of project success, i.e., FDA approval. This is a quantitative calculation based on the stage of development and the complexity of the project, and it is highly correlated with the project's phase of development. PTS is periodically adjusted to reflect actual experiences over a reasonable period of time.
Status Compared to Baseline Model: We developed a baseline model which allocated percentages of a standard development project to each major phase of the project based on our experience. We then overlaid the time-based status of each project to this baseline model, in order to calculate a percentage complete for each project.
Management's Estimate of Percentage Complete: Below is a list of the projects and their estimated percentage complete included in the IPR&D charge related to the Redemption.
We also identified five additional product programs that were at different stages of IPR&D. As of June 30, 1999, the Redemption date, we estimated that these projects would be substantially complete in years 1999 through 2004. The percent completion for each of these additional programs ranged from an estimated 35% to 90%. These projects did not receive material allocations of the purchase price.
In addition, our IPR&D at the Redemption date included a process technology program. The process technology program included the research and development of ideas and techniques that could improve the bulk production of antibodies, including cell culture productivity, and streamlined and improved recovery processes, and improvements in various areas of pharmaceutical manufacturing. We estimated that the process technology program was approximately 50% complete at the Redemption date. Material cash inflows from significant projects are generally expected to commence within one to two years after the substantial completion date has been reached.
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The significant changes to the projects in the IPR&D charge since the Redemption date through December 31, 2000, include:
- Nutropin Depot long-acting growth hormone project received FDA approval in December 1999.
- TNKase second generation t-PA project received FDA approval in June 2000.
- Anti-IgE antibody project has moved from Phase III studies to awaiting regulatory approval.
- Xubix (sibrafiban) oral IIb/IIIa antagonist project has been discontinued.
- Anti-CD18 antibody project has been discontinued.
- Anti-VEGF antibody project has moved from Phase II studies to Phase III studies.
- Dornase alfa AERx project discontinued in January 2001.
- Activase t-PA project has completed one Phase III trial and is awaiting regulatory approval.
- Anti-CD11a antibody project has moved to Phase III.
- Herceptin antibody for adjuvant therapy for breast cancer project has moved to Phase III.
- Thrombopoietin (TPO) project has moved to Phase III.
- AMD Fab project has moved to Phase I trials.
- LDP-02 project has moved to Phase II studies.
- Pulmozyme project has completed Phase III trials.
In connection with the Redemption of our Special Common Stock, the following changes occurred with respect to our stock options that were outstanding as of June 30, 1999:
- Options for the purchase of approximately 27.2 million shares of Special Common Stock were canceled in accordance with the terms of the applicable stock option plans, and the holders received cash payments in the amount of $20.63 per share, less the exercise price;
- Options for the purchase of approximately 16.0 million shares of Special Common Stock were converted into options to purchase a like number of shares of Common Stock at the same exercise price; and
- Options for the purchase of approximately 19.6 million shares of Special Common Stock were canceled in accordance with the terms of our 1996 Stock Option/Stock Incentive Plan, or the 1996 Plan. With certain exceptions, we granted new options for the purchase of 1.333 times the number of shares under the previous options with an exercise price of $24.25 per share, which was the July 23, 1999, public offering price of the Common Stock. The number of shares that were the subject of these new options, which were issued under our 1999 Stock Plan, or the 1999 Plan, was approximately 20.0 million. Alternative arrangements were provided for certain holders of some of the unvested options under the 1996 Plan.
Of the approximately 16.0 million shares of converted options, options with respect to approximately 4.0 million shares were outstanding at December 31, 2000, all of which are currently exercisable except for options with respect to approximately 320,507 shares. These outstanding options are held by 1,420 employees; no non-employee directors hold these options.
Our board of directors and Roche, then our sole stockholder, approved the 1999 Plan on July 16, 1999. Under the 1999 Plan, we granted new options to purchase approximately 26.0 million shares (including the 20.0 million shares referred to above) of Common Stock to approximately 2,400 employees at an exercise price of $24.25 per share, with the grant of such options made effective as of July 16, 1999. Of the options to purchase these 26.0 million shares, options to purchase approximately 19.8 million shares were outstanding at December 31, 2000, of which options to purchase approximately 7.7 million shares are currently exercisable.
In connection with these stock option transactions, we recorded:
- (1) cash compensation expense of approximately $284.5 million associated with the cash-out of such stock options and (2) non-cash compensation expense of approximately $160.1 million associated with the remeasurement, for accounting purposes, of the converted options, which non-cash amount represents the difference between each applicable option exercise price and the redemption price of the Special Common Stock; and
- Over a two-year period beginning July 1, 1999, an aggregate of approximately $27.4 million of deferred cash compensation available to be earned by a limited number of employees who elected the alternative arrangements described above. As of December 31, 2000, $11.1 million and as of December 31, 1999, $7.3 million of compensation expense has been recorded related to these alternative arrangements.
As a result of the Redemption of our Special Common Stock, the then-existing governance agreement between us and Roche terminated, except for provisions relating to indemnification and stock options, warrants and convertible securities. In July 1999, we entered into certain affiliation arrangements with Roche, amended our licensing and marketing agreement with Hoffmann-La Roche, and entered into a tax sharing agreement with Roche as follows:
Affiliation Arrangements
Our board of directors consists of two Roche directors, three independent directors nominated by a nominating committee currently controlled by Roche, and one Genentech employee. However, under the affiliation agreement, Roche has the right to obtain proportional representation on our board at any time. Roche intends to continue to allow our current management to conduct our business and operations as we have done in the past. However, we cannot ensure that Roche will not implement a new business plan in the future.
Except as follows, the affiliation arrangements do not limit Roche's ability to buy or sell our Common Stock. If Roche and its affiliates sell their majority ownership of shares of our Common Stock to a successor, Roche has agreed that it will cause the successor to purchase all shares of our Common Stock not held by Roche as follows:
- with consideration, if that consideration is composed entirely of either cash or equity traded on a U.S. national securities exchange, in the same form and amounts per share as received by Roche and its affiliates; and
- in all other cases, with consideration that has a value per share not less than the weighted-average value per share received by Roche and its affiliates as determined by a nationally recognized investment bank.
If Roche owns more than 90% of our Common Stock for more than two months, Roche has agreed that it will, as soon as reasonably practicable, effect a merger of Genentech with Roche or an affiliate of Roche.
Roche has agreed, as a condition to any merger of Genentech with Roche or the sale of our assets to Roche, that either:
- the merger or sale must be authorized by the favorable vote of a majority of non-Roche stockholders, provided no person will be entitled to cast more than 5% of the votes at the meeting; or
- in the event such a favorable vote is not obtained, the value of the consideration to be received by non-Roche stockholders would be equal to or greater than the average of the means of the ranges of fair values for the Common Stock as determined by two nationally recognized investment banks.
We have agreed not to approve, without the prior approval of the directors designated by Roche:
- any acquisition, sale or other disposal of all or a portion of our business representing 10% or more of our assets, net income or revenues;
- any issuance of capital stock except under certain circumstances; or
- any repurchase or redemption of our capital stock other than a redemption required by the terms of any security and purchases made at fair market value in connection with any of our deferred compensation plans.
Licensing Agreement
In 1995, we entered into a licensing and marketing agreement with Hoffmann-La Roche and its affiliates granting it a ten-year option to license to use and sell our products in non-U.S. markets. In July 1999, we amended that agreement, the major provisions of which include:
- extending Hoffmann-La Roche's option until at least 2015;
- Hoffmann-La Roche may exercise its option to license our products upon the occurrence of any of the following: (1) our decision to file an Investigational New Drug exemption application, or IND, for a product, (2) completion of a Phase II trial for a product or (3) if Hoffmann-La Roche previously paid us a fee of $10.0 million to extend its option on a product, completion of a Phase III trial for that product;
- we agreed, in general, to manufacture for and supply to Hoffmann-La Roche its clinical requirements of our products at cost, and its commercial requirements at cost plus a margin of 20%; however, Hoffmann-La Roche will have the right to manufacture our products under certain circumstances;
- Hoffmann-La Roche has agreed to pay, for each product for which Hoffmann-La Roche exercises its option upon either a decision to file an IND with the FDA or completion of the Phase II trials, a royalty of 12.5% on the first $100.0 million on its aggregate sales of that product and thereafter a royalty of 15% on its aggregate sales of that product in excess of $100.0 million until the later in each country of the expiration of our last relevant patent or 25 years from the first commercial introduction of that product; and
- Hoffmann-La Roche will pay, for each product for which Hoffmann-La Roche exercises its option after completion of the Phase III trials, a royalty of 15% on its sales of that product until the later in each country of the expiration of our relevant patent or 25 years from the first commercial introduction of that product; however, $5.0 million of any option extension fee paid by Hoffmann-La Roche will be credited against royalties payable to us in the first calendar year of sales by Hoffmann-La Roche in which aggregate sales of that product exceed $100.0 million.
Tax Sharing Agreement
Since the redemption of our Special Common Stock, and until Roche completed its second public offering of our Common Stock in October 1999, we were included in Roche's U.S. federal consolidated income tax group. Accordingly, we entered into a tax sharing agreement with Roche. Pursuant to the tax sharing agreement, we and Roche are to make payments such that the net amount paid by us on account of consolidated or combined income taxes is determined as if we had filed separate, stand-alone federal, state and local income tax returns as the common parent of an affiliated group of corporations filing consolidated or combined federal, state and local returns.
Effective with the consummation of the second public offering on October 26, 1999, we ceased to be a member of the consolidated federal income tax group (and certain consolidated or combined state and local income tax groups) of which Roche is the common parent. Accordingly, our tax sharing agreement with Roche now pertains only to the state and local tax returns in which we will be consolidated or combined with Roche. We will continue to calculate our tax liability or refund with Roche for these state and local jurisdictions as if we were a stand-alone entity.
Roche's Right to Maintain Its Percentage Ownership Interest in Our Stock
We expect from time to time to issue additional shares of common stock in connection with our stock option and stock purchase plans, and we may issue additional shares for other purposes. The affiliation agreement provides that we will, among other things, establish a stock repurchase program designed to maintain Roche's percentage ownership interest in our common stock. In addition, Roche has a continuing option to buy stock from us at prevailing market prices to maintain its percentage ownership interest. In connection with that provision, with respect to any issuance of common stock by Genentech in the future, the percentage of Genentech common stock owned by Roche immediately after such issuance is to be no lower than Roche's lowest percentage ownership of Genentech common stock at any time after the offering of common stock occurring in July 1999 and prior to the time of such issuance, except that Genentech may issue shares up to an amount that would cause Roche's lowest percentage ownership to be no more than 2% below the "Minimum Percentage." The Minimum Percentage equals the lowest number of shares of Genentech common stock owned by Roche since the July 1999 offering (to be adjusted in the future for dispositions of shares of Genentech common stock by Roche) divided by 509,194,352 (to be adjusted in the future for stock splits or stock combinations), which is the number of shares of Genentech common stock outstanding at the time of the July 1999 offering adjusted for the two-for-one splits of our common stock in October 2000 and November 1999. As long as Roche's percentage ownership is greater than 50%, prior to issuing any shares, Genentech has agreed to repurchase a sufficient number of shares of its common stock to provide that, immediately after its issuance of shares, Roche's percentage ownership will be greater than 50%. We have also agreed, upon request, to repurchase shares of our common stock to increase Roche's ownership to the Minimum Percentage.
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We used cash generated from operations, income from investments and proceeds from stock issuances to fund operations, purchase marketable securities and make capital and equity investments during 2000. In 1999, cash generated from operations, income from investments and proceeds from stock issuances were used to pay for the cash-out of stock options related to the Redemption in 1999, to purchase marketable securities and to make capital and equity investments.
Capital expenditures in 2000 and 1999 primarily consisted of equipment purchases and improvements to existing manufacturing and service facilities. Capital expenditures in 1998 included improvements to existing office and laboratory facilities and equipment purchases.
We believe that our cash, cash equivalents and short-term investments, together with funds provided by operations and leasing arrangements, will be sufficient to meet our foreseeable operating cash requirements. In addition, we believe we could access additional funds from the debt and, under certain circumstances, capital markets. See also "Our Affiliation Agreement With Roche Could Adversely Affect Our Cash Position" below for factors that could negatively affect our cash position.
Our long-term debt consists of $149.7 million of convertible subordinated debentures, with interest payable at 5%, due in March 2002. As a result of the redemption of our Special Common Stock, upon conversion, the holder receives, for each $74 in principal amount of debenture converted, $59.25 in cash, of which $18 will be reimbursed to us by Roche. Generally, we may redeem the debentures until maturity.
FORWARD-LOOKING INFORMATION AND CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
The following section contains forward-looking information based on our current expectations. Because our actual results may differ materially from this and any other forward-looking statements made by or on behalf of Genentech, this section also includes a discussion of important factors that could affect our actual future results, including, but not limited to, our product sales, royalties, contract revenues, expenses and net income.
Fluctuations in Our Operating Results Could Affect the Price of Our Common Stock
Our operating results may vary from period to period for several reasons including:
- The overall competitive environment for our products.
- For example, sales of our Activase product decreased in 2000, 1999 and 1998 primarily due to competition from Centocor Inc.'s Retavase and more recently to a decreasing size of the thrombolytic marketplace as other forms of acute myocardial infarction treatment gain acceptance.
- The amount and timing of sales to customers in the United States.
- For example, sales of our Growth Hormone products increased in 2000 and 1999 due to fluctuations in distributor ordering patterns.
- The amount and timing of our sales to Hoffmann-La Roche of products for sale outside of the United States and the amount and timing of its sales to its customers, which directly impact both our product sales and royalty revenues.
- For example, in the third quarter of 2000, Hoffmann-La Roche's approval of Herceptin in Europe increased our sales of Herceptin product.
- The timing and volume of bulk shipments to licensees.
- The availability of third-party reimbursements for the cost of therapy.
- The effectiveness and safety of our various products as determined both in clinical testing and by the accumulation of additional information on each product after it is approved by the FDA for sale.
- The rate of adoption and use of our products for approved indications and additional indications.
- For example, sales of Pulmozyme increased in 1998 due, in part, to new patients who were attracted to our product as a result of an FDA approval for a label extension to include cystic fibrosis patients under the age of five.
- The potential introduction of new products and additional indications for existing products in 2001 and beyond.
- The ability to successfully manufacture sufficient quantities of any particular marketed product.
- The number and size of any product price increases we may issue.
The Successful Development of Pharmaceutical Products Is Highly Uncertain
Successful pharmaceutical product development is highly uncertain and is dependent on numerous factors, many of which are beyond our control. Products that appear promising in the early phases of development may fail to reach the market for several reasons including:
- Preclinical and clinical trial results that may show the product to be less effective than desired or to have harmful problematic side effects;
For example:- In June 2000, we announced that the preliminary results from our 415-patient Phase II clinical trial of our recombinant humanized anti-CD18 monoclonal antibody fragment, which is known as rhuMAb CD18, for the treatment of myocardial infarction, more commonly known as a heart attack, did not meet its primary objectives.
- In 1999, our Phase III clinical trial of recombinant human nerve growth factor, which is known as rhNGF, for use in diabetic peripheral neuropathy did not meet its objectives and we decided not to file for product approval with the FDA.
- In 1999, our Phase II clinical study of recombinant human vascular endothelial growth factor, which is known as VEGF, protein failed to meet the primary endpoints of the study.
- Failure to receive the necessary regulatory approvals or delay in receiving such approvals;
- Manufacturing costs or other factors that make the product uneconomical; or
- The proprietary rights of others and their competing products and technologies that may prevent the product from being commercialized.
Success in preclinical and early clinical trials does not ensure that large-scale clinical trials will be successful. Clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals. The length of time necessary to complete clinical trials and to submit an application for marketing approval for a final decision by a regulatory authority varies significantly and may be difficult to predict.
Factors affecting our research and development expenses include, but are not limited to:
- The number of and the outcome of clinical trials currently being conducted by us and/or our collaborators.
- The number of products entering into development from late-stage research.
- For example, there is no guarantee that internal research efforts will succeed in generating sufficient data for us to make a positive development decision or that an external candidate will be available on terms acceptable to us. In the past, promising candidates have not yielded sufficiently positive preclinical results to meet our stringent development criteria.
- Hoffmann-La Roche's decisions whether to exercise its options to develop and sell our future products in non-U.S. markets and the timing and amount of any related development cost reimbursements.
- In-licensing activities, including the timing and amount of related development funding or milestone payments.
- For example, in February 2000, we entered into an agreement with Actelion Ltd. for the purchase of rights for the development and co-promotion in the United States of tezosentan, and paid Actelion an upfront fee of $15.0 million which was recorded as a research and development expense.
- As part of our strategy, we invest in R&D. R&D as a percent of revenues can fluctuate with the changes in future levels of revenue. Lower revenues can lead to more disciplined spending of R&D efforts.
- Future levels of revenue.
Roche, Our Controlling Stockholder, May Have Interests That Are Adverse to Other Stockholders
Roche, as our majority stockholder, controls the outcome of actions requiring the approval of our stockholders. Our bylaws provide, among other things, that the composition of our board of directors shall consist of two Roche directors, three independent directors nominated by a nominating committee and one Genentech employee nominated by the nominating committee. As long as Roche owns in excess of 50% of our common stock, Roche directors will comprise two of the three members of the nominating committee. However, at any time until Roche owns less than 5% of our stock, Roche will have the right to obtain proportional representation on our board. Roche intends to continue to allow our current management to conduct our business and operations as we have done in the past. However, we cannot assure stockholders that Roche will not institute a new business plan in the future. Roche's interests may conflict with your interests.
Our Affiliation Agreement With Roche Could Limit Our Ability to Make Acquisitions and Could Have a Material Negative Impact on Our Liquidity
The affiliation agreement between us and Roche contains provisions that:
- Require the approval of the directors designated by Roche to make any acquisition or any sale or disposal of all or a portion of our business representing 10% or more of our assets, net income or revenues;
- Enable Roche to maintain its percentage ownership interest in our common stock; and
- Establish a stock repurchase program designed to maintain Roche's percentage ownership interest in our common stock.
These provisions may have the effect of limiting our ability to make acquisitions and while the dollar amounts associated with the stock repurchase program cannot currently be estimated, these stock repurchases could have a material adverse impact on our liquidity, credit rating and ability to access capital in the financial markets.
Our Stockholders May Be Unable to Prevent Transactions That Are Favorable to Roche but Adverse to Us
Our certificate of incorporation includes provisions relating to:
- Competition by Roche with us;
- Offering of corporate opportunities;
- Transactions with interested parties;
- Intercompany agreements; and
- Provisions limiting the liability of specified employees.
Our certificate of incorporation provides that any person purchasing or acquiring an interest in shares of our capital stock shall be deemed to have consented to the provisions in the certificate of incorporation relating to competition with Roche, conflicts of interest with Roche, the offer of corporate opportunities to Roche and intercompany agreements with Roche. This deemed consent may restrict your ability to challenge transactions carried out in compliance with these provisions.
Potential Conflicts of Interest Could Limit Our Ability to Act on Opportunities That Are Adverse to Roche
Persons who are directors and/or officers of Genentech and who are also directors and/or officers of Roche may decline to take action in a manner that might be favorable to us but adverse to Roche. Two of our directors, Dr. Franz B. Humer and Dr. Jonathan K.C. Knowles, currently serve as directors, officers and employees of Roche Holding Ltd and its affiliates.
We May Be Unable to Retain Skilled Personnel and Maintain Key Relationships
The success of our business depends, in large part, on our continued ability to attract and retain highly qualified management, scientific, manufacturing and sales and marketing personnel, and on our ability to develop and maintain important relationships with leading research institutions and key distributors. Competition for these types of personnel and relationships is intense.
Roche has the right to maintain its percentage ownership interest in our common stock. Our affiliation agreement with Roche provides that, among other things, we will establish a stock repurchase program designed to maintain Roche's percentage ownership in our common stock if we issue or sell any shares. This right of Roche may limit our flexibility as to the number of shares we are able to grant under our stock option plans. We therefore cannot assure you that we will be able to attract or retain skilled personnel or maintain key relationships.
We Face Growing and New Competition
We face growing competition in two of our therapeutic markets and expect new competition in a third market. First, in the thrombolytic market, Activase has lost market share and could lose additional market share to Centocor's Retavase, either alone or in combination with the use of another Centocor product, ReoPro® (abciximab) and to the use of other mechanical therapies to treat acute myocardial infarction; the resulting adverse effect on sales has been and could continue to be material. Retavase received approval from the FDA in October 1996 for the treatment of acute myocardial infarction. We expect that the use of mechanical reperfusion in lieu of thrombolytic therapy for the treatment of acute myocardial infarction will continue to grow.
Second, in the growth hormone market, we continue to face increased competition from four other companies currently selling growth hormone and an additional company which may enter the market in the near future. As a result of that competition, we have experienced a loss in market share. The four competitors have also received approval to market their existing human growth hormone products for additional indications. As a result of this competition, sales of our Growth Hormone products may decline, perhaps significantly.
Third, in the non-Hodgkin's lymphoma market, Corixa Corporation, formerly Coulter Pharmaceutical, Inc., has filed and received an expedited review of a revised Biologics License Application, or BLA, in 2000 for Bexxar (tositumomab and iodine I 131 tositumomab), which may potentially compete with our product Rituxan and IDEC has filed a BLA for Zevalin (ibritumomab tiuxetan), a product which could also potentially compete with Rituxan. Both Bexxar and Zevalin are radiolabeled molecules while Rituxan is not. We are also aware of other potentially competitive biologic therapies for non-Hodgkin's lymphoma in development.
Other Competitive Factors Could Affect Our Product Sales
Other competitive factors that could affect our product sales include, but are not limited to:
- The timing of FDA approval, if any, of competitive products.
For example, in June 2000 one of our competitors, Novo, received FDA approval for a liquid formulation of its growth hormone product that will directly compete with our liquid formulation, Nutropin AQ. Also in June 2000, another of our competitors, Serono S.A., received FDA approval to deliver its competitive growth hormone product in a needle-free device. - Our pricing decisions and the pricing decisions of our competitors.
For example, we raised the prices of Rituxan in May 2000 and Pulmozyme in June 2000 by approximately 5%. - The degree of patent protection afforded our products by patents granted to us and by the outcome of litigation involving our patents.
For example, in January 2000, a federal court judge lifted a preliminary injunction that had been in effect since 1995 against Bio-Technology General Corporation, or BTG. Although an appeal of the judge's decision is pending, BTG is now permitted to sell its competitive growth hormone product in the United States. - The outcome of litigation involving patents of other companies concerning our products or processes related to production and formulation of those products or uses of those products.
For example, as further described in "Protecting Our Proprietary Rights Is Difficult and Costly," in May 1999, June 2000 and September 2000, several companies filed patent infringement lawsuits against us alleging that we are infringing certain of their patents. - The increasing use and development of alternate therapies.
For example, the overall size of the market for thrombolytic therapies, such as our Activase product, continues to decline as a result of the increasing use of mechanical reperfusion. - The rate of market penetration by competing products.
For example, in the past, we have lost market share to new competitors in the thrombolytic and growth hormone markets.
In Connection With the Redemption of Our Special Common Stock, We Recorded Substantial Goodwill and Other Intangibles, the Amortization of Which May Adversely Affect Our Earnings
As a result of the redemption of our special common stock, Roche owned all of our outstanding common stock. Consequently, push-down accounting under generally accepted accounting principles was required. Push-down accounting required us to establish a new accounting basis for our assets and liabilities, based on Roche's cost in acquiring all of our stock. In other words, Roche's cost of acquiring Genentech was "pushed down" to us and reflected on our financial statements. Push-down accounting required us to record goodwill and other intangible assets of approximately $1,685.7 million and $1,499.0 million, respectively, on June 30, 1999. The amortization of this goodwill and other intangible assets will have a significant negative impact on our financial results in future years. In addition, we will continuously evaluate whether events and circumstances have occurred that indicate the remaining balance of this and other intangible assets may not be recoverable. If our assets need to be evaluated for possible impairment, we may have to reduce the carrying value of our intangible assets. This could have a material adverse effect on our financial condition and results of operations during the periods in which we recognize a reduction. We may have to write down intangible assets in future periods. For more information about push-down accounting, see the "Redemption of Our Special Common Stock" note in the Notes to Consolidated Financial Statements.
Our Royalty and Contract Revenues Could Decline
Royalty and contract revenues in future periods could vary significantly. Major factors affecting these revenues include, but are not limited to:
- Hoffmann-La Roche's decisions whether to exercise its options and option extensions to develop and sell our future products in non-U.S. markets and the timing and amount of any related development cost reimbursements.
- Variations in Hoffmann-La Roche's sales and other licensees' sales of licensed products.
- For example, we began receiving royalty revenues from Immunex's sale of Enbrel in 1999.
- The conclusion of existing arrangements with other companies and Hoffmann-La Roche.
For example, royalty revenues decreased in 1999 from 1998 due to the expiration of royalty payments primarily on sales of human insulin, from Eli Lilly and Company in August 1998. - The timing of non-U.S. approvals, if any, for products licensed to Hoffmann-La Roche and other licensees.
For example, we expect the approval of Herceptin outside the United States which occurred in third quarter of 2000 to have a continuing positive impact on royalties. - Fluctuations in foreign currency exchange rates.
- The initiation of new contractual arrangements with other companies.
- For example, license fees from Immunex and Schwarz Pharma increased contract revenues in 1999.
- Whether and when contract benchmarks are achieved.
For example, milestone payments from Pharmacia increased contract revenue in 1997. - The failure of or refusal of a licensee to pay royalties.
- The expiration or invalidation of patents or licensed intellectual property.
Protecting Our Proprietary Rights Is Difficult and Costly
The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. Accordingly, we cannot predict the breadth of claims allowed in these companies' patents. Patent disputes are frequent and can preclude the commercialization of products. We have in the past been, are currently, and may in the future be involved in material patent litigation. Patent litigation is costly in its own right and could subject us to significant liabilities to third parties. In addition, an adverse decision could force us to either obtain third-party licenses at a material cost or cease using the technology or product in dispute. For example, in late 1999 we settled a patent infringement lawsuit brought against us by the Regents of the University of California in which the University alleged that the manufacture and sale of our Protropin and Nutropin growth hormone products infringed a patent owned by the University. In connection with that settlement we paid the University of California $150.0 million and donated $50.0 million for the construction of a new life sciences building on the University of California, San Francisco campus.
The presence of patents or other proprietary rights belonging to other parties may lead to our termination of the research and development of a particular product.
We believe that we have strong patent protection or the potential for strong patent protection for a number of our products that generate sales and royalty revenue or that we are developing. However, the courts will determine the ultimate strength of patent protection of our products and those on which we earn royalties.
Three lawsuits have been filed against us in which the companies involved allege that we have infringed their patents by the manufacture and sale of certain of our products:
- In May 1999, GlaxoSmithKline plc, or Glaxo, filed a complaint in which it appears to claim that our manufacture, use and sale of Rituxan and Herceptin antibody products infringe four Glaxo patents that relate to certain uses and preparations of antibodies.
- In June 2000, Chiron Corporation filed a complaint in which it claims that our manufacture and sale of Herceptin infringe a patent it owns.
- In September 2000, Glaxo filed another complaint in which it appears to claim that our manufacture, use and sale of Rituxan and Herceptin antibody products infringe a Glaxo patent that relates to certain cell culture methods.
We May Incur Material Litigation Costs
Litigation to which we are currently or have been subjected relates to, among other things, our patent and intellectual property rights, licensing arrangements with other persons, product liability and financing activities. We cannot predict with certainty the eventual outcome of pending litigation, and we might have to incur substantial expense in defending these lawsuits. We have in the past taken substantial special charges relating to litigation, including $230.0 million in 1999.
We May Incur Material Product Liability Costs
The testing and marketing of medical products entail an inherent risk of product liability. Pharmaceutical product liability exposures could be extremely large and pose a material risk. Our business may be materially and adversely affected by a successful product liability claim in excess of any insurance coverage that we may have.
We May Be Unable to Obtain Regulatory Approvals for Our Products
The pharmaceutical industry is subject to stringent regulation with respect to product safety and efficacy by various federal, state and local authorities. Of particular significance are the FDA's requirements covering research and development, testing, manufacturing, quality control, labeling and promotion of drugs for human use. A pharmaceutical product cannot be marketed in the United States until it has been approved by the FDA, and then can only be marketed for the indications and claims approved by the FDA. As a result of these requirements, the length of time, the level of expenditures and the laboratory and clinical information required for approval of a New Drug Application, or NDA, or a BLA, are substantial and can require a number of years. In addition, after any of our products receive regulatory approval, they remain subject to ongoing FDA regulation, including, for example, changes to their label, written advisements to physicians and product recall.
We cannot be sure that we can obtain necessary regulatory approvals on a timely basis, if at all, for any of the products we are developing or that we can maintain necessary regulatory approvals for our existing products, and all of the following could have a material adverse effect on our business:
- Significant delays in obtaining or failing to obtain required approvals.
- Loss of or changes to previously obtained approvals.
For example, in May 2000, we issued letters to physicians advising them of some serious adverse events associated with the administration of Herceptin. In October 2000, we issued a new package insert for Herceptin including this information. - Failure to comply with existing or future regulatory requirements.
For example, in 1999, we paid a $50.0 million settlement to the federal government in connection with a federal investigation of our former clinical, sales and marketing activities associated with our human growth hormone products.
Moreover, it is possible that the current regulatory framework could change or additional regulations could arise at any stage during our product development, which may affect our ability to obtain approval of our products.
Difficulties or Delays in Product Manufacturing Could Harm Our Business
We currently produce all of our products at our manufacturing facilities located in South San Francisco, California and Vacaville, California or through various contract manufacturing arrangements. Problems with any of our or our contractors' manufacturing processes could result in product defects, which could require us to delay shipment of products, recall products previously shipped or be unable to supply products at all.
For example, in March 2000, we issued an important drug notification regarding a defect in the packaging of our Pulmozyme product. During a quality assurance inspection, we had discovered that there was a defect in the packaging of Pulmozyme which occasionally caused a small puncture in ampules of that product. We suspended shipping the product while we determined the source and extent of the defect. We ultimately recalled some of the product.
On December 27, 2000, we received a Warning Letter from the FDA regarding our quality control at our South San Francisco manufacturing plant. The products cited were for cystic fibrosis, breast cancer and acute myocardial infarction. On February 7, 2001, we received a letter from the FDA accepting our responses and corrective actions with respect to the Warning Letter.
In addition, any prolonged interruption in the operations of our or our contractors' manufacturing facilities could result in cancellations of shipments. A number of factors could cause interruptions, including equipment malfunctions or failures, or damage to a facility due to natural disasters or otherwise. Because our manufacturing processes and those of our contractors are highly complex and are subject to a lengthy FDA approval process, alternative qualified production capacity may not be available on a timely basis or at all. Difficulties or delays in our and our contractors' manufacturing of existing or new products could increase our costs, cause us to lose revenue or market share and damage our reputation.
Our Stock Price, Like That of Many Biotechnology Companies, Is Highly Volatile
The market prices for securities of biotechnology companies in general have been highly volatile and may continue to be highly volatile in the future. In addition, due to the absence of the put and call that were associated with our special common stock, the market price of our common stock has been and may continue to be more volatile than our special common stock was in the past.
In addition, the following factors may have a significant impact on the market price of our common stock:
- Announcements of technological innovations or new commercial products by us or our competitors.
For example, our stock increased by approximately 4% on the day we announced FDA approval for our Nutropin Depot product. - Developments concerning proprietary rights, including patents.
For example, our stock price decreased by approximately 4% on the day one of our competitors, Chiron, announced a patent infringement suit against us. - Publicity regarding actual or potential medical results relating to products under development by us or our competitors.
For example, our stock price increased by approximately 9% on the day we announced positive preliminary Phase III results from the Anti-IgE asthma clinic. - Regulatory developments in the United States and foreign countries.
- Public concern as to the safety of biotechnology products.
For example, on May 8, 2000, we issued a warning concerning our Herceptin drug after 15 deaths resulted from the administration of Herceptin. Our stock price decreased by approximately 2% at that time. - Economic and other external factors or other disaster or crisis.
For example, our stock reached a high of $122.50 per share in March 2000 and decreased, as the biotech sector and stock market in general decreased, to a low of $42.25 per share in late May 2000. - Period-to-period fluctuations in financial results.
For example, our stock price has historically been affected by whether we met or exceeded analyst expectations.
Our Affiliation Agreement With Roche Could Adversely Affect Our Cash Position
Our affiliation agreement with Roche provides that we will establish a stock repurchase program designed to maintain Roche's percentage ownership interest in our common stock. While the dollar amounts associated with these future purchases cannot currently be estimated, these stock repurchases could have a material adverse effect on our cash position and may have the effect of limiting our ability to use our capital stock as consideration for acquisitions.
These provisions may have the effect of limiting our ability to make acquisitions and while the dollar amounts associated with the stock repurchase program cannot currently be estimated, these stock repurchases could have a material adverse impact on our liquidity, credit rating and ability to access capital in the financial markets.
Future Sales by Roche Could Cause the Price of Our Common Stock to Decline
As of December 31, 2000, Roche owned 306,594,352 shares of our common stock or approximately 58.4% of our outstanding shares. All of our shares owned by Roche are eligible for sale in the public market subject to compliance with the applicable securities laws. We have agreed that, upon Roche's request, we will file one or more registration statements under the Securities Act in order to permit Roche to offer and sell shares of our common stock. We have agreed to use our best efforts to facilitate the registration and offering of those shares designated for sale by Roche. Sales of a substantial number of shares of our common stock by Roche in the public market could adversely affect the market price of our common stock.
We Are Exposed to Market Risk
We are exposed to market risk, including changes to interest rates, foreign currency exchange rates and equity investment prices. To reduce the volatility relating to these exposures, we enter into various derivative investment transactions pursuant to our investment and risk management policies and procedures in areas such as hedging and counterparty exposure practices. We do not use derivatives for speculative purposes.
We maintain risk management control systems to monitor the risks associated with interest rates, foreign currency exchange rates and equity investment price changes, and our derivative and financial instrument positions. The risk management control systems use analytical techniques, including sensitivity analysis and market values. Though we intend for our risk management control systems to be comprehensive, there are inherent risks that may only be partially offset by our hedging programs should there be unfavorable movements in interest rates, foreign currency exchange rates or equity investment prices.
The estimated exposures discussed below are intended to measure the maximum amount we could lose from adverse market movements in interest rates, foreign currency exchange rates and equity investment prices, given a specified confidence level, over a given period of time. Loss is defined in the