| Editorial | Financials |
Letter to Stockholders
 |
"We see tremendous advances in understanding the biological basis of many debilitating diseases, and we believe these advances play to Genentech's greatest strengths as we try to translate the biology into new therapies." |
| Arthur D. Levinson, Ph.D. Chairman and Chief Executive Officer |
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Dear Stockholders,
I am happy to report that 2006 was another remarkable
year for Genentech, with important developments across
all areas of the business. Highlights included the approval
of Lucentis® (ranibizumab injection), seven product
line-extension approvals, significant pipeline expansion,
several manufacturing milestones, the announcement of
our first-ever proposed acquisition, and the celebration
of our 30th anniversary as a company.
Our financial performance in 2006 was strong, with total operating revenues of approximately $9.3 billion, an increase of 40 percent over 2005. We also increased our non-GAAP pre-tax operating margin¹ from 32 percent in 2005 to 39 percent in 2006. We made good progress toward our Horizon 2010 financial goals: our U.S. oncology sales in 2006 passed the $5 billion mark, and we are now number one in the United States in oncology sales; our non-GAAP earnings per share¹ in 2006 were $2.23, an increase of 74 percent over 2005; and our free cash flow² in 2006 was nearly $1 billion.
The approval of Lucentis in 2006 as a new therapy for patients with wet age-related macular degeneration (AMD) was a particularly important accomplishment. Lucentis provides new hope for patients with AMD, one of the leading causes of blindness in people over the age of 55, because it is the first therapy to reverse vision loss in up to 40 percent of patients with wet AMD. Even though ophthalmology represents an entirely new market for Genentech, the Lucentis launch was our most successful to date. Lucentis had U.S. sales of $380 million in 2006 with only six months on the market.
We achieved a record-breaking year in terms of new indications for existing products, with seven U.S. Food and Drug Administration (FDA) line-extension approvals in 2006: four for Rituxan® (Rituximab), two for Avastin® (bevacizumab), and one for Herceptin® (Trastuzumab). (Read more about the new indication for Herceptin in "Herceptin: 25 Years of Progress in Breast Cancer Treatment.")
In addition to these approvals, we continued to make progress in building our product pipeline. With our collaborators, we announced positive results from a Phase III study of Avastin in renal cell cancer, a Phase II study of Rituxan in relapsing remitting multiple sclerosis, a Phase II study of Avastin plus Tarceva® (erlotinib) in non-small cell lung cancer, and a Phase II study of Omnitarg™ (pertuzumab) in advanced ovarian cancer (announced in early 2007). We also moved one new molecule into Phase III studies, two new molecules into Phase II and seven new molecular entities from research into development. Finally, we closed or executed agreements for approximately 50 business development collaborations in 2006, including eight significant collaborations for products that are either currently in clinical development or expected to move into clinical development in the next one to two years.
2006 also included a couple of disappointments in the pipeline. In June, we learned that a Phase III study of Avastin in advanced pancreatic cancer did not meet its primary endpoint. In September, we received a Complete Response Letter from the FDA for the supplemental Biologics License Application submitted for Avastin in first-line metastatic breast cancer; we are currently addressing the FDA’s requests and anticipate resubmission in mid-2007.
With regard to manufacturing, I am pleased to report that our efforts over the last two years have been highly successful in enhancing our mammalian cell culture production. We achieved several manufacturing milestones in 2006, including approvals of new high-titer processes for Avastin and Rituxan; submission of the licensure application for our Oceanside, CA facility; and the groundbreaking on our fill/finish facility in Hillsboro, OR. Other milestones included the approvals received for the Novartis and Wyeth facilities to manufacture Xolair® (Omalizumab) and Herceptin, respectively. Finally, we signed agreements with Lonza Group Ltd. selling them our Porriño, Spain facility and giving us the option to purchase their Singapore facility. The Lonza agreements support our efforts to meet both near- and long-term capacity needs and enable us to significantly improve our cost structure.
Towards the end of the year, we announced our intention to acquire Tanox, Inc., which represents the first proposed acquisition in Genentech’s 30-year history. Genentech and Tanox have been working in collaboration with Novartis since 1996 to develop and commercialize Xolair. Closing the acquisition will result in an improvement of our financial results for Xolair and the acquisition of Tanox’s product pipeline, which has some interesting molecules being developed for diseases such as asthma, HIV and AMD. We currently anticipate closing the deal within the first half of 2007, subject to customary closing conditions, including expiration of the waiting period under the Hart-Scott-Rodino Act.
Looking Ahead
While we are pleased with our progress as a company
in 2006, we remain focused on the future and our long-term
success. Below are several areas that I believe will
be especially important for Genentech in 2007 and beyond.
Continuing to build the product pipeline. In the short term, Genentech’s growth will be driven by our ability to execute on recent approvals, including Lucentis for wet AMD and Avastin in non-small cell lung cancer, and by potential new indications for our existing products, such as Avastin for breast cancer and Rituxan for immunological disorders.
We recognize that continued long-term growth will depend on our ability to bring innovative new molecules to the market that make a meaningful difference for patients and provide significant commercial opportunities. We are also aware that our recent success has raised the bar in terms of what our pipeline needs to look like to drive continued growth. Additionally, we face increasing competition from pharmaceutical companies and other biotechnology companies in diseases of interest to us. For these reasons, building a strong pipeline is our number one focus and priority as a company.
Although the process takes time, we are confident in the rigorous and disciplined approach to overseeing research and development (R&D) that we have built over the past 30 years. We believe the majority of new projects entering the pipeline will come from our internal efforts, but we will continue to look for ways to supplement the pipeline, especially through early-stage in-licensing.
As of the end of 2006, we had 16 new molecules in the early development pipeline and approximately 30 projects in late-stage research. Most of these molecules target novel mechanisms based on promising biology and could represent significant treatment advances. Over the next few years, we look forward to generating clinical data with new molecules and building our late-stage pipeline through advancement of these molecules.
Addressing pricing and reimbursement issues. With a new Congress in place, pricing will continue to be a topic of conversation in 2007. Externally, we will continue to work with patient groups, physicians, payers and government officials to discuss our business model and pricing philosophy, and to understand their concerns and ideas.
We believe that our pricing is appropriate given the difference our novel medicines make in the lives of patients. The price of our products also sustains our business model; the high risks and costs of R&D innovation are only viable if there is a reasonable return on our investments. We will continue to support our position and educate policymakers about our pricing, while at the same time working to ensure that price is not a barrier to access for patients. In February 2007, we launched the Avastin Patient Assistance Program, which caps the annual expenditure for eligible patients in order to address concerns in certain tumor types where the Avastin doses are high and treatment durations are long.
This new program complements our existing suite of patient access programs. Since 1985, the Genentech® Access to Care Foundation (GATCF) and the Genentech Endowment for Cystic Fibrosis have donated free product to eligible uninsured patients and those deemed uninsured due to payer denial. In 2006 alone, GATCF supported more than 14,000 patients by providing approximately $205 million in free medicine. Since 2005, Genentech has also contributed approximately $70 million to various independent public charities that provide financial assistance to eligible patients who cannot access needed medical treatment due to high co-pay costs. Finally, through our Single Point of Contact program, we provide patients with assistance and information on a broad array of reimbursement services and support.
Continuing to hire and grow our culture thoughtfully. In the last five years, Genentech has more than doubled our number of employees, adding approximately 6,000 people. Even though we are growing quickly, we are dedicated to making careful hiring decisions in order to continue to bring in individuals who fit well with the company culture. As I’ve discussed before, our distinctive culture is characterized by a commitment to excellent science, a dedication to patients, a respect for the individual, and decision-making that is focused on Genentech’s long-term interest.
We were pleased to have been named in 2006 by Science magazine as “the top employer and most admired company in the biotechnology and pharmaceutical industries” for the fifth year in a row and by Working Mother to its “100 Best Companies for Working Mothers” list for the 14th time. Additionally, in early January 2007, FORTUNE magazine named Genentech number two on its 2007 list of “The 100 Best Companies to Work For.” We have earned a place on the FORTUNE list for nine consecutive years, and in the past four years, we have been the only biotech or pharmaceutical company to appear in the top 20 positions. We believe our unique Genentech culture offers us a competitive advantage in stimulating innovation and productivity, contributing in a very important way to our continued success.
In closing, as we proceed into 2007, we have a solid foundation in place to deliver on our Horizon 2010 growth goals. We will continue to focus on developing important new medicines through excellent science, long-term planning, disciplined execution against our goals, and a passionate commitment to patients and employees. We see tremendous advances in understanding the biological basis of many debilitating diseases, and we believe these advances play to Genentech’s greatest strengths as we try to translate the biology into new therapies. We are confident that as long as we continue to invest wisely and appropriately in R&D, we will continue to develop first-in-class and best-in-class molecules for significant unmet medical needs and create long-term value for our stockholders.
Arthur D. Levinson, Ph.D.
Chairman and Chief Executive Officer
¹ Our GAAP pre-tax operating margin for 2006 was 34 percent, an increase from 29 percent in 2005, and our GAAP earnings per share for 2006 was $1.97, an increase of 67 percent compared to 2005. Our 2006 non-GAAP amounts exclude the effects of (i): employee stock-based compensation expense associated with our adoption of Statement of Financial Standards No. 123R, “Share-Based Payment” (FAS 123R) on January 1, 2006 of $309 million on a pretax basis, (ii) recurring amortization charges related to the 1999 redemption of our Special Common Stock by Roche, which was $105 million on a pretax basis, (iii), litigation-related special items for accrued interest and associated bond costs on the City of Hope judgment, which was $54 million on a pretax basis, and (iv) the related income tax benefits on these items of $191 million. Our 2005 non-GAAP amounts exclude the effects of: (i) recurring amortization charges related to the 1999 redemption of our Special Common Stock by Roche, which was $123 million on a pretax basis, (ii) litigation-related special items for accrued interest and associated bond costs on the City of Hope judgment and net amounts paid on other litigation settlements, which was $58 million on a pretax basis, and (iii) the related income tax benefits on these items of $73 million. See pages 26-27 for the full reconciliation between our non-GAAP and GAAP numbers.
² Our free cash flow measure is defined as cash from ongoing operations less gross capital expenditures. Cash from ongoing operations is derived from the “net cash provided by operating activities” line in our consolidated statements of cash flows excluding the effect of changes in the trading portfolio, but this number may be adjusted for items that would allow the measure to better reflect our operational performance. These adjustments include, for example, cash receipts or payments related to litigation settlements, investments in trading securities and other potential items, any of which may be significant. For 2006, cash from ongoing operations represents net cash provided by operating activities, excluding the effect of changes in the trading portfolio.
This Annual Report contains forward-looking statements regarding our development pipeline, time frame for filing an Avastin sBLA and closing the Tanox acquisition, adding 20 molecules into clinical development by 2010, bringing 15 major new products/indications onto the market by 2010, becoming the number one U.S. oncology company in sales by 2010, Genentech’s long-term growth, including growth in non-GAAP earnings per share (EPS) and cumulative free cash flow by 2010, and creation of long-term value for stockholders. Such statements are predictions and involve risks and uncertainties such that actual results may differ materially. Among other things, our development pipeline, time frame for filing an Avastin sBLA and adding molecules into clinical development could be affected by a number of factors, including unexpected safety, efficacy or manufacturing issues, additional time requirements for coordination with third parties, data analysis, BLA preparation and decision-making, need for additional clinical studies, and FDA actions or delays; closing the Tanox acquisition could be affected or prevented by failure of certain closing conditions to occur, including FTC and other regulatory actions or delays; bringing new products/indications to market could be affected by all of the foregoing and by a number of other factors, including failure to obtain or maintain FDA approval; becoming a leader in oncology sales could be affected by all of the foregoing and by a number of other factors, including competition, pricing, reimbursement, intellectual property or contract rights, the ability to supply product, product withdrawals and new product approvals and launches; and Genentech’s growth, including growth in non-GAAP EPS and cumulative free cash flow, and creation of long-term value for stockholders could be affected by all of the foregoing and by a number of other factors, including achieving sales revenue consistent with internal forecasts, costs of sales, R&D and MG&A expenses, stock-based compensation expense, unanticipated expenses such as litigation or legal settlement expenses or equity securities write-downs, royalties and contract revenues, and fluctuations in tax and interest rates. Please also refer to Genentech’s periodic reports filed with the Securities and Exchange Commission. Genentech disclaims, and does not undertake, any obligation to update or revise any forward-looking statements in this Annual Report.