-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, E0q+YPdqApgsheCGfIDJ9PQy+6HM18nUI50mqvt1vPd2KZZfQvw1zXO+d5zHOUnU w2h8cSJ1cEc9eaxxIb60ug== 0000318771-97-000007.txt : 19970814 0000318771-97-000007.hdr.sgml : 19970814 ACCESSION NUMBER: 0000318771-97-000007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970813 SROS: NYSE SROS: PSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENENTECH INC CENTRAL INDEX KEY: 0000318771 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 942347624 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-09813 FILM NUMBER: 97658455 BUSINESS ADDRESS: STREET 1: 460 POINT SAN BRUNO BLVD CITY: SOUTH SAN FRANCISCO STATE: CA ZIP: 94080 BUSINESS PHONE: 4152251000 MAIL ADDRESS: STREET 1: 460 POINT SAN BRUNO BLVD STREET 2: . CITY: SOUTH SAN FRANCISCO STATE: CA ZIP: 94080 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q (Mark One) X Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended June 30, 1997. Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from to . Commission File Number 1-9813 GENENTECH, INC. (Exact name of registrant as specified in its charter) Delaware 94-2347624 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification number) 1 DNA Way, South San Francisco, California 94080 (Address of principal executive offices and zip code) (650) 225-1000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock $0.02 par value 76,621,009 Class Outstanding at June 30, 1997 Special Common Stock $0.02 par value 46,566,033 Class Outstanding at June 30, 1997 GENENTECH, INC. INDEX PART I. FINANCIAL INFORMATION PAGE NO. Condensed Consolidated Statements of Income - for the three months and six months ended June 30, 1997 and 1996 3 Condensed Consolidated Statements of Cash Flows - for the six months ended June 30, 1997 and 1996 4 Condensed Consolidated Balance Sheets - June 30, 1997 and December 31, 1996 5 Notes to Condensed Consolidated Financial Statements 6 Financial Review 11 Independent Accountants' Review Report 19 PART II. OTHER INFORMATION 20 SIGNATURES 21 Page 2
PART I. FINANCIAL INFORMATION GENENTECH, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (thousands, except per share amounts) (unaudited) Three Months Six Months Ended June 30 Ended June 30 --------------------- -------------------- 1997 1996 1997 1996 --------- --------- --------- --------- Revenues: Product sales (including amounts from related parties: three months - 1997-$4,504; 1996-$5,537; six months - 1997-$8,998; 1996-$9,492) $ 145,018 $ 148,305 $ 299,231 $ 300,642 Royalties (including amounts from related parties: three months - 1997-$6,225; 1996-$5,886; six months - 1997-$13,023; 1996-$12,513) 55,379 53,224 120,691 106,117 Contract and other (including amounts from related parties: three months - 1997-$10,695; 1996-$24,675; six months - 1997-$26,401; 1996-$43,432) 16,659 27,032 38,068 49,132 Interest 16,437 15,201 32,788 30,755 --------- --------- --------- --------- Total revenues 233,493 243,762 490,778 486,646 Costs and expenses: Cost of sales (including amounts from related parties: three months - 1997-$3,664; 1996-$4,379; six months - 1997-$7,563; 1996-$7,842) 25,567 27,153 53,252 53,032 Research and development (including contract related: three months - 1997-$10,695; 1996-$11,547; six months - 1997-$26,401; 1996-$19,163) 110,890 112,603 233,633 228,236 Marketing, general and administrative 63,073 60,987 125,054 113,029 Interest 916 1,333 1,904 2,892 --------- --------- --------- --------- Total costs and expenses 200,446 202,076 413,843 397,189 Income before taxes 33,047 41,686 76,935 89,457 Income tax provision 9,253 19,967 21,542 29,521 --------- --------- --------- --------- Net income $ 23,794 $ 21,719 $ 55,393 $ 59,936 ========= ========= ========= ========= Net income per share $ 0.19 $ 0.18 $ 0.44 $ 0.49 ========= ========= ========= ========= Weighted average number of shares used in computing per share amounts 126,539 123,257 126,101 123,309 ========= ========= ========= ========= See notes to condensed consolidated financial statements.
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GENENTECH, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (thousands) (unaudited) Six Months Ended June 30 ---------------------- 1997 1996 ---------- ---------- Cash flows from operating activities: Net income $ 55,393 $ 59,936 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation and amortization 33,568 30,714 Deferred income taxes (4,445) (7,305) Gain on sales of securities available-for-sale (5,836) (90) Loss on sales of securities available-for-sale 1,217 - Loss on fixed asset dispositions 83 529 Changes in assets and liabilities: Trading securities (101,631) (3,334) Receivables and other current assets (17,618) (17,427) Inventories (7,724) 8,201 Accounts payable, other current liabilities and other long-term liabilities 6,064 (6,708) ---------- ---------- Net cash (used in) provided by operating activities (40,929) 64,516 Cash flows from investing activities: Purchases of securities held-to-maturity (213,523) (326,510) Proceeds from maturities of securities held-to-maturity 281,045 422,329 Purchases of securities available-for-sale (204,141) (156,410) Proceeds from sales of securities available-for-sale 237,383 75,683 Purchases of non-marketable equity securities - (7,523) Capital expenditures (76,454) (58,184) Change in other assets (34,334) 3,136 ---------- ---------- Net cash used in investing activities (10,024) (47,479) Cash flows from financing activities: Stock issuances 51,420 43,682 Repayment of long-term debt, including current portion - (358) ---------- ---------- Net cash provided by financing activities 51,420 43,324 ---------- ---------- Net increase in cash and cash equivalents 467 60,361 Cash and cash equivalents at beginning of period 207,264 137,043 ---------- ---------- Cash and cash equivalents at end of period $ 207,731 $ 197,404 ========== ========== See notes to condensed consolidated financial statements.
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GENENTECH, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (thousands) (unaudited) June 30 December 31 1997 1996 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 207,731 $ 207,264 Short-term investments 476,572 415,900 Accounts receivable, net (including amounts from related party: 1997-$25,470; 1996-$33,377) 209,622 197,612 Inventories 99,667 91,943 Prepaid expenses and other current assets 47,480 42,365 ------------ ------------ Total current assets 1,041,072 955,084 Long-term marketable securities 472,586 535,916 Property, plant and equipment, less accumulated depreciation (1997-$347,424; 1996-$320,100) 633,942 586,167 Other assets 183,682 149,205 ------------ ------------ Total assets $ 2,331,282 $ 2,226,372 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 49,121 $ 45,501 Accrued liabilities - related party 9,768 9,908 Other accrued liabilities 190,063 194,542 ------------ ------------ Total current liabilities 248,952 249,951 Long-term debt 150,000 150,000 Other long-term liabilities 25,520 25,362 ------------ ------------ Total liabilities 424,472 425,313 Commitments and contingencies Stockholders' equity: Preferred stock - - Special common stock 931 896 Common stock 1,532 1,532 Additional paid-in capital 1,422,613 1,362,585 Retained earnings (since October 1, 1987 quasi-reorganization) 437,490 382,097 Net unrealized gain on securities available-for-sale 44,244 53,949 ------------ ------------ Total stockholders' equity 1,906,810 1,801,059 ------------ ------------ Total liabilities and stockholders' equity $ 2,331,282 $ 2,226,372 ============ ============ See notes to condensed consolidated financial statements.
Page 5 GENENTECH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 1. Statement of Accounting Presentation and Significant Accounting Policies In the opinion of Genentech, Inc. (the Company), the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of adjustments of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the three-month and six-month periods ended June 30, 1997 and 1996 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. The condensed consolidated balance sheet as of December 31, 1996 has been derived from the audited financial statements as of that date. For further information, refer to the consolidated financial statements and notes thereto included in the Company's Annual Report to Stockholders for the year ended December 31, 1996. In January 1997, the Securities and Exchange Commission issued new derivatives and exposures to market risk disclosure requirements. To comply with these new requirements, the following supplements the disclosures included in the Company's 1996 Form 10-K and Annual Report. Trading: The Company uses external money managers to manage part of its investment portfolio that is held for trading purposes. When the money managers purchase securities denominated in a foreign currency, they enter into foreign currency forward contracts which are recorded at fair value with the related gain or loss recorded in interest income. Foreign Currency Instruments: Simple foreign currency put options (options) are generally terminated, or offsetting contracts are entered into, upon determination that purchased options no longer qualify as a hedge or are determined to exceed probable anticipated net foreign revenues. The realized gains and losses are recorded as a component of other revenues. For early termination of options that qualify as hedges, the gain or loss on termination will be deferred through the original term of the option and then recognized as a component of the hedged revenues. Changes in the fair value of hedging instruments that qualify as a hedge are not recognized and changes in the fair value of instruments that do not qualify as a hedge would be recognized through earnings. Interest Rate Swaps: The accrued net settlement amount on the interest rate swaps (swaps) are reflected on the balance sheet as other accounts receivable or other accrued liabilities. For early termination of swaps where the underlying asset is not sold, the amount of the terminated swap is deferred and amortized over the remaining life of the original swap. For early termination of swaps with the corresponding termination or sale of the underlying asset, the amounts are recognized through interest income. Changes in the fair value of swap hedging instruments that qualify as a hedge are not recognized and changes in the fair value of swap instruments that do not qualify as a hedge would be recognized through earnings. Equity Collar Instruments: Equity collar instruments that do not qualify for hedge accounting and early termination of these instruments with the call of the underlying security would be recognized through earnings. For early termination of these instruments without the sale of the underlying security, Page 6 GENENTECH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) the time value would be recognized through earnings and the intrinsic value will adjust the cost basis of the underlying security. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Note 2. New Accounting Standards In February 1997, the Financial Accounting Standards Board (FASB)issued Statement of Financial Accounting Standards (FAS) 128, "Earnings per Share," and FAS 129, "Disclosure of Information about Capital Structure," which are required to be adopted on December 31, 1997. At that time, the Company will be required to change the method currently used to compute earnings per share (EPS) and to restate all prior periods as required by FAS 128. Under the new requirements for calculating EPS, the dilutive effect of stock options will be excluded from a new EPS measure, Basic EPS. The impact is expected to result in an increase in Basic EPS for the three- and six-month period ended June 30, 1997 and June 30, 1996; however, this impact is expected to be immaterial. The impact of FAS 128 on the calculation of the second new EPS measure, Diluted Earnings Per Share, for these quarters is also expected to be immaterial. FAS 129 consolidates existing guidance relating to disclosure about a company's capital structure. Since the Company has been in compliance with existing disclosure requirements of its capital structure, adoption of FAS 129 is not expected to have a material impact on the financial position, results of operations or cash flows of the Company. The FASB also issued FAS 130, "Reporting Comprehensive Income," and FAS 131, "Disclosures about Segments of an Enterprise and Related Information," in June 1997, which requires additional disclosures to be reflected in the Company's 1998 annual report. Under FAS 130, the Company is required to display comprehensive income and its components as part of the Company's full set of financial statements. FAS 131 requires that the Company report financial and descriptive information about its reportable operating segments. Note 3. Relationship with Roche Holdings, Inc. On October 25, 1995, the Company and Roche Holdings, Inc. (Roche) entered into a new agreement (the Agreement). Each share of the Company's common stock not held by Roche or its affiliates on that date automatically converted to one share of callable putable common stock (special common stock). The Agreement extends until June 30, 1999, Roche's option to cause the Company to redeem (call) the outstanding special common stock of the Company at predetermined prices. Should the call be exercised, Roche will concurrently purchase from the Company a like number of shares of common stock for a price equal to the Company's cost to redeem the special common stock. During the quarter beginning July 1, 1997, the call price is $72.00 per share and increases by $1.50 per share each quarter through the end of the option period on June 30, 1999, on which date the price is $82.50 per share. If Roche does not cause the redemption as of June 30, 1999, the Company's stockholders will have the option Page 7 GENENTECH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (the put) to cause the Company to redeem none, some, or all of their shares of special common stock at $60.00 per share (and Roche will concurrently provide the necessary redemption funds to the Company by purchasing a like number of shares of common stock at $60.00 per share) within thirty business days commencing July 1, 1999. Roche Holding Ltd, a Swiss corporation, has guaranteed Roche's obligation under the put. In conjunction with the Agreement, F. Hoffmann-La Roche Ltd (HLR) was granted an option for ten years for licenses to use and sell certain of the Company's products in non-United States (U.S.) markets. In the second quarter of 1997, the Company and HLR have agreed in principle to changes to their 1995 ex-U.S. license agreement (license agreement). Key changes to the license agreement are summarized below: (1) For future products, HLR may choose to exercise its option either when the Company determines to move a product into development, or at the end of Phase II (as in the 1995 agreement). U.S. and European development costs will be shared (discontinuing the distinction regarding location or purpose of studies). (2) If HLR exercises its option at the development determination point, U.S. and European development costs will be shared 50/50. (3) If HLR exercises its option at the end of Phase II, HLR will reimburse the Company for 50 percent of any development costs incurred, and subsequent U.S. and European development costs will be shared 75/25, HLR/Genentech. (4) For insulin-like growth factor in diabetes (IGF-I) and for nerve growth factor (NGF), both of which HLR has already exercised its option to develop, prospective U.S. and European development costs will be shared 60/40, HLR/Genentech. (5) HLR will assume development of the oral IIbIIIa antagonist globally on its own. The Company will provide clinical and scientific input for the IIbIIIa program and may subsequently opt-in and join development at any time up to the New Drug Application (NDA) filing for the first indication. If the Company chooses to opt-in, it will reimburse HLR for 50 percent of the U.S. and European IIbIIIa development costs incurred to that date. HLR and Genentech will co-promote IIbIIIa in the U.S. with a 60/40, Genentech/HLR, profit-sharing if the NDA filing for the first indication is for acute therapy or a 50/50 profit-sharing if the NDA filing for the first indication is for chronic therapy. If the Company does not opt-in, it will receive from HLR a 6.0 percent royalty on worldwide sales of the oral IIbIIIa antagonist. In general, HLR pays a royalty of 12.5% until a product reaches $100 million in aggregate sales outside of the U.S., at which time the royalty rate increases to 15%. In addition, HLR has exclusive rights to, and pays the Company 20% royalties on, Canadian sales of the Company's existing products and European sales of Pulmozyme, registered trademark. The Company supplies its products to HLR, and has agreed to supply products for which HLR has exercised its option, for sales outside of the U.S. at cost plus 20%. Under the Agreement, independent of its right to cause the Company to redeem the special common stock, Roche may increase its ownership of the Company up to 79.9% by making purchases on the open market. Roche holds approximately 67.4% of the outstanding common equity of the Company as of June 30, 1997. Contract revenue for the quarter ended June 30, 1997, and on a year-to-date basis totaled $10.7 million and $26.4 million, respectively, of which $7.4 million and $20.0 million, respectively, are reimbursements for ongoing development expenses for the three development projects - rituximab (the C2B8 antibody), IGF-1 and NGF - that HLR exercised its development option for under the Agreement in 1996. Page 8 GENENTECH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) Note 4. Legal Proceedings The Company is a party to various legal proceedings including patent infringement cases involving human growth hormone products and Activase, registered trademark, product liability cases, and employment related cases. See also Note 8, "Subsequent Event." Based upon the nature of the claims made and the investigations completed to date by the Company and its counsel, the Company believes that the outcome of these cases will not have a material adverse effect on the financial position, results of operations or cash flows of the Company. However, were an unfavorable ruling to occur in any quarterly period, there exists the possibility of a material impact on the net income of that period. Note 5. Note Receivable Pursuant to its research and development collaboration agreement entered into with Scios Inc. (Scios) in 1995, the Company established a line of credit for $30 million that Scios may draw down at Scios' discretion through 2002. This commitment was supported by a bank letter of credit under which Scios could draw up to $30 million directly from the bank with repayment of the funds due to the bank by the Company. On March 31, 1997, Scios drew down the entire $30 million with replacement of funds paid to the bank by the Company on April 1, 1997. The $30 million drawn by Scios under the bank letter of credit plus interest (which accrues at the prime rate of interest) is repayable in the form of cash or Scios common stock (at the average market price over the thirty day period before the date of repayment) at Scios' option any time through December 30, 2002. On April 2, 1997, Scios suspended development of Auriculin, registered trademark, anaritide based upon the results of an interim analysis of data from the Phase III study in oliguric acute renal failure. Auriculin was under development in collaboration with the Company. Note 6. Inventories Inventories at June 30, 1997, and December 31, 1996, are summarized below: 1997 1996 ---------- ---------- (thousands) Raw materials and supplies $ 20,327 $ 17,971 Work in process 65,914 61,368 Finished goods 13,426 12,604 ---------- ---------- Total $ 99,667 $ 91,943 ========== ========== Note 7. Change in Effective Income Tax Rate The Company's effective income tax rate in the three- and six-month periods ended June 30, 1997, was 28% compared to 48% and 33%, respectively, for the same periods ended June 30, 1996. The effective rate for the full year 1997 is expected to be 28%. The rate decrease to 28% in the second quarter of 1997 from 48% in the same quarter last year was due to a catch-up adjustment in the Page 9 GENENTECH, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) second quarter of 1996 to bring the 1996 year-to-date rate to 33%. The decrease for the six-month period ended June 30, 1997, compared to the same period in 1996 was primarily due to 1996 foreign losses not currently providing a tax benefit. The 1997 effective tax rate is less than the U.S. statutory rate of 35% primarily due to research and development tax credits. Note 8. Subsequent Event In July 1997, an action was filed in the U.S. District Court for the Northern District of California alleging that the Company's manufacture, use and sale of its Nutropin, registered trademark, human growth hormone products infringed a patent (the Goodman Patent) owned by the Regents of the University of California (UC). This action is substantially the same as a previous action filed in 1990 against the Company by UC alleging that the Company's manufacture, use and sale of its Protropin, registered trademark, human growth hormone products infringed the Goodman Patent. Page 10 GENENTECH, INC. FINANCIAL REVIEW RELATIONSHIP WITH ROCHE HOLDINGS, INC. On October 25, 1995, Genentech, Inc. (the Company) and Roche Holdings, Inc. (Roche) entered into a new agreement (the Agreement) to extend until June 30, 1999, Roche's option to cause the Company to redeem (call) the outstanding callable putable common stock (special common stock) of the Company at predetermined prices. Should the call be exercised, Roche will concurrently purchase from the Company a like number of shares of common stock for a price equal to the Company's cost to redeem the special common stock. If Roche does not cause the redemption as of June 30, 1999, the Company's stockholders will have the option to cause the Company to redeem none, some, or all of their shares of special common stock (and Roche will concurrently provide the necessary redemption funds to the Company by purchasing a like number of shares of common stock) within thirty business days commencing July 1, 1999. See the Relationship with Roche Holdings, Inc. note in the Notes to Condensed Consolidated Financial Statements for further information. In conjunction with the Agreement, F. Hoffmann-La Roche Ltd (HLR) was granted an option for ten years for licenses to use and sell certain of the Company's products in non-United States (U.S.) markets. In the second quarter of 1997, the Company and HLR have agreed in principle to changes to their 1995 ex-U.S. license agreement (license agreement). In general, these changes will allow for the sharing of U.S. and European development costs regardless of location or purpose of studies. Under these changes, HLR could exercise its option either when the Company determines to move a product into development or at the end of Phase II. U.S. and European development costs will be shared 50/50 if HLR exercises its option at the development determination point or 75/25, HLR/Genentech, of subsequent costs if HLR exercises its option at the end of Phase II with 50 percent of any development costs incurred to date by the Company to be reimbursed by HLR. For insulin-like growth factor in diabetes (IGF-I) and for nerve growth factor (NGF), both of which HLR has already exercised its option to develop, prospective U.S. and European development costs will be shared 60/40, HLR/Genentech. HLR will assume development of the oral IIbIIIa antagonist globally on its own. The Company may subsequently opt-in and join development of IIbIIIa at any time up to the New Drug Application filing for the first indication. See the Relationship with Roche Holdings, Inc. note in the Notes to Condensed Consolidated Financial Statements for further information on the key changes to the license agreement. As a result of the Agreement, contract revenue for the quarter ended June 30, 1997, and on a year-to-date basis totaled $10.7 million and $26.4 million, respectively, of which $7.4 million and $20.0 million, respectively, are reimbursements for ongoing development expenses for the three development projects - rituximab (the C2B8 antibody), IGF-1 and NGF - that HLR exercised its development option for under the Agreement in 1996. Page 11
RESULTS OF OPERATIONS (dollars in millions, except per share amounts) Quarter ended June 30 Six months ended June 30 ---------------------- ------------------------ REVENUES 1997 1996 % Change 1997 1996 % Change - ---------------------- ------ ------ -------- ------ ------ -------- Revenues $233.5 $243.8 (4) % $490.8 $486.6 1 % ====== ====== ======== ====== ====== ======== PRODUCT SALES - ---------------------- Activase $ 68.3 $ 72.3 (6)% $143.3 $148.9 (4)% Protropin and Nutropin 55.6 54.1 3 111.5 110.1 1 Pulmozyme 20.2 20.8 (3) 42.5 39.7 7 Actimmune 0.9 1.1 (18) 1.9 1.9 0 ------ ------ -------- ------ ------ -------- Total product sales $145.0 $148.3 (2) % $299.2 $300.6 0 % ====== ====== ======== ====== ====== ========
Net sales of Activase, registered trademark, (Alteplase, recombinant), a tissue plasminogen activator (t-PA), decreased in the three- and six-month periods ended June 30, 1997, compared to same periods of 1996. This decrease was due to lower U.S. sales attributable to a decrease in the size of the thrombolytic market and competition from Boehringer Mannheim's (BM) Retavase, registered trademark. In the second quarter of 1997, Activase's market share declined to approximately 79%, compared to approximately 80% in the same quarter of 1996 and approximately 84% in the first quarter of 1997 as a result of competition from Retavase. In addition, the overall size of the market has declined due to the increasing use of angioplasty rather than thrombolytic therapy. In March 1997, results from the GUSTO III clinical trial which involved a head-to-head comparison of Activase and Retavase, failed to demonstrate that Retavase has a statistically significant lower mortality rate than Activase. Net sales of the Company's three growth hormone products - Protropin, registered trademark, (somatrem for injection), Nutropin, registered trademark, [somatropin (rDNA origin) for injection] and Nutropin AQ, trademark, [somatropin (rDNA origin) injection] - were higher in the three- and six-month periods ended June 30, 1997 over the comparable periods in 1996 due to modest market growth. The Company continues to maintain a 2/3 share of the U.S. market for treatment of children with growth hormone inadequacy. In the first quarter of 1997, Serono Laboratories, Inc. and Novo Nordisk A/S (Novo) began selling their human growth hormone products. Novo began selling Norditropin, registered trademark, after the U.S. Court of Appeals stayed a preliminary injunction against Novo. The Court of Appeals subsequently invalidated the patent that was the subject of the preliminary injunction. Net sales of Pulmozyme, registered trademark, decreased slightly in the second quarter of 1997 from the comparable period in 1996. On a year-to-date basis, net sales of Pulmozyme increased by 7% due to increased market penetration in its currently approved indications - management of patients with moderate or advanced cystic fibrosis (CF). Page 12
Quarter ended June 30 Six months ended June 30 ROYALTIES, CONTRACT AND ---------------------- ------------------------ OTHER, AND INTEREST INCOME 1997 1996 % Change 1997 1996 % Change - ----------------------------- ------ ------ -------- ------ ------ -------- Royalties $55.4 $53.2 4 % $120.7 $106.1 14 % Contract and other 16.7 27.0 (38) 38.1 49.1 (22) Interest income 16.4 15.3 7 32.8 30.8 6
Royalty income increased by 4% and 14% in the three- and six-month periods, respectively, ended June 30, 1997, over the comparable periods of 1996 due primarily to increased sales of products by licensees. In addition, $2.2 million of reserves against certain royalty revenues for 1996 were reversed in the first quarter of 1997 due to the favorable outcome of certain patent proceedings. Contract and other revenues decreased in the second quarter of 1997 and on a year-to-date basis over the same periods last year due primarily to the absence in 1997 of Roche opt-in revenue. This decrease was partially offset by $7.4 million in the second quarter of 1997 and $20.0 million on a year-to- date basis of Roche ongoing development cost reimbursements for IGF-1, NGF and rituximab, and $4.8 million of gains on sales of biotechnology equity securities primarily in the second quarter of 1997. Contract and other revenues in the first quarter of 1996 included $17.1 million from Roche for the exercise of its option regarding rituximab, and $19.3 million in the second quarter of 1996 for the exercise of its option regarding IGF-1. Interest income increased in the second quarter of 1997 and on a year-to-date basis compared to the comparable periods in 1996 due primarily to an increase in the average yield on the portfolio. The total investment portfolio, consisting of cash and cash equivalents, and short- and long-term marketable securities, increased to $1,156.9 million as of June 30, 1997 from $1,145.3 million as of June 30, 1996 and decreased from $1,159.1 million as of December 31, 1996.
Quarter ended June 30 Six months ended June 30 ---------------------- ------------------------ COSTS AND EXPENSES 1997 1996 % Change 1997 1996 % Change - ----------------------------- ------ ------ -------- ------ ------ -------- Cost of sales $ 25.6 $ 27.2 (6)% $ 53.3 $ 53.0 1 % Research and development 110.9 112.6 (2) 233.6 228.3 2 Marketing, general and administrative 63.0 61.0 3 125.0 113.0 11 Interest expense 0.9 1.3 (31) 1.9 2.9 (34) ------ ------ -------- ------ ------ -------- Total costs and expenses $200.4 $202.1 (1)% $413.8 $397.2 4 % ====== ====== ======== ====== ====== ========
Cost of sales as a percent of product sales was 18% in the second quarter of 1997 and on a year-to-date basis, which was comparable to the same periods in 1996. Research and development (R&D) expenses decreased 2% in the second quarter of 1997 and increased 2% on a year-to-date basis over the comparable periods in 1996. The increase on a year-to-date basis was primarily due to increased expenses for additional large-scale clinical trials for products in late-stage development, continued testing of products currently in late-stage clinical testing and costs to license technology from collaborative partners. These increases, totaling approximately $10.0 million, were partially offset by a $5.0 million payment in the first quarter of 1996 to Washington University for a license for worldwide rights to human neurturin, a neurotrophic factor that promotes nerve cell growth and may be useful for the treatment of neurodegenerative disorders, and to other neurotrophic factors. R&D as a Page 13 percent of revenue was approximately 47% and 48% in the second quarter of 1997 and on a year-to-date basis, respectively, which is 1% higher than the comparable periods in 1996. Marketing, general and administrative (MG&A) expenses increased in the second quarter of 1997 over the comparable period in 1996 due to increased sales and marketing expenses related to pre-launch activities for rituximab. The year- to-date increase from the prior year was due to increased sales and marketing expenses primarily related to promoting Roche's Roferon-A, registered trademark, in the U.S. for its approved oncology indications, expenses related to pre-launch activities for rituximab and higher corporate expenses. Interest expense declined in the second quarter and year-to-date periods of 1997 over the comparable periods in 1996 due to an increase in capitalized interest resulting from higher capital expenditures.
Quarter ended June 30 Six months ended June 30 --------------------- ------------------------ INCOME TAXES 1997 1996 1997 1996 - ----------------------------- ---------- --------- ---------- ---------- Income taxes $ 9.3 $ 20.0 $ 21.6 $ 29.5
The Company's effective income tax rate in the three- and six-month periods ended June 30, 1997, was 28% compared to 48% and 33%, respectively, for the same periods ended June 30, 1996. The effective rate for the full year 1997 is expected to be 28%. The rate decrease to 28% in the second quarter of 1997 from 48% in the same quarter last year was due to a catch-up adjustment in the second quarter of 1996 to bring the 1996 year-to-date rate to 33%. The decrease for the six-month period ended June 30, 1997, compared to the same period in 1996 was primarily due to 1996 foreign losses not currently providing a tax benefit. The 1997 effective tax rate is less than the U.S. statutory rate of 35% primarily due to research and development tax credits.
Quarter ended June 30 Six months ended June 30 ---------------------- -------------------------- NET INCOME 1997 1996 % Change 1997 1996 % Change - ----------------------------- ------ ------ -------- ------ ------ -------- Net income $ 23.8 $ 21.7 10 % $ 55.4 $ 59.9 (8) % Earnings per share $ 0.19 $ 0.18 $ 0.44 $ 0.49
Net income increased 10% in the second quarter of 1997 over the same period last year due primarily to a decrease in the Company's income tax provision partly offset by lower contract and other revenues. For the first half of 1997, net income decreased by 8% compared to prior year due to lower contract and other revenues and higher MG&A and R&D expenses, partially offset by increased royalty revenues and lower income tax expense. LIQUIDITY AND CAPITAL RESOURCES June 30, 1997 December 31, 1996 - ----------------------------- -------------------- ------------------- Cash and cash equivalents, $ 1,156.9 $ 1,159.1 short-term investments and long-term marketable securities Working capital 792.1 705.1 Page 14 Cash generated from operations, maturing investments and stock issuances were used to make investments in marketable securities and capital additions. Cash and cash equivalents at June 30, 1997, were comparable to December 31, 1996 and working capital increased by $87.0 million in the first half of 1997. Capital expenditures totaled $76.5 million in the first half of 1997 compared to $58.2 million in the same period of 1996. The increase was related to improvements to existing manufacturing and office facilities in the first half of 1997. FORWARD-LOOKING STATEMENTS The following section contains forward-looking statements that are based on the Company's current expectations. Because the Company's actual results may differ materially from these and any other forward-looking statements made by or on behalf of the Company, this section also includes a discussion of important factors that could affect the Company's actual future results, including its product sales, royalties, contract revenues, expenses and net income. Total Product Sales: Product sales will be dependent on the overall competitive environment. Factors affecting the Company's total product sales include, but are not limited to, the amount of sales to customers in the U.S., increased competition in the growth hormone and thrombolytic markets, the amount and timing of the Company's sales to HLR, the timing and volume of bulk shipments to licensees, the possibility of the introduction of rituximab in late 1997 and the potential introduction of additional new products and indications for existing products in 1998 and beyond. On July 25, 1997, the U.S. Food and Drug Administration (FDA) advisory panel unanimously recommended the agency grant marketing clearance to rituximab for the treatment of patients suffering from relapsed or refractory low-grade non- Hodgkin's lymphoma. If rituximab receives FDA approval, it will be the first monoclonal antibody sold for treating cancer. A final FDA decision is expected later this year. Activase Sales: The Company faces new competition in the thrombolytic market. BM received FDA approval in October 1996 to market its product, Retavase, for the treatment of acute myocardial infarction (AMI) in the U.S. and Activase is losing market share to this product. The Company has brought suit against BM for patent infringement. In addition, there is an increasing use of angioplasty for the treatment of AMI patients in lieu of thrombolytic therapy. The Company expects such competition to continue to have an adverse effect on its sales of Activase and such effect could be material. Other factors affecting the Company's Activase sales include, but are not limited to, the timing of FDA approval, if any, of additional competitive products, pricing decisions made by the Company, the outcome of litigation against BM involving the Company's patents for t-PA and processes related to its production and formulation, ongoing physician response to the outcome of the GUSTO III clinical trial, the increasing use of other therapies such as angioplasty techniques for the treatment of AMI, and the rate of adoption and use of Activase for the treatment of acute ischemic stroke. Growth Hormone Sales: The Company continues to face increased competition in the growth hormone market. Three companies received FDA approval in 1995, and a fourth company received FDA approval in October 1996, to market their growth hormone products for treatment of growth hormone inadequacy in children, although one of those companies has been preliminarily enjoined from selling its product. In the first quarter of 1997, two of those companies began selling their growth hormone products. Page 15 Two of the Company's competitors have received approval to market their existing human growth hormone products for additional indications. The Company expects such competition to have an adverse effect on its sales of Protropin, Nutropin and Nutropin AQ which, depending on the extent and type of competition, could be material. Other factors affecting the Company's growth hormone sales include, but are not limited to, the timing of FDA approval, if any, of other new competitive products, the outcome of litigation involving the Company's patents for human growth hormone and related processes, pricing decisions made by the Company, the availability of third-party reimbursement for the cost of growth hormone therapy, and the impact of sales of Nutropin as a treatment for short stature associated with Turner syndrome, and the timing and likelihood of FDA approval of Nutropin for the treatment of growth hormone inadequacy in adults. Pulmozyme Sales: Factors that may influence the future sales of Pulmozyme include, but are not limited to, physician perception of the number and kinds of patients who will benefit from such therapy, the availability of third- party reimbursement for the costs of therapy, the timing of the development of alternative therapies for the treatment and care of CF, the outcome of the Phase III clinical trial in patients with early CF, whether and when additional indications are approved, and the cost of therapy. Royalty and Contract Revenues: Royalty and contract revenues in future periods could vary significantly from 1996 levels. Major factors affecting these revenues include, but are not limited to: HLR's decisions to exercise or not to exercise its option to develop and sell the Company's future products in non-U.S. markets and the timing and amount of related development cost reimbursement, if any; variations in HLR's sales of Genentech products, and other licensees' sales of licensed products; the expiration of royalties from Eli Lilly and Company in 1998; fluctuations in foreign currency exchange rates; the timing of non-U.S. approvals, if any, for products licensed to HLR; whether and when contract benchmarks are achieved; the initiation of other new contractual arrangements; and the conclusion of existing arrangements with other companies and HLR. R&D Expenses: The Company intends to continue its commitment to aggressive investment in R&D. As it continues late-stage clinical testing of products, the Company anticipates that its R&D expenses will continue at a high percentage of revenues over the short-term. Over the long-term, however, as revenues increase, R&D as a percent of revenues should decrease. Factors affecting the Company's R&D expenses include, but are not limited to: the outcome of clinical trials currently being conducted; the number of products entering into development from late-stage research; future levels of the Company's product sales (including the impact of competition), royalty and contract revenues; the possibility of competition with respect to products or technologies under development; and decisions by HLR to exercise or not to exercise its option to develop and sell potential products of the Company in non-U.S. markets and the timing of such decisions. As part of the Company and HLR's agreed upon changes to their license agreement, HLR will assume development of the oral IIbIIIa antagonist on its own. As a result, the Company will not be incurring future IIbIIIa related R&D costs unless it decides to opt-in on the development of this product. Such costs were approximately $4.5 million in the first half of 1997. Income Tax Provision: The Company expects its effective tax rate to be between 25% and 35% in 1997 and for the next several years, dependent upon several factors. These factors include, but are not limited to, changes in tax laws and rates, future levels of R&D spending, the outcome of clinical trials of certain development products, the Company's success in Page 16 commercializing such products, and potential competition regarding the products. Successful Development of Products: The Company intends to continue to develop new products. Successful pharmaceutical product development is highly uncertain and is dependent on numerous factors, many of which are beyond the Company's control. Products that appear promising in the early phases of development may fail to reach the market for numerous reasons: they may be found to be ineffective or to have harmful side effects in preclinical or clinical testing; may fail to receive necessary regulatory approvals; may turn out to be uneconomical because of manufacturing costs or other factors; or may be precluded from commercialization by the proprietary rights of others or by competing products or technologies for the same indication. 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 which 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. Uncertainties Surrounding Proprietary Rights: The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions. Accordingly, the breadth of claims allowed in such companies' patents cannot be predicted. Patent disputes are frequent and can preclude commercialization of products. The Company has in the past, is currently and may in the future be involved in material patent litigation. Such litigation is costly in its own right and could subject the Company to significant liabilities to third-parties and, if decided adversely, the Company may need to obtain third-party licenses or cease using the technology or product in dispute. The presence of patents or other proprietary rights belonging to other parties may lead to the termination of R&D of a particular product. The Company believes it has strong patent protection or the potential for strong patent protection for a number of its products that generate sales and royalty revenue or that the Company is developing; however, the courts will determine the ultimate strength of patent protection of the Company's products and those on which the Company earns royalties. Liquidity: The Company believes that its cash, cash equivalents, and short- term investments, together with funds provided by operations and leasing arrangements, will be sufficient to meet its foreseeable operating cash requirements. In addition, the Company believes it could access additional funds from the capital markets. Factors affecting the Company's cash position include, but are not limited to, future levels of the Company's product sales, royalty and contract revenues, expenses and capital expenditures. Market Potential/Risk: Over the longer term, the Company's (and its partners') ability to successfully market current products, expand their usage, and bring new products to the marketplace will depend on many factors, including, but not limited to, the effectiveness and safety of the products, FDA and foreign regulatory agencies' approvals for new products and new indications, and the degree of patent protection afforded to particular products. Roche Holdings, Inc.: The Company expects to continue to have material transactions with Roche, including royalty and contract development revenues, product sales and joint product development. Foreign Exchange: The Company receives royalty revenues from countries throughout the world. As a result, the Company's financial results could be materially affected by factors such as changes in foreign currency exchange Page 17 rates or weak economic conditions in the foreign markets in which the Company's products are sold. The Company is exposed to changes in exchange rates in Europe, Asia and Canada. When the U.S. dollar strengthens against the currencies in these countries, the U.S. dollar value of non-U.S. dollar- based revenue decreases; when the U.S. dollar weakens, the U.S. dollar value of the non-U.S. dollar-based revenues increases. Accordingly, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may adversely affect the Company's royalty revenues as expressed in U.S. dollars. To mitigate this risk, the Company hedges certain of these anticipated revenues by purchasing foreign currency put option contracts with expiration dates and amounts of currency that are based on a portion of probable revenues so the adverse impact of movements in currency exchange rates on the non- dollar denominated revenues will be at least partly offset by an associated increase in the value of the option. The Company also enters into foreign currency forward contracts to lock in the dollar value of a portion of these anticipated revenues. Interest Rates: The Company's interest income is sensitive to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company's cash equivalents, short-term investments and long-term investments. To mitigate the short-term impact of fluctuations in U.S. interest rates, the Company invests in securities with durations ranging from overnight to ten years. The purchase of a combination of both long- and short-term securities minimizes the quarterly fluctuation in the average yield of the portfolio by locking in some rates for longer periods of time than can be accomplished with only short-term investments. Equity Securities: As part of its strategic alliance efforts, the Company invests in equity instruments that are subject to fluctuations from market value changes in stock prices. To mitigate this risk, certain equity securities are hedged with costless collars. A costless collar is a purchased put option and a written call option in which the cost of the purchased put and the proceeds of the written call offset each other; therefore, there is no initial cost or cash outflow for these instruments at the time of purchase. The purchased put protects the Company from a decline in the market value of the security below a certain minimum level (the put "strike" level); while the call effectively limits the Company's potential to benefit from an increase in the market value of the security above a certain maximum level (the call "strike" level). Credit Risk of Counterparties: The Company could be exposed to losses related to the above financial instruments should one of its counterparties default. This risk is mitigated through credit quality standards and credit monitoring procedures. Legal Proceedings: The Company is a party to various legal proceedings including patent infringement cases and various cases involving product liability and other matters. Page 18 INDEPENDENT ACCOUNTANTS' REVIEW REPORT The Board of Directors and Stockholders Genentech, Inc. We have reviewed the accompanying condensed consolidated balance sheet of Genentech, Inc. as of June 30, 1997, and the related condensed consolidated statements of income for the three-month and six-month periods ended June 30, 1997 and 1996, and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 1997 and 1996. These financial statements are the responsibility of the Company's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Genentech, Inc. as of December 31, 1996, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended (not presented herein) and in our report dated January 17, 1997, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1996, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. ERNST & YOUNG LLP San Jose, California July 10, 1997 Page 19 GENENTECH, INC. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On July 10, 1997, the Regents of the University of California (UC) filed suit against Genentech, Inc. (the Company) in the United States District Court for the Northern District of California alleging that patent No. 4,353,877 (the Goodman Patent) is infringed by the Company's manufacture, use and sale of its Nutropin, registered trademark, human growth hormone products. This suit is similar to previous pending suits filed by UC alleging infringement of the Goodman Patent by the Company's Protropin, registered trademark, human growth products. See also the Legal Proceedings and Subsequent Event notes in the Notes to Condensed Consolidated Financial Statements of Part I. See also Item 1 of the Company's report on Form 10-Q for the period ended March 31, 1997. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 15.1 Letter re: Unaudited Interim Financial Information 27.1 Financial Data Schedule *99.1 Incentive Units Plan *Indicates management contract or compensatory plan or arrangement of the Company. (b) Reports on Form 8-K There were no reports on Form 8-K filed during the quarter ended June 30, 1997. Page 20 GENENTECH, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 12, 1997 GENENTECH, INC. /S/ARTHUR D. LEVINSON /S/LOUIS J. LAVIGNE, JR. ------------------------------------- ---------------------------- Arthur D. Levinson, Ph.D. Louis J. Lavigne, Jr. President and Chief Executive Officer Executive Vice President and Chief Financial Officer /S/BRADFORD S. GOODWIN ---------------------------- Bradford S. Goodwin Vice President, Finance and Controller Page 21 EX-27 2
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 1997, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND THE NOTES THERETO. 6-MOS DEC-31-1997 JUN-30-1997 207,731 949,158 209,622 0 99,667 1,041,072 981,366 347,424 2,331,282 248,952 150,000 0 0 2,463 1,904,347 2,331,282 299,231 490,778 53,252 53,252 233,633 0 1,904 76,935 21,542 55,393 0 0 0 55,393 .44 0 ACCOUNTS RECEIVABLE ARE PRESENTED NET OF ALLOWANCE FOR DOUBTFUL ACCOUNTS IN THE CONDENSED CONSOLIDATED BALANCE SHEET. THE PROVISION FOR LOSSES ON DOUBTFUL ACCOUNTS IS NOT REPORTED AS A SEPARATE LINE IN THE CONDENSED CONSOLIDATED STATEMENT OF INCOME OR STATEMENT OF CASH FLOWS.
EX-15.1 3 Exhibit 15.1 August 12, 1997 The Board of Directors and Stockholders Genentech, Inc. We are aware of the incorporation by reference in the Registration Statements pertaining to the 1991 Employee Stock Plan, the 1996 Stock Option/Stock Incentive Plan, the 1994 Stock Option Plan, the 1990 Stock Option/Stock Incentive Plan, the 1984 Incentive Stock Option Plan and the 1984 Non-Qualified Stock Option Plan, the shares issuable to certain convertible subordinated debenture holders, the Genentech, Inc. Tax Reduction Investment Plan and in the related prospectuses, as applicable, contained in such Registration Statements of our report dated July 10, 1997 relating to the unaudited condensed consolidated interim financial statements of Genentech, Inc. which are included in its Form 10-Q for the quarter ended June 30, 1997. Pursuant to Rule 436(c) of the Securities Act of 1933 our report is not a part of the registration statement prepared or certified by accountants within the meaning of Section 7 or 11 of the Securities Act of 1933. Very truly yours, ERNST & YOUNG LLP EX-99 4 GENENTECH, INC. EPR INCENTIVE UNITS PROGRAM 1. Purpose. The purpose of the Genentech EPR Incentive Units Program (the "Program") is to provide eligible employees of Genentech, Inc. (the "Company") with a cash-based supplement to the long-term incentive and retention value of Company stock options. Under the Program, each eligible employee shall receive a number of Units, as defined below, which will be assigned potential value if the Company achieves key performance benchmarks during the term of the Program. Participating employees are entitled to earn the potential Unit value only in the event of a Shareholder Put, as defined below, during the period after the Shareholder Put occurs based on continuous employment with the Company through certain defined cash payment dates, subject to certain employment termination events provided herein. 2. Definitions. As used herein, the following definitions shall apply: (a) "Benchmark Value" means the total dollar value per Unit attributable to attainment of Success Benchmarks as determined in accordance with Section 5. (b) "Board" means the Board of Directors of the Company. (c) "Committee" means the Compensation Committee of the Board. (d) "Company" means Genentech, Inc., a Delaware corporation. (e) "Continuous Employment" means the Employee's continuous and uninterrupted employment with the Company except for approved absences and other interruptions approved by the Executive Committee or pursuant to a formal written Company policy. (f) "Defined Period Employees" means Employees who are hired by the Company to work for a specified period of time and/or on a specified project, including post-doctoral hires, visiting scientists, and such other Employees as determined by the Committee, in its discretion. (g) "Disability" means total and permanent disability as defined in Section 22(e)(3) of the Internal Revenue Code of 1986, as amended, or any successor provision. (h) "Early Retirement Date" means the date of which an Employee attains both (i) age 55 and (ii) ten (10) Years of Service. (i) "Earnings per Share" or "EPS" means, as to any fiscal year of the Company during the Program Term, the Company's net income per share as publicly reported by the Company to its stockholders for such fiscal year, provided that the Committee may, in its sole discretion, determine whether any significant item(s) shall be included or excluded from the calculation of Earnings per Share for purposes of the Program. (j) "Employee" means a natural person who is employed by the Company and who is treated as an employee by the Company for tax purposes. (k) "Ending Stock Value" means a value calculated as the average of the closing sales prices of the Company's Callable Putable Common Stock for each day during the period beginning July 1, 1999 and ending at the close of business on the thirtieth (30th) business day thereafter, on which national stock exchanges and the Nasdaq System are open for trading, as reported in The Wall Street Journal or such other source as the Committee deems reliable. Page 1 (l) "Executive Committee" means the committee comprised mainly of the Chief Executive Officer's direct reports, which sets the Company's operating objectives, approves major operating recommendations and interfaces with the Board. (m) "Job Elimination" means elimination of an Employee's job or function as part of an organizational restructuring or broad-based layoff or in connection with the elimination of all or a significant portion of a particular corporate group or function. (n) "Normal Retirement Age" means an Employee's 65th birthday. (o) "Participant" means an Employee who receives an award of Units pursuant to the Plan. (p) "Product Approval" means the U.S. Food and Drug Administration grants a marketing license for a product identified by the Committee for purposes of the Program. (q) "Program" means this EPR Incentive Units Program. (r) "Program Term" means the period from January 1, 1997 through December 31, 2000. (s) "Research Prospects" means research-stage products chosen for development that are identified by the chief executive officer of the Company in collaboration with the Executive Committee as Research Prospects for purposes of the Program based upon their potential commercial success as determined by the chief executive officer and the Executive Committee with reference to internal Company projections. (t) "Retirement" means the Employee's voluntary resignation from his or her employment with the Company upon or after attaining his or her Normal Retirement Age or Early Retirement Date. (u) "Shareholder Put" means the exercise of the put right by the Company's stockholders as described in Section 1.01(b) of the Amended and Restated Governance Agreement between the Company and Roche Holdings, Inc. ("Roche") and a tender of sufficient shares of the Company's Callable Putable Common Stock to the Company such that Roche owns at least eighty-five percent (85%) of the total outstanding shares of the Company's Callable Putable Common Stock and the Company's Common Stock, when considered in the aggregate. (v) "Stock Appreciation" means the per share increase, if any, in the value of the Company's Callable Putable Common Stock over the Program Term, calculated as the excess of the Ending Stock Value over $53.53 (the average per share stock price during the 4th quarter, 1996). (w) "Success Benchmarks" means Company performance milestones based on (i) Earnings per Share targets, (ii) Product Approvals, (iii) Research Prospects, or (iv) such other performance milestones as the Committee may establish. (x) "Units" means the incentive Units awarded by the Committee under this Program. (y) "Unit Value" means the dollar value of a Unit calculated as the excess of the Benchmark Value over the Stock Appreciation. Page 2 3. Administration of the Program. (a) Administration. The Program shall be administered by the Committee. (b) Powers of the Committee. Subject to the provisions of the Program and to the specific duties, if any, delegated by the Board to the Committee, the Committee shall have the authority, at its discretion: (i) to select the Employees to whom Units may be granted hereunder and the number of Units to be covered by each such award; (ii) to identify Success Benchmarks under the Program and the values associated therewith; (iii) to determine the terms and conditions of Units awarded under the Program to the extent consistent with the terms of the Program including, but not limited to, Benchmark Value, Earnings per Share, Ending Stock Value, Product Approval and Research Prospects; (iv) to construe and interpret the terms of the Program and Units granted pursuant to the Program; and (v) to make all other determinations deemed necessary or advisable for administering the Program. (c) Effect of Committee's Decisions. The Committee's decisions, determinations and interpretations shall be final and binding on all Participants. 4. Award of Units. (a) Eligibility. All Employees other than Defined Period Employees are eligible to receive Units under the Program. (b) Number of Units - General Rule. Unless determined otherwise by the Executive Committee, each Employee shall be awarded a number of Units similar to the aggregate number of shares of the Company's Callable Putable Common Stock covered by stock options granted to the Employee under the Company's stock option plans in 1995 and 1996. Each Employee who is hired after December 31, 1996 shall be awarded a number of Units similar to the number of shares of the Company's Callable Putable Common Stock covered by stock options granted to the Employee under the Company's stock option plans upon becoming an Employee. (c) Number of Units - Special Rules. Unless determined otherwise by the Committee, each eligible Employee who did not receive stock options under the Company's stock option plans in 1995 or 1996 or otherwise does not receive stock options during the Program Term shall be awarded 100 Units. If an Employee first becomes an eligible Employee after June 30, 1997, the number of Units shall be equal to the product of (i) the number of stock options granted upon hire or 100, if no stock options were granted upon hire, multiplied by (ii) a fraction, the numerator of which is the number of whole calendar months between the date the Employee first becomes an eligible Employee and January 1, 2001, and the denominator of which is 48. Notwithstanding the foregoing, the Committee may, in its discretion, award Units from time to time during the Program Term and may award Units other than as provided in Sections 4(b) and 4(c). The Committee may also make more than one award of Units to each eligible Employee. Page 3 (d) Notice of Award. Participants who receive an award of Units shall be given written notice thereof by the Committee stating the number of Units awarded and the conditions (if any) to which the Units are subject. This notice, when duly acknowledged and accepted either electronically or in writing by the Participant, shall become a Unit agreement between the Company and the Participant. 5. Benchmark Value. Benchmark Value shall be determined by the Committee based upon the values assigned by the Committee to the achievement of Success Benchmarks for the Program Term. Except as otherwise specified by the Committee, the Success Benchmarks and their associated values shall be as set forth in Exhibit A hereto. 6. Payment. (a) General Rule. Payment of the Unit Value shall only occur in the event of a Stockholder Put. If a Stockholder Put occurs, each Participant shall, subject to Section 7, be entitled to receive a cash payment as to the value of his or her Units as provided herein. A Participant who becomes entitled to a payment with respect to Units hereunder shall receive a cash payment from the Company in an amount determined by multiplying the number of Units with respect to which the payment is to be made by the Unit Value, valued as of December 31, 2000, less applicable withholding, provided the Participant remains in the Continuous Employment of the Company through such date. Subject to Section 6(b) (Early Distribution) and to Section 7 (Termination Events), any payment to be made hereunder shall be made within thirty (30) days after the Company's earnings are released publicly for the year ended December 31, 2000. Notwithstanding the foregoing, the Committee may, in its discretion, unilaterally establish that the payment to be made with respect to Units awarded to one or more Participants who are also Executive Committee members shall be determined by multiplying the Unit Value by 1.25, with payment of such amount to be made as soon as the Company's earnings are released publicly for the year ended December 31, 2000, subject to the Participant's Continuous Employment by the Company through December 31, 2000. (b) Early Distribution. A Participant may elect (an "Early Distribution Election") to receive payment as to 50% of the value of his or her Units, valued as of December 31, 1999, less applicable withholding, provided the Participant remains in the Continuous Employment of the Company through such date. A Participant who wishes to make an Early Distribution Election may do so by giving written notice to the Company on a form provided by the Committee before December 1, 1999. A Participant who makes an Early Distribution Election will receive payment as to 50% of the value of his or her Units within thirty (30) days after the Company's earnings are released publicly for the year ended December 31, 1999, and as to the remaining value of his or her Units in accordance with Sections 6(a) and 7. 7. Termination Events. (a) General Rule. A Participant whose Continuous Employment with the Company terminates for any reason prior to the Shareholder Put shall forfeit his or her Units upon such termination and shall not be entitled to receive any payment with respect thereto. Except as provided herein, a Participant whose Continuous Employment with the Company terminates for any reason on or before December 31, 2000, but after the Shareholder Put, shall forfeit his or her Units and shall not be entitled to receive any payment with respect thereto; provided, however, that a Participant who makes an Early Distribution Election pursuant to Section 6(b) and whose Continuous Employment terminates after December 31, 1999 but prior to receiving payment for his or her Units shall not forfeit the payment as to 50% of the value of his or her Units on December 31, 1999, but shall forfeit the remaining value of his or her Units. Page 4 (b) Termination After 1999. A Participant who did not make an Early Distribution Election pursuant to Section 6(b) and whose Continuous Employment with the Company terminates after December 31, 1999 because of Job Elimination, death, Retirement, or Disability shall be entitled to a payment with respect to his or her Units as follows: (i) if such termination occurs on or after January 1, 2000 but before December 31, 2000, the Participant shall be entitled to payment as to 50% of the value of his or her Units, valued as of December 31, 1999, payment to be made within fifteen (15) days of such termination; and (ii) if such termination occurs on or after December 31, 2000, the Participant shall be entitled to payment as provided in Section 6(a). 8. Nontransferability. Units awarded to Participants pursuant to the Program may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner. 9. Limitations. Neither the Program nor any award of Units shall confer upon a Participant any right with respect to continuing the Participant's employment relationship with the Company, nor shall it interfere in any way with the Participant's right or the Company's right to terminate such employment at any time, with or without cause. 10. Amendment and Termination. The Board shall have the power to amend, suspend or terminate the Program at any time, including as to Units previously awarded under the Program, provided that on or after the occurrence of the Shareholder Put, if any, no such amendment, suspension or termination shall adversely affect Units previously awarded to and held by a Participant without the Participant's written consent. Notwithstanding the preceding sentence, the Committee may, at the request of the Company's Chief Executive Officer, change the Unit Value with respect to Units awarded to a Participant who is a member of the Company's Executive Committee by applying a multiplier of 1.25 to his or her December 31, 2000 Unit Value, subject to the Participant's Continuous Employment with the Company through such date and to such other terms and conditions, consistent with the Program, as the Committee may specify. 11. Governing Law. The Program shall be governed by the internal substantive laws, and not the choice of law rules, of the State of California. Page 5
EXHIBIT A Success Approach 1997 1998 1999 2000 Benchmark Earnings Per $1.50 is credited EPS EPS EPS EPS Share (EPS) if EPS Trigger for Trigger= Trigger= Trigger= Trigger= each year is achieved. $1.00 $1.25 $1.45 $1.70 An additional $0.50 is credited for each 10% increment in EPS beyond the EPS Trigger. Product Product approvals are (1) C2B8 (3)Activase (4)Anti-IgE (9)IGF-1(I) Approvals* assigned a value by Antibody= =$0.50 Antibody= =$0.50 the Compensation $0.75 $0.75 (10)IGF-1(II) Committee based on (2)Nutropin= (5)TNK=$0.75 =$0.50 projected value to $0.25 (6)NGF=$0.50 (11)Oral Genentech. Value is (7)TPO= $0.50 IGF-1=$0.25 credited upon receipt (8)Anti-Her2 (12)Sustained of FDA approval. Antibody= Release Product approval values $0.25 Growth Hormone will be doubled in any =$0.25 year in which EPS Trigger is met. Research Research prospects $0.50 $0.50 $0.50 $0.50 Prospects where commercial value each each each each (the projected net present value at the time of product launch) times success probability probablity exceeds $100 Million. NOTES: *Early product approvals receive full value (and that value will be doubled in any year the EPS Trigger is met). However, if a product approval is received after the target year, no value will be credited. EXPECTED INDICATIONS FOR PRODUCT APPROVALS: (1) Non-Hodgkins B-cell lymphoma (2) Growth hormone inadequacy in adults (3) Acute ischemic stroke with 3-5 hours of symptom onset (4) Asthma (5) Acute myocardial infarction (6) Diabetic neuropathy (7) Blood stem cell transplant or cancer chemotherapy (8) Breast cancer (9) Type I diabetes (10) Type II diabetes (11) Oral formulation of IGF-1 - Type I and II diabetes (12) Alkermes ProLease sustained release formulation - growth hormone inadequacy in children
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