UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
____________________
FORM
10-K
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(Mark
One)
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þ
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
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For
the fiscal year ended December 31, 2006
or
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o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
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For
the transition period from to
Commission
file number: 1-9813
GENENTECH,
INC.
(Exact
name of registrant as specified in its charter)
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A
Delaware Corporation
(State
or other jurisdiction of incorporation or organization)
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94-2347624
(I.R.S.
Employer Identification No.)
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1
DNA Way, South San Francisco, California
(Address
of principal executive offices)
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94080
(Zip
Code)
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(650) 225-1000
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
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Title
of Each Class
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Name
of Each Exchange on Which Registered
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Common
Stock, $0.02 par value
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New
York Stock Exchange
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Securities
registered pursuant to Section 12(g) of the Act:
None
(Title
of class)
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes þ No o
Indicate
by check mark if the registrant is not required to file reports pursuant
to
Section 13 or Section 15(d) of the
Act. Yes o No þ
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past
90 days. Yes þ No o
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. þ
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
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Large
accelerated filer þ
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Accelerated
filer o
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Non-accelerated
filer o
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of Act). Yes o No þ
The
aggregate market value of Common Stock held by non-affiliates as of June
30,
2006 was $38,078,024,827.(A)
All executive officers and directors of the registrant and Roche Holdings,
Inc.
have been deemed, solely for the purpose of the foregoing calculation, to
be
“affiliates” of the registrant.
Number
of shares of Common Stock outstanding as of February 9,
2007: 1,053,185,944
Documents
incorporated by reference:
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Portions
of the Definitive Proxy Statement with respect to the 2006 Annual
Meeting of Stockholders to be filed by Genentech, Inc. with the
Securities
and Exchange Commission (hereinafter referred to as “Proxy
Statement”)
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Part III
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________________________
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(A)
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Excludes
587,254,604 shares of Common Stock held by directors and executive
officers of Genentech and Roche Holdings,
Inc.
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GENENTECH,
INC.
2006
Form 10-K Annual Report
Table
of Contents
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Page
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Item 1
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1
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Item 1A
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11
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Item 1B
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23
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Item 2
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23
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Item 3
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24
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Item 4
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26
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27
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Item 5
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29
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Item 6
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31
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Item 7
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32
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Item 7A
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61
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Item 8
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64
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Item 9
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103
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Item 9A
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103
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Item 9B
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106
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Item 10
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107
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Item 11
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107
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Item 12
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107
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Item 13
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107
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Item 14
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107
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Item 15
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108
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113
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In
this report, “Genentech,” “we,” “us” and “our” refer to Genentech, Inc. “Common
Stock” refers to Genentech’s Common Stock, par value $0.02 per share, “Special
Common Stock” refers to Genentech’s callable putable common stock, par value
$0.02 per share, all of which was redeemed by Roche Holdings, Inc. (or “Roche”)
on June 30, 1999.
We
own or have rights to various copyrights, trademarks and trade names used
in our
business including the following: Activase® (alteplase, recombinant)
tissue-plasminogen activator; Avastin® (bevacizumab) anti-VEGF antibody;
Cathflo® Activase® (alteplase for catheter clearance); Herceptin® (trastuzumab)
anti-HER2 antibody; Lucentis® (ranibizumab, rhuFab V2) anti-VEGF antibody
fragment; Nutropin® (somatropin (rDNA origin) for injection) growth hormone;
Nutropin AQ® and Nutropin AQ Pen® (somatropin (rDNA origin) for injection)
liquid formulation growth hormone; Nutropin Depot® (somatropin (rDNA origin) for
injectable suspension) encapsulated sustained-release growth hormone; Omnitarg™
(pertuzumab) HER dimerization inhibitor; Pulmozyme® (dornase alfa, recombinant)
inhalation solution; Raptiva® (efalizumab) anti-CD11a antibody; and TNKase®
(tenecteplase) single-bolus thrombolytic agent. Rituxan® (rituximab) anti-CD20
antibody is a registered trademark of Biogen Idec Inc.; Tarceva® (erlotinib) is
a trademark of OSI Pharmaceuticals, Inc.; and Xolair® (omalizumab) anti-IgE
antibody is a trademark of Novartis AG. This report also includes other
trademarks, service marks and trade names of other companies.
i
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Item
1.
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Overview
Genentech
is a leading biotechnology company that discovers, develops, manufactures,
and
commercializes biotherapeutics for significant unmet medical needs. A number
of
the currently approved biotechnology products originated from or are based
on
Genentech science. Genentech manufactures and commercializes multiple
biotechnology products, and receives royalties from companies that are licensed
to market products based on our technology. See “Marketed Products” and
“Licensed Products” below. Genentech was organized in 1976 as a California
corporation and was reincorporated in Delaware in 1987.
Marketed
Products
We
commercialize in the United States (or “U.S.”) the biotechnology products listed
below:
Avastin
(bevacizumab) is an anti-VEGF humanized antibody approved for use in combination
with intravenous 5-fluorouracil based chemotherapy as a treatment for patients
with first- or second-line metastatic cancer of the colon or rectum. It is
also
approved for use
in combination with carboplatin and paclitaxel chemotherapy for the first-line
treatment of unresectable, locally advanced, recurrent or metastatic
non-squamous non-small cell lung cancer.
Rituxan
(rituximab)
is an anti-CD20 antibody which we commercialize with Biogen Idec Inc. It
is
approved for:
|
·
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The
treatment of patients with relapsed or refractory, low-grade or
follicular, CD20-positive, B-cell non-Hodgkin’s lymphoma, including
retreatment and bulky disease;
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·
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The
first-line treatment of patients with diffuse large B-cell, CD20-positive,
non-Hodgkin’s lymphoma in combination with CHOP (cyclophosphamide,
doxorubicin, vincristine and prednisone) or other anthracycline-based
chemotherapy;
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·
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The
first-line treatment of previously untreated patients with follicular,
CD20-positive, B-cell non-Hodgkin’s lymphoma in combination with CVP
(cyclophosphamide, vincristine and prednisone) chemotherapy
regimens;
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·
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The
treatment of patients with low-grade, CD20-positive, B-cell non-Hodgkin’s
lymphoma in patients with stable disease or who achieve a partial
or
complete response following first-line treatment with CVP chemotherapy;
and
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|
·
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Use
in combination with methotrexate for reducing signs and symptoms
in adult
patients with moderately-to-severely active rheumatoid arthritis
(or “RA”)
who have had an inadequate response to one or more tumor necrosis
factor
antagonist therapies.
|
Herceptin
(trastuzumab)
is a humanized anti-HER2 antibody approved for use as an adjuvant treatment
of
node-positive breast cancer as part of a treatment regimen containing
doxorubicin, cyclophosphamide, and paclitaxel for patients who have tumors
that
overexpress the human
epidermal growth factor receptor 2 (or “HER2”)
protein. It is approved for use as a first-line therapy in combination with
paclitaxel and as a single agent in second- and third-line therapy for patients
with HER2-positive metastatic breast cancer.
Lucentis
(ranibizumab) is an anti-VEGF
antibody fragment approved
for the treatment of neovascular (wet) age-related macular
degeneration.
1
Xolair
(omalizumab) is a humanized anti-IgE antibody, which we commercialize with
Novartis Pharma AG (or “Novartis”). Xolair is approved for adults and
adolescents (12 years of age and above) with moderate to severe persistent
asthma who have a positive skin test or in vitro reactivity to a perennial
aeroallergen and whose symptoms are inadequately controlled with inhaled
corticosteroids.
Tarceva
(erlotinib),
which we commercialize with OSI Pharmaceuticals, Inc., is a small-molecule
tyrosine kinase inhibitor of the HER1/epidermal growth factor receptor (or
“EGFR”) signaling pathway. Tarceva is approved for the treatment of patients
with locally advanced or metastatic non-small
cell lung cancer (or “NSCLC”)
after failure of at least one prior chemotherapy regimen. It is also approved,
in combination with gemcitabine chemotherapy, for the first-line treatment
of
patients with locally advanced, unresectable or metastatic pancreatic cancer.
Nutropin
(somatropin
[rDNA origin] for injection) and Nutropin
AQ are
growth hormone products approved for the treatment of growth hormone deficiency
in children and adults, growth failure associated with chronic renal
insufficiency prior to kidney transplantation, short stature associated with
Turner syndrome and long-term treatment of idiopathic short
stature.
Activase
(alteplase,
recombinant) is a tissue plasminogen activator (or “t-PA”) approved for the
treatment of acute myocardial infarction (heart attack), acute ischemic stroke
(blood clots in the brain) within three hours of the onset of symptoms and
acute
massive pulmonary embolism (blood clots in the lungs).
TNKase
(tenecteplase)
is a modified form of t-PA approved for the treatment of acute myocardial
infarction (heart attack).
Cathflo
Activase (alteplase,
recombinant) is a t-PA approved in adult and pediatric patients for the
restoration of function to central venous access devices that have become
occluded due to a blood clot.
Pulmozyme
(dornase
alfa, recombinant) is an inhalation solution of deoxyribonuclease (rhDNase)
I,
approved for the treatment of cystic fibrosis.
Raptiva
(efalizumab) is a humanized anti-CD11a antibody approved for the treatment
of
chronic moderate-to-severe plaque psoriasis in adults age 18 or older who
are
candidates for systemic therapy or phototherapy.
See
“Total Product Sales” under Results of Operations in Part II, Item 7 of this
Form 10-K for a discussion of the sales of each of our products in the last
three years, including those that accounted for 10% or more of our consolidated
revenues.
2
Licensed
Products
Royalty
Revenue
We
receive royalty revenue under license agreements with companies that sell
and/or
manufacture products based on technology developed by us or intellectual
property to which we have rights. These licensed products are sometimes sold
under different trademarks or trade names. Significant licensed products,
including all related party licenses, representing approximately 92% of our
royalty revenues in 2006, are presented in the following table:
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Product
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Trade
Name
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Licensee
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Licensed
Territory
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Trastuzumab
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Herceptin
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F.
Hoffmann-La Roche
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Worldwide
excluding U.S.
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Rituximab
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Rituxan/MabThera®
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F.
Hoffmann-La Roche
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Worldwide
excluding U.S. and Japan
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Bevacizumab
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Avastin
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F.
Hoffmann-La Roche
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Worldwide
excluding U.S.
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Dornase
alfa, recombinant
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Pulmozyme
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F.
Hoffmann-La Roche
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Worldwide
excluding U.S.
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Alteplase
and Tenecteplase
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Activase
and TNKase
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F.
Hoffmann-La Roche
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Canada
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Somatropin
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Nutropin
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F.
Hoffmann-La Roche
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Canada
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Etanercept
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ENBREL®
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Immunex
Corporation (whose rights were acquired by Amgen Inc.)
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Worldwide
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D2E7/adalimumab
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Humira®
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Abbott
Laboratories
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Worldwide
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Infliximab
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Remicade®
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Celltech
Pharmaceuticals plc (which transferred rights to Centocor, Inc.
/ Johnson
& Johnson)
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Worldwide
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Cetuximab
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ERBITUX®
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ImClone
Systems, Inc.
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Worldwide
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Antihemophilic
factor, recombinant
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Kogenate®/Helixate®
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Bayer
Corporation
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Worldwide
|
See
Item 3, “Legal Proceedings” below for information regarding certain patent
litigation matters.
Other
Revenues
We
have granted a license to Zenyaku Kogyo Co., Ltd. (or “Zenyaku”), a Japanese
pharmaceutical company, for the manufacture, use and sale of rituximab in
Japan.
Zenyaku co-promotes rituximab in Japan with Chugai Pharmaceutical Co., Ltd.,
a
Japanese subsidiary of F. Hoffmann-La Roche, under the trademark Rituxan.
The
revenue earned from our sales of rituximab to Zenyaku is included in product
sales.
3
Products
in Development
Our
product development efforts, including those of our collaborators, cover
a wide
range of medical conditions, including cancer and immune diseases. Below
is a
summary of products, current stages of development, and the estimated completion
of the current phase of development. For additional information on our
development pipeline, please visit
our website at http://www.gene.com.
|
Product
|
Description
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Estimated
Completion of Current Phase(1)
|
|
Awaiting
U.S. Food and Drug Administration (or “FDA”)
Action
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||
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Herceptin
|
A
supplemental Biologics Licensure Application (or “sBLA”) was submitted to
the FDA on December 21, 2006 for the use of Herceptin for the treatment
of
patients with early-stage HER2-positive breast cancer based on
the HERA
study to enable a broader label. This product is being developed
in
collaboration with F. Hoffmann-La Roche.
|
2007-2008
|
|
Preparing
for Filing
|
||
|
Avastin
|
We
are preparing to resubmit an sBLA to the FDA for the use of Avastin
in
combination with paclitaxel chemotherapy for the treatment of patients
who
have not previously received chemotherapy for their locally recurrent
or
metastatic breast cancer. This product is being developed in collaboration
with F. Hoffmann-La Roche.
|
2007
|
|
Avastin
|
We
are in discussions with the FDA regarding the submission requirements
for
a potential sBLA for the use of Avastin in combination with interferon
alpha-2a for the treatment of patients with previously untreated
advanced
renal cell carcinoma. This product is being developed in collaboration
with F. Hoffmann-La Roche.
|
2007-2008
|
|
Herceptin
|
We
are preparing to submit an sBLA to the FDA for the use of Herceptin
for
the treatment of patients with early-stage HER2-positive breast
cancer
based on the BCIRG 006 study to enable a broader label. This product
is
being developed in collaboration with F. Hoffmann-La Roche.
|
2007
|
|
Rituxan
Immunology
|
We
and our collaborator Biogen Idec are preparing to submit an sBLA
to the
FDA seeking expansion of the rheumatoid arthritis (anti-tumor necrosis
factor inadequate responders) indication to include radiographic
data
demonstrating inhibition of joint damage in Rituxan treated patients.
This
product is being developed in collaboration with F. Hoffmann-La
Roche and
Biogen Idec.
|
2007
|
4
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Phase
III
|
||
|
2nd
Generation anti-CD20
|
2nd
Generation anti-CD20 is being evaluated in rheumatoid arthritis.
This
product is being developed in collaboration with F. Hoffmann-La
Roche and
Biogen Idec(2).
|
2009-2010
|
|
Avastin
|
Avastin
is being evaluated in adjuvant colon cancer, adjuvant rectal cancer,
first- and second-line metastatic breast cancer in combination
with
several chemotherapy regimens, first-line non-squamous NSCLC, first-line
ovarian cancer, and hormone refractory prostate cancer. This product
is
being developed in collaboration with F. Hoffmann-La Roche.
|
2007-2012
|
|
Avastin
+/- Tarceva
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Avastin
and Tarceva are being evaluated as combination therapy in first-line
NSCLC
in combination with several chemotherapy regimens. This product
is being
developed in collaboration with F. Hoffmann-La Roche and OSI.
|
2009
|
|
Rituxan
Hematology/Oncology
|
Rituxan
is being evaluated in first-line follicular non-Hodgkin’s lymphoma with
several chemotherapy regimens and in relapsed chronic lymphocytic
leukemia. This product is being developed in collaboration with
F.
Hoffmann-La Roche and Biogen Idec.
|
2010
|
|
Rituxan
Immunology
|
Rituxan
is being evaluated in rheumatoid arthritis (DMARD inadequate responders)
in collaboration with F. Hoffmann-La Roche and Biogen Idec. Rituxan
is
also being evaluated in primary progressive multiple sclerosis,
systemic
lupus erythematosus, lupus nephritis, and ANCA-associated vasculitis
in
collaboration with Biogen Idec.
|
2007-2009
|
|
Tarceva
|
Tarceva
is being evaluated in adjuvant NSCLC with several chemotherapy
regimens
and first-line NSCLC. This product is being developed in collaboration
with F. Hoffmann-La Roche and OSI.
|
2013
|
|
Tarceva
+/- Avastin
|
Tarceva
and Avastin are being evaluated as combination therapy in first-line
metastatic pancreatic cancer and second-line NSCLC. This product
is being
developed in collaboration with F. Hoffmann-La Roche and OSI.
|
2008
|
|
TNKase
|
TNKase
is being evaluated in the treatment of dysfunctional hemodialysis
and
central venous access catheters.
|
2008
|
|
Xolair
|
Xolair
is being evaluated in pediatric asthma. This product is being developed
in
collaboration with Novartis and Tanox, Inc. (or “Tanox”).
|
2008
|
5
|
Preparing
for Phase III
|
||
|
2nd
Generation anti-CD20
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We
are preparing Phase III clinical trials in lupus nephritis and
systemic
lupus erythematosus. This product is being developed in collaboration
with
F. Hoffmann-La Roche and Biogen Idec(2).
|
2007
|
|
ALTU-238
|
Altus
is preparing a Phase III clinical trial in adult growth hormone
deficiency. We have entered into an agreement to develop this product
in
collaboration with Altus, and this transaction is subject to closing
conditions.
|
(3)
|
|
Avastin
|
We
are preparing for Phase III clinical trials in adjuvant breast
cancer,
first-line metastatic breast cancer in combination with antihormonal
therapy, adjuvant NSCLC, gastrointestinal stromal tumors, and second-line
ovarian cancer. This product is being developed in collaboration
with F.
Hoffmann-La Roche.
|
2007
|
|
Herceptin
+/- Avastin
|
We
are preparing for a Phase III clinical trial of Herceptin and Avastin
as
combination therapy in first-line HER2-positive metastatic breast
cancer.
This product is being developed in collaboration with F. Hoffmann-La
Roche.
|
2007
|
|
Lucentis
|
We
are preparing for Phase III clinical trials in diabetic macular
edema and
retinal vein occlusion. This product is being developed in collaboration
with Novartis Ophthalmics.
|
2007
|
|
Phase
II
|
||
|
Anti-CD40
|
Anti-CD40
is being evaluated in non-Hodgkin’s lymphoma. We are developing this
product in collaboration with Seattle Genetics Inc.
|
2008-2009
|
|
Avastin
|
Avastin
is being evaluated in adjuvant HER2-negative breast cancer, relapsed
glioblastoma multiforme, and non-squamous NSCLC with previously
treated
central nervous system metastases. This product is being developed
in
collaboration with F. Hoffmann-La Roche.
|
2007
|
|
HAE1
|
HAE1
is being evaluated in moderate-to-severe allergic asthma.
|
2008-2009
|
|
Omnitarg
|
Our
Phase II clinical trial evaluating Omnitarg in combination with
chemotherapy in platinum-resistant ovarian cancer showed encouraging
results. Roche is conducting a clinical trial evaluating Omnitarg
in
combination with chemotherapy in platinum-sensitive ovarian cancer.
This
product is being developed in collaboration with F. Hoffmann-La
Roche.
|
2007
|
|
Topical
VEGF
|
Topical
VEGF is being evaluated for the treatment of diabetic foot
ulcers.
|
2007
|
6
|
Preparing
for Phase II
|
||
|
2nd
Generation anti-CD20
|
We
are preparing for a Phase II clinical trial in relapsing remitting
multiple sclerosis. This product is being developed in collaboration
with
F. Hoffmann-La Roche and Biogen Idec(2).
|
2007-2008
|
|
ALTU-238
|
Altus
is preparing for a Phase II clinical trial in pediatric growth
hormone
deficiency. We have entered into an agreement to develop this product
in
collaboration with Altus, and this transaction is subject to closing
conditions.
|
(3)
|
|
Avastin
|
We
are preparing to initiate a Phase II clinical trial in extensive
small
cell lung cancer. This product is being developed in collaboration
with F.
Hoffmann-La Roche.
|
2007
|
|
Phase
I and Preparing for Phase I
|
We
have multiple new molecular entities in Phase I or preparing for
Phase
I.
|
________________________
|
(1)
|
For
those projects preparing for a Phase, the estimated date of completion
refers to the date the project is expected to enter the Phase for
which it
is preparing.
|
|
(2)
|
Our
collaborator Biogen Idec disagrees with certain of our development
decisions under our 2003 collaboration agreement with them. We
continue to
pursue a resolution of our differences with Biogen Idec, and the
disputed
issues have been submitted to arbitration. See Part I, Item 3,
“Legal
Proceedings,” of this Form 10-K for further
information.
|
|
(3)
|
Our
collaborator is conducting the trial(s) and we are unable to provide
the
estimated date of completion for the current
phase.
|
Related
Party Arrangements
See
“Relationship with Roche” and “Related Party Transactions” sections below in
Part II, Item 7 of this Form 10-K for information on our collaboration
arrangements with Roche, F. Hoffmann-La Roche and Novartis.
Distribution
and Commercialization
We
have a U.S.-based marketing, sales and distribution organization. Our sales
efforts are focused on specialist physicians in private practice or at hospitals
and major medical centers in the U.S. In general, our products are sold largely
to wholesalers, specialty distributors or directly to hospital pharmacies.
We
utilize common pharmaceutical company marketing techniques, including sales
representatives calling on individual physicians and distributors,
advertisements, professional symposia, direct mail, public relations and
other
methods.
The
Genentech Access to Care Foundation provides free product to eligible uninsured
patients and those deemed uninsured due to payer denial in the U.S. We have
the
Genentech Endowment for Cystic Fibrosis to assist cystic fibrosis patients
in
the U.S. with obtaining Pulmozyme. We also provide customer service programs
relating to our products. We maintain a physician-related product waste
replacement program for Rituxan, Avastin, Herceptin, Activase, TNKase and
Lucentis, that, subject to specific conditions, provides physicians the right
to
return these products to us for replacement. We also maintain expired product
programs for all our products that, subject to certain specific conditions,
provide customers the right to return expired products to us for replacement
or
credit at a price based on a 12-month rolling average. To further support
patient access to therapies for various diseases we donate to various
independent, public charities that offer financial assistance, such as co-pay
assistance, to eligible patients. We maintain the right to renew, modify
or
discontinue any of the patient programs described above.
In
October 2006, we announced our plan to launch the Avastin Patient Assistance
Program in the first quarter of 2007, which is a voluntary program that enables
eligible patients who receive greater than 10,000 milligrams of Avastin over
a
12-month period to receive free Avastin during the remainder of the 12-month
period. Eligible patients include those who are being treated for an
FDA-approved indication and who meet the household income criteria for this
program. The program will be available for eligible patients who enroll
regardless of whether they are insured.
7
As
discussed in Note 12, “Segment, Significant Customer and Geographic
Information,” in the Notes to Consolidated Financial Statements of Part II, Item
8 of this Form 10-K, our combined sales to three major wholesalers provided
approximately 85% in 2006, 82% in 2005, and 79% in 2004, of our total net
U.S.
product sales. Also discussed in the note are material net foreign revenues
by
country in 2006, 2005 and 2004.
Manufacturing
and Raw
Materials
Manufacturing
biotherapeutics is difficult and complex, and requires facilities specifically
designed and validated for this purpose. It can take longer than five years
to
design, construct, validate, and license a new biotechnology manufacturing
facility. Production problems in any of our operations or our contractors’
manufacturing plants could result in failure to produce adequate product
supplies or could result in product defects which could require us to delay
shipment of products, recall products previously shipped or be unable to
supply
products at all. In addition, we may need to record period charges associated
with manufacturing or inventory failures or other production-related costs
or
incur costs to secure additional sources of capacity. Furthermore, there
are
inherent uncertainties associated with forecasting future demand, especially
for
newly introduced products of ours or of those for whom we produce products,
and
as a consequence we may have inadequate capacity to meet our own actual demands
and/or the actual demands of those for whom we produce product.
Raw
materials and supplies required for the production of our principal products
are
available, in some instances from one supplier and in other instances, from
multiple suppliers. In those cases where raw materials are only available
through one supplier, such supplier may be either a sole source (the only
recognized supply source available to us) or a single source (the only approved
supply source for us among other sources). We have adopted policies to attempt,
to the extent feasible, to minimize raw material supply risks to the Company,
including maintenance of greater levels of raw materials inventory and
coordination with our collaborators to implement raw materials sourcing
strategies.
For
risks associated with manufacturing and raw materials, see “Difficulties or
delays in product manufacturing or in obtaining materials from our suppliers
could harm our business and/or negatively affect our financial performance”
under “Risk Factors.”
Proprietary
Technology — Patents and Trade Secrets
We
seek patents on inventions originating from our ongoing research and development
(or “R&D”) activities. We have either been issued patents or have patent
applications pending that relate to a number of current and potential products,
including products licensed to others. Patents, issued or applied for, cover
inventions ranging from basic recombinant DNA techniques to processes relating
to specific products and to the products themselves. Our issued patents extend
for varying periods according to the date of patent application filing or
grant
and the legal term of patents in the various countries where patent protection
is obtained. The actual protection afforded by a patent, which can vary from
country to country, depends upon the type of patent, the scope of its coverage
as determined by the patent office or courts in the country, and the
availability of legal remedies in the country. We consider that in the aggregate
our patent applications, patents and licenses under patents owned by third
parties are of material importance to our operations. Significant legal issues
remain to be resolved as to the extent and scope of available patent protection
for biotechnology products and processes in the U.S. and other important
markets
outside of the U.S. We expect that litigation will likely be necessary to
determine the validity and scope of certain of our proprietary rights. We
are
currently involved in a number of legal proceedings relating to the scope
of
protection and validity of our patents and those of others. These proceedings
may result in a significant commitment of our resources in the future and,
depending on their outcome, may adversely affect the validity and scope of
certain of our patent or other proprietary rights. We cannot assure that
the
patents we obtain or the unpatented proprietary technology we hold will afford
us significant commercial protection.
We
have obtained licenses from various parties that we deem to be necessary
or
desirable for the manufacture, use or sale of our products. These licenses
(both
exclusive and non-exclusive) generally require us to pay royalties to the
parties on product sales. In conjunction with these licenses, disputes sometimes
arise regarding whether royalties are
8
owed
on certain product sales or the amount of royalties that are owed. The
resolution of such disputes may cause us to incur significant additional
royalty
expenses or other expenses.
Our
trademarks, Activase, Avastin, Cathflo, Herceptin, Lucentis, Nutropin, Nutropin
AQ, Nutropin AQ Pen, Omnitarg, Pulmozyme, Raptiva, Rituxan (licensed from
Biogen
Idec), TNKase, Xolair (licensed from Novartis) and Tarceva (licensed from
OSI),
in the aggregate are considered to be of material importance. All are covered
by
registrations or pending applications for registration in the U.S. Patent
and
Trademark Office and in other countries. Trademark protection continues in
some
countries for as long as the mark is used and, in other countries, for as
long
as it is registered. Registrations generally are for fixed, but renewable,
terms.
Our
royalty income for patent licenses, know-how and other related rights amounted
to $1,354 million in 2006, $935 million in 2005, and $641 million in 2004.
Royalty expenses were $568 million in 2006, $462 million in 2005, and $355
million in 2004.
Competition
We
face competition from pharmaceutical companies and biotechnology companies.
The
introduction of new competitive products or follow-on biologics or new
information about existing products or pricing decisions by us or our
competitors may result in lost market share for us, reduced utilization of
our
products, and/or lower prices, even for products protected by patents. For
risks
associated with competition, see “We face competition” under “Risk Factors”
below in Part I, Item 1A of this Form 10-K.
Government
Regulation
Regulation
by governmental authorities in the U.S. and other countries is a significant
factor in the manufacture and marketing of our products and in ongoing research
and product development activities. All of our products require regulatory
approval by governmental agencies prior to commercialization. Our products
are
subject to rigorous preclinical and clinical testing and other premarket
approval requirements by the FDA and regulatory authorities in other countries.
Various statutes and regulations also govern or influence the manufacturing,
safety, labeling, storage, record keeping and marketing of such products.
The
lengthy process of seeking these approvals, and the subsequent compliance
with
applicable statutes and regulations, require the expenditure of substantial
resources.
The
activities required before a pharmaceutical product may be marketed in the
U.S.
begin with preclinical testing. Preclinical tests include laboratory evaluation
of product chemistry and required animal studies to assess the potential
safety
and efficacy of the product and its formulations. The results of these studies
must be submitted to the FDA as part of an Investigational New Drug Application,
which must be reviewed by the FDA before proposed clinical testing in humans
can
begin. Typically, clinical testing involves a three-phase process. In Phase
I,
clinical trials are conducted with a small number of subjects to determine
the
early safety profile and the pattern of drug distribution and metabolism.
In
Phase II, clinical trials are conducted with groups of patients afflicted
with a
specified disease in order to provide enough data to evaluate the preliminary
efficacy, optimal dosages and expanded evidence of safety. In Phase III,
large
scale, multicenter clinical trials are conducted with patients afflicted
with a
target disease in order to provide enough data to statistically evaluate
the
efficacy and safety of the product, as required by the FDA. The results of
the
preclinical and clinical testing of a chemical pharmaceutical product are
then
submitted to the FDA in the form of a New Drug Application (or “NDA”), or for a
biological pharmaceutical product in the form of a Biologics License Application
(or “BLA”), for approval to commence commercial sales. In responding to an NDA
or a BLA, the FDA may grant marketing approval, request additional information
or deny the application if it determines that the application does not provide
an adequate basis for approval. Most R&D projects fail to produce data
sufficiently compelling to enable progression through all the stages of
development and to obtain FDA approval for commercial sale. See also “The
successful development of biotherapeutics is highly uncertain and requires
significant expenditures and time” under “Risk Factors.”
Among
the conditions for an NDA or a BLA approval is the requirement that the
prospective manufacturer’s quality control and manufacturing procedures conform
on an ongoing basis with current Good Manufacturing Practices (or “GMP”). Before
approval of a BLA, the FDA will usually perform a preapproval inspection
of the
facility to
9
determine
its compliance with GMP and other rules and regulations. Manufacturers must
continue to expend time, money and effort in the area of production and quality
control to ensure full compliance with GMP. After the establishment is licensed
for the manufacture of any product, manufacturers are subject to periodic
inspections by the FDA.
The
requirements that we and our collaborators must satisfy to obtain regulatory
approval by governmental agencies in other countries prior to commercialization
of our products in such countries can be as rigorous, costly and
uncertain.
We
are also subject to various laws and regulations relating to safe working
conditions, clinical, laboratory and manufacturing practices, the experimental
use of animals and the use and disposal of hazardous or potentially hazardous
substances, including radioactive compounds and infectious disease agents,
used
in connection with our research.
The
levels of revenues and profitability of biopharmaceutical companies may be
affected by the continuing efforts of government and third-party payers to
contain or reduce the costs of health care through various means. For example,
in certain foreign markets, pricing or profitability of therapeutic and other
pharmaceutical products is subject to governmental control. In the U.S. there
have been, and we expect that there will continue to be, a number of federal
and
state proposals to implement similar governmental control.
In
addition, in the U.S. and elsewhere, sales of therapeutic and other
pharmaceutical products are dependent in part on the availability of
reimbursement to the physician or consumer from third-party payers, such
as the
government or private insurance plans. Government and private third-party
payers
are increasingly challenging the prices charged for medical products and
services, through class action litigation and otherwise. For example, the
Medicare Prescription Drug Improvement and Modernization Act, enacted in
December 2003 (or “Medicare Act”), revised the Medicare reimbursement rate for
many drugs, including our oncology products, which resulted in a decrease
in the
revised reimbursement rate of several of our products and which was possibly
offset to some extent by increased physician payment rates for drug
administration services related to certain of our oncology products. To date,
we
have not seen any detectable effects of the new rules on our product sales,
and
we anticipate minimal effects on our revenues in 2007. See also “Decreases in
third party reimbursement rates may affect our product sales, results of
operations and financial condition” under “Risk Factors.”
We
are also subject to various federal and state laws pertaining to health care
fraud and abuse, including anti-kickback laws and false claims laws. For
risks
associated with health care fraud and abuse, see “If there is an adverse outcome
in our pending litigation or other legal actions our business may be harmed”
under “Risk Factors.”
Research
and Development
A
significant portion of our operating expenses is related to R&D. Generally,
R&D expenses consist of independent R&D costs and costs associated with
collaborative R&D and in-licensing arrangements. R&D expenses were
$1,773 million in 2006, $1,262 million in 2005, and $948 million in 2004.
We
intend to maintain our strong commitment to R&D. Biotechnology products
generally take 10 to 15 years to research, develop and bring to market in
the
U.S. As discussed above, clinical development typically involves three phases
of
study: Phase I, II, and III. The most significant costs associated with clinical
development are the Phase III trials as they tend to be the longest and largest
studies conducted during the drug development process. Product completion
dates
and completion costs vary significantly by product and are difficult to predict.
Human
Resources
As
of December 31, 2006, we had 10,533 employees.
10
Environment
We
have made, and will continue to make, expenditures for environmental compliance
and protection. Expenditures for compliance with environmental laws have
not
had, and are not expected to have, a material effect on our capital
expenditures, results of operations, or competitive position.
Available
Information
The
following information can be found on our website at http://www.gene.com
or can
be obtained free of charge by contacting our Investor Relations Department
at
(650) 225-1599 or by sending an e-mail message to investor.relations@gene.com:
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our
annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports as soon
as
reasonably practicable after such material is electronically filed
with
the Securities and Exchange Commission;
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our
policies related to corporate governance, including Genentech’s
Principles
of Corporate Governance, Good
Operating Principles (Genentech’s code of ethics applying to Genentech’s
directors, officers and employees) as well as Genentech’s Code of Ethics
applying to our CEO, CFO and senior financial officials;
and
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the
charters of the Audit Committee and the Compensation Committee
of our
Board of Directors.
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Item
1A.
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This
Form 10-K contains forward-looking information based on our current
expectations. Because
our actual results may differ materially from any forward-looking statements
we
make or that are made on our behalf, this section includes a discussion of
important factors that could affect our actual future results, including,
but
not limited to, our product sales, royalties, contract revenues, expenses,
net
income and earnings per share.
The
successful development of biotherapeutics is highly uncertain and requires
significant expenditures and time
Successful
development of biotherapeutics is highly uncertain. Products that appear
promising in research or development may be delayed or fail to reach later
stages of development or the market for several reasons including:
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Preclinical
tests may show the product to be toxic or lack efficacy in animal
models.
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Clinical
trial results may show the product to be less effective than desired
or to
have harmful or problematic side
effects.
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Failure
to receive the necessary regulatory approvals or a delay in receiving
such
approvals. Among other things, such delays may be caused by slow
enrollment in clinical studies, extended length of time to achieve
study
endpoints, additional time requirements for data analysis or Biologic
Licensing Application (or “BLA”) preparation, discussions with the U.S.
Food and Drug Administration (or “FDA”), FDA requests for additional
preclinical or clinical data, analyses or changes to study design,
or
unexpected safety, efficacy or manufacturing
issues.
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Difficulties
formulating the product, scaling the manufacturing process or in
getting
approval for manufacturing.
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Manufacturing
costs, pricing or reimbursement issues, or other factors that make
the
product uneconomical.
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The
proprietary rights of others and their competing products and technologies
that may prevent the product from being developed or
commercialized.
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The
contractual rights of our collaborators or others that may prevent
the
product from being developed or
commercialized.
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Success
in preclinical and early clinical trials does not ensure that large-scale
clinical trials will be successful. Clinical results are frequently susceptible
to varying interpretations that may delay, limit or prevent regulatory
approvals. The length of time necessary to complete clinical trials and to
submit an application for marketing approval for a final decision by a
regulatory authority varies significantly and may be difficult to predict.
If
our large-scale clinical trials are not successful, we will not recover our
substantial investments in the product.
Factors
affecting our research and development (or “R&D”) productivity and the
amount of our R&D expenses include, but are not limited to:
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The
number of and the outcome of clinical trials currently being conducted
by
us and/or our collaborators. For example, our R&D expenses may
increase based on the number of late-stage clinical trials being
conducted
by us and/or our collaborators.
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The
number of products entering into development from late-stage research.
For
example, there is no guarantee that internal research efforts will
succeed
in generating a sufficient number of candidate products that are
ready to
move into development or that product candidates will be available
for
in-licensing on terms acceptable to us and permitted under the
anti-trust
laws.
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Decisions
by F. Hoffmann-La Roche
(or “Hoffmann-La Roche”) whether to exercise its options to develop and
sell our future products in non-U.S. markets and the timing and
amount of
any related development cost
reimbursements.
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Our
ability to in-license projects of interest to us and the timing
and amount
of related development funding or milestone payments for such licenses.
For example, we may enter into agreements requiring us to pay a
significant upfront fee for the purchase of in-process R&D, which we
may record as an R&D expense.
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Participation
in a number of collaborative research arrangements. On many of
these
collaborations, our share of expenses recorded in our financial
statements
is subject to volatility based on our collaborators’ spending activities
as well as the mix and timing of activities between the
parties.
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Charges
incurred in connection with expanding our product manufacturing
capabilities, as described in “Difficulties or delays in product
manufacturing or in obtaining materials from our suppliers could
harm our
business and/or negatively affect our financial performance”
below.
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Future
levels of revenue.
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We
may be unable to obtain or maintain regulatory approvals for our
products
We
are subject to stringent regulation with respect to product safety and efficacy
by various international, federal, state and local authorities. Of particular
significance are the FDA’s requirements covering R&D, testing,
manufacturing, quality control, labeling and promotion of drugs for human
use. A
biotherapeutic cannot be marketed in the United States (or “U.S.”) until it has
been approved by the FDA, and then can only be marketed for the indications
approved by the FDA. As a result of these requirements, the length of time,
the
level of expenditures and the laboratory and clinical information required
for
approval of a BLA or NDA, are substantial and can require a number of years.
In
addition, even if our products receive regulatory approval, they remain subject
to ongoing FDA
12
regulation,
including, for example, changes to the product label, new or revised regulatory
requirements for manufacturing practices, written advisements to physicians
and/or a product recall or withdrawal.
We
may not obtain necessary regulatory approvals on a timely basis, if at all,
for
any of the products we are developing or manufacturing or we may not maintain
necessary regulatory approvals for our existing products, and all of the
following could have a material adverse effect on our business:
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Significant
delays in obtaining or failing to obtain approvals as described
in “The
successful development of biotherapeutics is highly uncertain and
requires
significant expenditures and time”
above.
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Loss
of, or changes to, previously obtained approvals, including those
resulting from post-approval safety or efficacy
issues.
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Failure
to comply with existing or future regulatory
requirements.
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Changes
to manufacturing processes, manufacturing process standards or
Good
Manufacturing Practices (or “GMP”) following approval or changing
interpretations of these factors.
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In
addition, the current regulatory framework could change or additional
regulations could arise at any stage during our product development or
marketing, which may affect our ability to obtain or maintain approval of
our
products or require us to make significant expenditures to obtain or maintain
such approvals.
We
face competition
We
face competition from pharmaceutical companies and biotechnology
companies.
The
introduction of new competitive products or follow-on biologics, new information
about existing products or pricing decisions by us or our competitors may
result
in lost market share for us, reduced utilization of our products, reduced
product sales, and/or lower prices, even for products protected by
patents.
Avastin: Avastin
competes with Erbitux® (Imclone/Bristol-Myers Squibb), which is an
EGFR-inhibitor approved for the treatment of irinotecan refractory or intolerant
metastatic colorectal cancer (or “CRC”) patients, Nexavar® (sorafenib Bayer
Corporation/Onyx Pharmaceuticals, Inc.) for the treatment of patients with
advanced renal cell carcinoma (or “RCC”) or kidney cancer (an unapproved use of
Avastin), Sutent® (sunitinib malate, Pfizer, Inc.) for use in advanced RCC (an
unapproved use of Avastin), Gleevec® (imatinib mesylate, Novartis) for use in
refractory/intolerant gastrointestinal stromal tumor (an unapproved use of
Avastin), and Vectibix™ (panitumumab, Amgen), for the treatment of
EGFR-expressing, metastatic colorectal carcinoma with disease progression
on or
following fluoropyrimidine-, oxaliplatin-, and irinotecan-containing
chemotherapy regimens. Avastin could face competition from products in
development that currently do not have regulatory approval. Amgen has stated
that it will initiate head-to-head clinical trials comparing AMG 706 and
Avastin. There
are also head-to-head clinical trials that have recently begun comparing
both
Sutent and AZD2171 (AstraZeneca) to Avastin. Additionally,
there are more than 65 molecules that target VEGF inhibition, and over 130
companies that are developing molecules that, if approved, may compete with
Avastin.
Rituxan: Rituxan’s
primary competitor is Bexxar® (GlaxoSmithKline (or “GSK”)) which is
radioimmunotherapy indicated for the treatment of patients with relapsed
or
refractory low-grade, follicular, or transformed B-cell non-Hodgkin’s lymphoma
(or “NHL”). Other potential competitors include Campath® in relapsed CLL (an
unapproved use of Rituxan), Velcade® (Millennium Pharmaceuticals, Inc.) which is
indicated for multiple myeloma and more recently, mantle cell lymphoma (both
unapproved uses of Rituxan). Ofatumumab (Humax CD20™), an anti-CD20 antibody
being co-developed by Genmab and GSK is in late-stage development for refractory
CLL and NHL. In addition to the products detailed above, we are aware of
other
anti-CD20 molecules in development that, if successful in clinical trials,
may
compete with Rituxan.
13
Rituxan’s
current biologic competitors in rheumatoid arthritis (or “RA”) include Enbrel®
(Amgen/Wyeth), Humira® (Abbott), Remicade® (Johnson & Johnson), Orencia®
(Bristol-Myers Squibb), and Kineret® (Amgen). These products are approved for
use in a broader RA patient population than the approved population for
Rituxan.
Herceptin: Herceptin
could face competition in the future from experimental drugs and products
in
development that do not currently have regulatory approval for use outside
of
clinical trials, including lapatinib ditosylate (Tykerb®), a tyrosine kinase
inhibitor being developed by GSK. On April 3, 2006, GSK announced that it
stopped enrollment in its Phase III clinical trial to evaluate lapatinib
ditosylate because of positive results in treating HER2-positive metastatic
breast cancer in women whose disease had progressed following a
Herceptin-containing regimen and other cancer therapies. Results from this
trial
showed that lapatinib ditosylate in combination with capecitabine increased
time
to disease progression compared to capecitabine alone. GSK filed for regulatory
approval of lapatinib ditosylate in the third quarter of 2006 and was granted
priority review with approval expected in the first quarter of
2007.
Lucentis: We
are aware that retinal specialists are currently using Avastin to treat the
wet
form of age-related macular degeneration, an unapproved use for Avastin,
which
results in significantly less revenue to us per treatment as compared to
Lucentis. We expect Avastin use to continue in this setting. Additionally,
the
National Eye Institute and National Institute of Health have announced a
head-to-head trial of Avastin and Lucentis in this setting. Lucentis also
competes with Macugen® (Pfizer/OSI Pharmaceuticals), and Visudyne® (Novartis)
alone, or in combination with the off-label steroid triamcinolone in wet
AMD.
Xolair: Xolair
faces competition from other asthma therapies, including inhaled
corticosteroids, long-acting beta agonists, combination products such as
fixed
dose inhaled corticosteroids/long-acting beta agonists and leukotriene
inhibitors, as well as oral corticosteroids and immunotherapy.
Tarceva: Tarceva
competes with the chemotherapy agents Taxotere® (Sanofi-Aventis) and Alimta®
(Eli Lilly and Company), both of which are indicated for the treatment of
relapsed non-small
cell lung cancer
(or “NSCLC”). Recent increases in the off-label use of Avastin in combination
with chemotherapy in second-line NSCLC have also had an impact in this setting.
In front-line pancreatic cancer, Tarceva primarily competes with Gemzar® (Eli
Lilly) monotherapy and Gemzar® in combination with other chemotherapeutic
agents. Tarceva could also face competition in the future from products in
late-phase development that currently do not have regulatory approval for
use in
NSCLC or pancreatic cancer. Examples of potential competitors in NSCLC include
Erbitux® (Bristol-Myers Squibb), Xyotax® (Cell Therapeutics Inc.), Telcyta®
(Telik, Inc.), Nexavar® (sorafenib, Bayer/Onyx) and Zactima® (Astra Zeneca).
Examples of potential competitors in Phase III pancreatic cancer trials are
Xeloda® (F. Hoffmann-La Roche) and Erbitux® (Bristol-Myers Squibb).
Nutropin: In
the growth hormone market, we face competition from other companies currently
selling growth hormone products. Nutropin’s current competitors are Genotropin®
(Pfizer), Norditropin® (Novo Nordisk), Humatrope® (Eli Lilly and Company),
Tev-Tropin® (Teva Pharmaceutical Industries Ltd.), and Saizen® (Serono, Inc.).
In addition, follow-on biologics are beginning to enter the growth hormone
market. The FDA recently approved the first follow-on version of a protein
product, Omnitrope® (Sandoz), as a biologic similar to Genotropin® (Pfizer).
Furthermore, as a result of multiple competitors, we have experienced, and
may
continue to experience, a loss of patient share and increased competition
for
managed care product placement. Obtaining placement on the preferred product
lists of managed care companies may require that we discount the price of
Nutropin.
Thrombolytics: We
face competition in our acute myocardial infarction market, with sales of
TNKase
and Activase affected by the adoption by physicians of mechanical reperfusion
strategies. We expect that the use of mechanical reperfusion in lieu of
thrombolytic therapy for the treatment of acute myocardial infarction will
continue to grow. TNKase, for acute myocardial infarction, also faces
competition from Retavase® (PDL BioPharma Inc.), which engages in competitive
price discounting.
Pulmozyme: Pulmozyme
faces competition from the use of hypertonic saline, an emerging, inexpensive
approach to clearing the lungs of cystic fibrosis patients.
14
Raptiva: Raptiva
competes with established therapies for moderate-to-severe psoriasis including
oral systemics such as methotrexate and cyclosporin, as well as ultraviolet
light therapies. In addition, Raptiva competes with biologic agents Amevive®
(Astellas), Enbrel® (Amgen), and Remicade® (Centocor, Inc.). Raptiva also
competes with the biologic agent Humira® (Abbott Laboratories), which is
currently used off-label in the psoriasis market.
In
addition to the commercial and late stage development products listed above,
there are numerous products in earlier stages of development at other
biotechnology and pharmaceutical companies that, if successful in clinical
trials, may compete with our products.
Decreases
in third party reimbursement rates may affect our product sales, results
of
operations and financial condition
Sales
of our products will depend significantly on the extent to which reimbursement
for the cost of our products and related treatments will be available to
physicians from government health administration authorities, private health
insurers and other organizations. Third party payers and governmental health
administration authorities increasingly attempt to limit and/or regulate
the
reimbursement for medical products and services, including branded prescription
drugs. Changes in government legislation or regulation, such as the Medicare
Act, or changes in private third-party payers’ policies toward reimbursement for
our products may reduce reimbursement of our products’ costs to physicians.
Decreases in third-party reimbursement for our products could reduce physician
usage of the product and may have a material adverse effect on our product
sales, results of operations and financial condition.
Difficulties
or delays in product manufacturing or in obtaining materials from our suppliers
could harm our business and/or negatively affect our financial
performance
Manufacturing
biotherapeutics is difficult and complex, and requires facilities specifically
designed and validated for this purpose. It can take longer than five years
to
design, construct, validate, and license a new biotechnology manufacturing
facility. We currently produce our products at our manufacturing facilities
located in South San Francisco, California and Vacaville, California and
through
various contract-manufacturing arrangements. Maintaining an adequate supply
to
meet demand for our products depends on our ability to execute on an aggressive
production plan. Any significant problem in the operations of our or our
contractors’ manufacturing facilities could result in cancellations of
shipments, loss of product in the process of being manufactured, a shortfall
or
stock-out or recall of available product inventory, or unplanned increases
in
production costs, any of which could have a material adverse effect on our
business. A number of factors could cause significant production problems
or
interruptions, including:
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the
inability of a supplier to provide raw materials used for manufacture
of
our products;
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equipment
obsolescence, malfunctions or
failures;
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product
quality or contamination problems;
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damage
to a facility, including our warehouses and distribution facilities,
due
to natural disasters, including, but not limited to, earthquakes
as our
South San Francisco, Oceanside and Vacaville facilities are located
in
areas where earthquakes occur;
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changes
in FDA regulatory requirements or standards that require modifications
to
our manufacturing processes;
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action
by the FDA or by us that results in the halting or slowdown of
production
of one or more of our products or products we make for
others;
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a
contract manufacturer going out of business or failing to produce
product
as contractually required;
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failure
to maintain an adequate state of GMP compliance;
and
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successful
implementation and integration of our new enterprise resource planning
system, including the portions relating to manufacturing and
distribution.
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In
addition, there are inherent uncertainties associated with forecasting future
demand, especially for newly introduced products of ours or of those for
whom we
produce products, and as a consequence we may have inadequate capacity to
meet
our own actual demands and/or the actual demands of those for whom we produce
product. Increasing our manufacturing capacity to keep pace with growing
demand
will depend, in part, on our ability to successfully implement key capacity
enhancement projects, including the following: (i) licensure of
90,000 liters of capacity at our Oceanside, California manufacturing facility
during the first half of 2007 to produce Avastin, and (ii) completion of
construction, qualification and licensure of our new plant in Vacaville,
California in 2009.
Furthermore,
certain of our raw materials and supplies required for the production of
our
principal products or products we make for others are available only through
sole-source suppliers (the only recognized supplier available to us) or
single-source suppliers (the only approved supplier for us among other sources),
and we may not be able to obtain such raw materials without significant delay
or
at all. If such sole-source or single-source suppliers were to limit or
terminate production or otherwise fail to supply these materials for any
reason,
such failures could also have a material adverse effect on our product sales
and
our business.
Because
our manufacturing processes and those of our contractors are highly complex
and
are subject to a lengthy FDA approval process, alternative qualified production
capacity may not be available on a timely basis or at all. Difficulties or
delays in our or our contractors’ manufacturing and supply of existing or new
products could increase our costs, cause us to lose revenue or market share,
damage our reputation and could result in a material adverse effect on our
product sales, financial condition and results of operations.
Protecting
our proprietary rights is difficult and costly
The
patent positions of pharmaceutical and biotechnology companies can be highly
uncertain and involve complex legal and factual questions. Accordingly, we
cannot predict with certainty the breadth of claims allowed in these companies’
patents. Patent disputes are frequent and can preclude the commercialization
of
products. We have in the past been, are currently, and may in the future
be,
involved in material litigation and other legal proceedings relating to our
proprietary rights, such as the Cabilly reexaminations discussed in Note
8, “Leases, Commitments and Contingencies,” in the Notes to Consolidated
Financial Statements of Part II, Item 8 of
this Form 10-K. Such litigation and other legal proceedings are costly in
their
own right and could subject us to significant liabilities to third-parties.
An
adverse decision could force us to either obtain third-party licenses at
a
material cost or cease using the technology or commercializing the product
in
dispute. An adverse decision with respect to one or more of our patents or
other
intellectual property rights could cause us to incur a material loss of
royalties and other revenue from licensing arrangements that we have with
third-parties, and could significantly interfere with our ability to negotiate
future licensing arrangements.
The
presence of patents or other proprietary rights belonging to other parties
may
lead to our termination of the R&D of a particular product, or to a loss of
our entire investment in the product and subject us to infringement
claims.
If
there is an adverse outcome in our pending litigation or other legal actions
our
business may be harmed
Litigation
or other legal actions to which we are currently or have been subjected relates
to, among other things, our patent and other intellectual property rights,
licensing arrangements and other contracts with third parties, and product
liability. We cannot predict with certainty the eventual outcome of pending
proceedings, which may include an injunction against the development,
manufacture or sale of a product or potential product or a judgment with
significant monetary award, including the possibility of punitive damages,
or a
judgment that certain of our patent or other intellectual property rights
are
invalid or unenforceable. Furthermore, we may have to incur substantial expense
in these proceedings and such matters could divert management’s attention from
ongoing business concerns.
16
Our
activities relating to the sale and marketing of our products are subject
to
regulation under the U.S. Federal Food, Drug and Cosmetic Act and other federal
statutes. Violations of these laws may be punishable by criminal and/or civil
sanctions, including fines and civil monetary penalties, as well as the
possibility of exclusion from federal health care programs (including Medicare
and Medicaid). In 1999 we agreed to pay $50 million to settle a federal
investigation relating to our past clinical, sales and marketing activities
associated with human growth hormone. We are currently being investigated
by the
Department of Justice with respect to our promotional practices, and may
in the
future be investigated for our promotional practices relating to any of our
products. If the government were to bring charges against or convict us of
violating these laws, or if we were subject to third party litigation relating
to the same promotional practices, there could be a material adverse effect
on
our business, including our financial condition and results of
operations.
We
are subject to various U.S. federal and state laws pertaining to healthcare
fraud and abuse, including anti-kickback and false claims laws. Anti-kickback
laws make it illegal for a prescription drug manufacturer to solicit, offer,
receive, or pay any remuneration in exchange for, or to induce, the referral
of
business, including the purchase or prescription of a particular drug. Due
to
the breadth of the statutory provisions and the absence of guidance in the
form
of regulations or court decisions addressing some of our practices, it is
possible that our practices might be challenged under anti-kickback or similar
laws. False claims laws prohibit anyone from knowingly and willingly presenting,
or causing to be presented for payment to third-party payers (including Medicare
and Medicaid) claims for reimbursed drugs or services that are false or
fraudulent, claims for items or services not provided as claimed, or claims
for
medically unnecessary items or services. Violations of fraud and abuse laws
may
be punishable by criminal and/or civil sanctions, including fines and civil
monetary penalties, as well as the possibility of exclusion from federal
health
care programs (including Medicare and Medicaid). If a court were to find
us
liable for violating these laws, or if the government were to allege against
or
convict us of violating these laws, there could be a material adverse effect
on
our business, including on our stock price.
We
may be unable to manufacture certain of our products if there is BSE
contamination of our bovine source raw material
Most
biotechnology companies, including Genentech, have historically used bovine
source raw materials to support cell growth in our production processes.
Bovine
source raw materials from within or outside the U.S. are increasingly subject
to
greater public and regulatory scrutiny because of the perceived risk of
contamination with bovine spongiform encephalopathy (or “BSE”). Should BSE
contamination occur during the manufacture of any of our products that require
the use of bovine source raw materials, it would negatively affect our ability
to manufacture those products for an indefinite period of time (or at least
until an alternative process is approved), negatively affect our reputation
and
could result in a material adverse effect on our product sales, financial
condition and results of operations.
We
may be unable to retain skilled personnel and maintain key
relationships
The
success of our business depends, in large part, on our continued ability
to (i)
attract and retain highly qualified management, scientific, manufacturing
and
sales and marketing personnel, (ii) successfully integrate large numbers
of new
employees into our corporate culture, and (iii) develop and maintain important
relationships with leading research and medical institutions and key
distributors. Competition for these types of personnel and relationships
is
intense. We cannot be sure that we will be able to attract or retain skilled
personnel or maintain key relationships or that the costs of retaining such
personnel or maintaining such relationships will not materially
increase.
Other
factors could affect our product sales
Other
factors that could affect our product sales include, but are not limited
to:
|
·
|
The
timing of FDA approval, if any, of competitive
products.
|
17
|
·
|
Our
pricing decisions, including a decision to increase or decrease
the price
of a product, the pricing decisions of our competitors, as well
as our
Avastin Patient Assistance Program, which is a voluntary program
that
enables eligible patients who receive greater than 10,000 milligrams
of
Avastin over a 12-month period to receive free Avastin during the
remainder of the 12-month period. Eligible patients include those
who are
being treated for an FDA-approved
indication.
|
|
·
|
Government
and third-party payer reimbursement and coverage decisions that
affect the
utilization of our products and competing
products.
|
|
·
|
Negative
safety or efficacy data from new clinical studies conducted either
in the
U.S. or internationally by any party could cause the sales of our
products
to decrease or a product to be recalled or
withdrawn.
|
|
·
|
Negative
safety or efficacy data from post-approval marketing experience
or
production quality problems could cause sales of our products to
decrease
or a product to be recalled.
|
|
·
|
Efficacy
data from clinical studies conducted by any party in the U.S. or
internationally, showing or perceived to show, a similar or an
improved
treatment benefit at a lower dose or shorter duration of therapy
could
cause the sales of our products to
decrease.
|
|
·
|
The
degree of patent protection afforded our products by patents granted
to us
and by the outcome of litigation involving our
patents.
|
|
·
|
The
outcome of litigation involving patents of other companies concerning
our
products or processes related to production and formulation of
those
products or uses of those products.
|
|
·
|
The
increasing use and development of alternate
therapies.
|
|
·
|
The
rate of market penetration by competing
products.
|
|
·
|
Our
distribution strategy, including the termination of, or change
in, an
existing arrangement with any major wholesalers who supply our
products.
|
Any
of these factors could have a material adverse effect on our sales and results
of operations.
Our
results of operations are affected by our royalty and contract revenues,
and
sales to collaborators
Royalty
and contract revenues, and sales to collaborators in future periods could
vary
significantly. Major factors affecting these revenues include, but are not
limited to:
|
·
|
Hoffmann-La
Roche’s decisions whether to exercise its options and option extensions
to
develop and sell our future products in non-U.S. markets and the
timing
and amount of any related development cost
reimbursements.
|
|
·
|
Variations
in Hoffmann-La Roche’s sales and other licensees’ sales of licensed
products.
|
|
·
|
The
expiration or termination of existing arrangements with other companies
and Hoffmann-La Roche, which may include development and marketing
arrangements for our products in the U.S., Europe and other countries
outside the U.S.
|
|
·
|
The
timing of non-U.S. approvals, if any, for products licensed to
Hoffmann-La
Roche and to other licensees.
|
18
|
·
|
Government
and third-party payer reimbursement and coverage decisions that
affect the
utilization of our products and competing
products.
|
|
·
|
Fluctuations
in foreign currency exchange rates.
|
|
·
|
The
initiation of new contractual arrangements with other
companies.
|
|
·
|
Whether
and when contract milestones are
achieved.
|
|
·
|
The
failure of or refusal of a licensee to pay
royalties.
|
|
·
|
The
expiration or invalidation of our patents or licensed intellectual
property. For example, patent litigations, interferences, oppositions,
and
other proceedings involving our patents often include claims by
third-parties that such patents are invalid, unenforceable, or
unpatentable. If a court, patent office, or other authority were
to
determine that a patent under which we receive royalties and/or
other
revenues is invalid, unenforceable, or unpatentable, that determination
could cause us to suffer a loss of such royalties and/or revenues,
and
could cause us to incur other monetary
damages.
|
|
·
|
Decreases
in licensees’ sales of product due to competition, manufacturing
difficulties or other factors that affect the sales of
product.
|
Our
affiliation agreement with Roche Holdings, Inc. could adversely affect our
cash
position
Our
affiliation agreement with Roche provides that we establish a stock repurchase
program designed to maintain Roche’s percentage ownership interest in our Common
Stock based on an established Minimum Percentage. For more information on
our
stock repurchase program, see discussion in “Liquidity and Capital
Resources—Cash Used in or Provided by Financing Activities.” See Note 9,
“Relationship with Roche and Related Party Transactions,” in the Notes to
Consolidated Financial Statements in Part II, Item 8 of this Form 10-K for
information regarding the Minimum Percentage.
Roche’s
ownership percentage is diluted by the exercise of stock options to purchase
shares of our Common Stock by our employees and the purchase of shares of
our
Common Stock through our employee stock purchase plan. In order to maintain
Roche’s Minimum Percentage, we repurchase shares of our Common Stock under the
stock repurchase program. See Note 3, “Employee Stock-Based Compensation,” in
the Notes to Consolidated Financial Statements in Part II, Item 8 of this
Form
10-K for information regarding employee stock plans. While the dollar amounts
associated with future stock repurchase programs cannot currently be determined,
future stock repurchases could have a material adverse effect on our liquidity,
credit rating and ability to access additional capital in the financial
markets.
Our
affiliation agreement with Roche could limit our ability to make
acquisitions
The
affiliation agreement between us and Roche contains provisions
that:
|
·
|
Require
the approval of the directors designated by Roche to make any acquisition
or any sale or disposal of all or a portion of our business representing
10% or more of our assets, net income or
revenues.
|
|
·
|
Enable
Roche to maintain its percentage ownership interest in our Common
Stock.
|
|
·
|
Require
us to establish a stock repurchase program designed to maintain
Roche’s
percentage ownership interest in our Common Stock based on an established
Minimum Percentage. For information regarding Minimum Percentage,
see Note
9, “Relationship with Roche and Related Party Transactions,” in the Notes
to Consolidated Financial Statements in Part II, Item 8 of this
Form
10-K.
|
19
These
provisions may have the effect of limiting our ability to make
acquisitions.
Future
sales of our Common Stock by Roche could cause the price of our Common Stock
to
decline
As
of December 31, 2006, Roche owned 587,189,380 shares of our Common Stock,
or
55.8%
of our outstanding shares. All of our shares owned by Roche are eligible
for
sale in the public market subject to compliance with the applicable securities
laws. We have agreed that, upon Roche’s request, we will file one or more
registration statements under the Securities Act in order to permit Roche
to
offer and sell shares of our Common Stock. Sales of a substantial number
of
shares of our Common Stock by Roche in the public market could adversely
affect
the market price of our Common Stock.
Roche
Holdings, Inc., our controlling stockholder, may seek to influence our business
in a manner that is adverse to us or adverse to other stockholders who may
be
unable to prevent actions by Roche
Roche,
as our majority stockholder, controls the outcome of most actions requiring
the
approval of our stockholders. Our bylaws provide, among other things, that
the
composition of our board of directors shall consist of at least three directors
designated by Roche, three independent directors nominated by the nomination
committee and one Genentech executive officer nominated by the nominations
committee. Our bylaws also provide that Roche will have the right to obtain
proportional representation on our board until such time that Roche owns
less
than 5% of our stock. Currently, three of our directors, Mr. William Burns,
Dr.
Erich Hunziker and Dr. Jonathan K.C. Knowles, also serve as officers and
employees of Roche Holding Ltd and its affiliates. As long as Roche owns
in
excess of 50% of our Common Stock, Roche directors will comprise two of the
three members of the nominations committee. Our certificate of incorporation
includes provisions relating to competition by Roche affiliates with us,
offering of corporate opportunities, transactions with interested parties,
intercompany agreements, and provisions limiting the liability of specified
employees. We cannot assure that Roche will not seek to influence our business
in a manner that is contrary to our goals or strategies or the interests
of
other stockholders. Moreover, persons who are directors and/or officers of
Genentech and who are also directors and/or officers of Roche may decline
to
take action in a manner that might be favorable to us but adverse to
Roche.
Additionally,
our certificate of incorporation provides that any person purchasing or
acquiring an interest in shares of our capital stock shall be deemed to have
consented to the provisions in the certificate of incorporation relating
to
competition with Roche, conflicts of interest with Roche, the offer of corporate
opportunities to Roche and intercompany agreements with Roche. This deemed
consent might restrict the ability to challenge transactions carried out
in
compliance with these provisions.
We
may incur material product liability costs
The
testing and marketing of medical products entail an inherent risk of product
liability. Liability exposures for biotherapeutics could be extremely large
and
pose a material risk. Our business may be materially and adversely affected
by a
successful product liability claim or claims in excess of any insurance coverage
that we may have.
Insurance
coverage is increasingly more difficult and costly to obtain or
maintain
While
we currently have a certain amount of insurance to minimize our direct exposure
to certain business risks, premiums are generally increasing and coverage
is
narrowing in scope. As a result, we may be required to assume more risk in
the
future or make significant expenditures to maintain our current levels of
insurance. If we are subject to third-party claims or suffer a loss or damages
in excess of our insurance coverage, we will incur the cost of the portion
of
the retained risk. Furthermore, any claims made on our insurance policies
may
affect our ability to obtain or maintain insurance coverage at reasonable
costs.
We
are subject to environmental and other risks
We
use certain hazardous materials in connection with our research and
manufacturing activities. In the event such hazardous materials are stored,
handled or released into the environment in violation of law or any permit,
we
could
20
be
subject to loss of our permits, government fines or penalties and/or other
adverse governmental or private actions. The levy of a substantial fine or
penalty, the payment of significant environmental remediation costs or the
loss
of a permit or other authorization to operate or engage in our ordinary course
of business could materially adversely affect our business.
We
also have acquired, and may continue to acquire in the future, land and
buildings as we expand our operations. Some of these properties are
“brownfields” for which redevelopment or use is complicated by the presence or
potential presence of a hazardous substance, pollutant or contaminant. Certain
events which could occur may require us to pay significant clean-up or other
costs in order to maintain our operations on those properties. Such events
include, but are not limited to, changes in environmental laws, discovery
of new
contamination, or unintended exacerbation of existing contamination. The
occurrence of any such event could materially affect our ability to continue
our
business operations on those properties.
Fluctuations
in our operating results could affect the price of our Common
Stock
Our
operating results may vary from period to period for several reasons
including:
|
·
|
The
overall competitive environment for our products as described in
“We face
competition” above.
|
|
·
|
The
amount and timing of sales to customers in the U.S. For example,
sales of
a product may increase or decrease due to pricing changes, fluctuations
in
distributor buying patterns or sales initiatives that we may undertake
from time to time.
|
|
·
|
The
amount and timing of our sales to Hoffmann-La Roche and our other
collaborators of products for sale outside of the U.S. and the
amount and
timing of sales to their respective customers, which directly affects
both
our product sales and royalty
revenues.
|
|
·
|
The
timing and volume of bulk shipments to
licensees.
|
|
·
|
The
availability and extent of government and private third-party
reimbursements for the cost of
therapy.
|
|
·
|
The
extent of product discounts extended to
customers.
|
|
·
|
The
efficacy and safety of our various products as determined both
in clinical
testing and by the accumulation of additional information on each
product
after the FDA approves it for sale.
|
|
·
|
The
rate of adoption by physicians and use of our products for approved
indications and additional indications. Among other things, the
rate of
adoption by physicians and use of our products may be affected
by results
of clinical studies reporting on the benefits or risks of a
product.
|
|
·
|
The
potential introduction of new products and additional indications
for
existing products.
|
|
·
|
The
ability to successfully manufacture sufficient quantities of any
particular marketed product.
|
|
·
|
Pricing
decisions that we or our competitors have adopted or may adopt,
as well as
our Avastin Patient Assistance
Program.
|
Our
integration of new information systems could disrupt our internal operations,
which could harm our revenues and increase our expenses
Portions
of our information technology infrastructure may experience interruptions,
delays or cessations of service or produce errors. As part of our Enterprise
Resource Planning efforts, we are implementing new information systems, but
we
may not be successful in implementing all of the new systems, and transitioning
data and other aspects of the
21
process
could be expensive, time consuming, disruptive and resource intensive. Any
disruptions that may occur in the implementation of new systems or any future
systems could adversely affect our ability to report in an accurate and timely
manner the results of our consolidated operations, our financial position
and
cash flows. Disruptions to these systems also could adversely affect our
ability
to fulfill orders and interrupt other operational processes. Delayed sales,
lower margins or lost customers resulting from these disruptions could adversely
affect our financial results.
Our
stock price, like that of many biotechnology companies, is
volatile
The
market prices for securities of biotechnology companies in general have been
highly volatile and may continue to be highly volatile in the future. In
addition, the market price of our Common Stock has been and may continue
to be
volatile.
The
following factors may have a significant effect on the market price of our
Common Stock.
|
·
|
Announcements
of technological innovations or new commercial products by us or
our
competitors.
|
|
·
|
Publicity
regarding actual or potential medical results relating to products
under
development or being commercialized by us or our competitors.
|
|
·
|
Concerns
about the pricing of our products, or our pricing initiatives (including
our Avastin Patient Assistance Program), and the potential effect
of such
on their utilization or our product
sales.
|
|
·
|
Developments
or outcome of litigation, including litigation regarding proprietary
and
patent rights.
|
|
·
|
Regulatory
developments or delays concerning our products in the U.S. and
foreign
countries.
|
|
·
|
Issues
concerning the safety of our products or of biotechnology products
generally.
|
|
·
|
Economic
and other external factors or a disaster or
crisis.
|
|
·
|
Period
to period fluctuations in our financial
results.
|
Our
effective income tax rate may vary significantly
Various
internal and external factors may have favorable or unfavorable effects on
our
future effective income tax rate. These factors include but are not limited
to
changes in tax laws, regulations and/or rates, changing interpretations of
existing tax laws or regulations, changes in estimates of prior years’ items,
past and future levels of R&D spending, and changes in overall levels of
income before taxes.
To
pay our indebtedness will require a significant amount of cash and may adversely
affect our operations and financial results
As
of December 31, 2006, we had approximately $2.0 billion of long-term debt.
Our
ability to make payments on and to refinance our indebtedness, including
our
long-term debt obligations, and to fund planned capital expenditures, R&D,
as well as stock repurchases and expansion efforts will depend on our ability
to
generate cash in the future. This, to a certain extent, is subject to general
economic, financial, competitive, legislative, regulatory and other factors
that
are and will remain beyond our control. Additionally, our indebtedness may
increase our vulnerability to general adverse economic and industry conditions,
require us to dedicate a substantial portion of our cash flow from operations
to
payments on our indebtedness, which would reduce the availability of our
cash
flow to fund working capital, capital expenditures, R&D, expansion efforts
and other general corporate purposes, and limit our flexibility in planning
for,
or reacting to, changes in our business and the industry in which we
operate.
22
Accounting
pronouncements may affect our future financial position and results of
operations
Under
Financial Accounting Standards Board (or “FASB”) Interpretation No. 46R (or “FIN
46R”), a revision to Interpretation 46, “Consolidation
of Variable Interest Entities,”
we are required to assess new business development collaborations as well
as to
reassess, upon certain events, some of which are outside our control, the
accounting treatment of our existing business development collaborations
based
on the nature and extent of our variable interests in the entities as well
as
the extent of our ability to exercise influence over the entities with which
we
have such collaborations. Our continuing compliance with FIN 46R may result
in
our consolidation of companies or related entities with which we have a
collaborative arrangement and this may have a material effect on our financial
condition and/or results of operations in future periods.
In
June 2006, the FASB issued FASB Interpretation (or “FIN”) No. 48, “Accounting
for Uncertainty in Income Taxes.”
FIN 48 clarifies the application of FASB Statement 109, “Accounting
for Income Taxes,”
by defining criteria that must be met for any part of a benefit related to
an
individual tax position to be recognized in the financial statements. FIN
48
also provides guidance on measurement, derecognition, classification, interest
and penalties, accounting in interim periods, disclosure, and transition
and is
effective for us beginning January 1, 2007. We are currently evaluating the
effect that the adoption of FIN 48 will have on our consolidated results
of
operations and financial position, but we do not expect the effect to be
material.
|
Item
1B.
|
None.
|
Item
2.
|
Our
headquarters facilities are located in a research and industrial area in
South
San Francisco, California where we currently occupy 30 owned and 8 leased
buildings which house our research and development, marketing and administrative
activities, as well as bulk manufacturing facilities, a fill and finish facility
and a warehouse. We have made and will continue to make improvements to these
properties to accommodate our growth. We also have a commitment to lease
an
additional eight buildings in South San Francisco, California. We occupied
one
of these buildings in 2006, and we will occupy additional buildings beginning
in
2007. In addition, we own other properties in South San Francisco for future
expansion.
We
own a manufacturing facility in Vacaville, California, which is licensed
to
produce commercial quantities of select products. We are currently expanding
our
Vacaville site by constructing an additional manufacturing facility adjacent
to
the existing facility as well as office buildings to support the added
manufacturing capacity. We expect completion of construction, qualification
and
licensure of our new Vacaville plant by the end of 2009.
In
June 2005, we acquired a biologics manufacturing facility in Oceanside,
California. In 2006 we began manufacturing Avastin bulk product at the plant
and
we anticipate FDA licensure in the first half of 2007.
In
September 2006, we acquired land in Hillsboro, Oregon for the construction
of a
new fill, finish, warehousing and related office facility. Construction is
expected to begin in 2007 with completion and FDA licensure in early
2010.
In
December 2006, Lonza acquired the warehouse and cell culture manufacturing
facility that we owned in Porriño, Spain and at which Lonza will continue to
manufacture Avastin for us through December 31, 2009. We also have an agreement
under which we can elect to purchase Lonza’s manufacturing facility currently
under construction in Singapore. Such facility is expected to be licensed
for
the production of Avastin in 2010.
We
also lease additional office facilities as regional offices for sales and
marketing and other functions in several locations throughout the United
States.
23
In
general, our existing facilities, owned or leased, are in good condition
and
adequate for all present and near term uses and we believe our capital resources
are sufficient to purchase, lease or construct any additional facilities
required to meet our long-term growth needs.
|
Item
3.
|
We
are a party to various legal proceedings, including patent infringement
litigation and licensing and contract disputes, and other matters.
On
October 4, 2004, we received a subpoena from the U.S. Department of Justice,
requesting documents related to the promotion of Rituxan, a prescription
treatment now approved for five indications: (1) the treatment of
relapsed or refractory, low-grade or follicular, CD20-positive, B-cell
non-Hodgkin’s lymphoma, (2) the first-line treatment of diffuse large B-cell,
CD20-positive, non-Hodgkin’s lymphoma in combination with CHOP
(cyclophosphamide, doxorubicin, vincristine and prednisone) or other
anthracycline-based chemotherapy regimens (approved on February 10, 2006),
(3)
the first-line treatment of previously untreated patients with follicular,
CD20-positive, B-cell non-Hodgkin’s lymphoma in combination with
cyclophosphamide, vincristine, prednisone (or “CVP”) chemotherapy (approved
September 29, 2006), (4) the treatment of low-grade, CD20-positive, B-cell
non-Hodgkin’s lymphoma in patients with stable disease or who achieve a partial
or complete response following first-line treatment with CVP chemotherapy
(approved on September 29, 2006), and (5) for use in combination with
methotrexate to reduce signs and symptoms in adult patients with moderately-
to
severely- active rheumatoid arthritis who have had an inadequate response
to one
or more tumor necrosis factor antagonist therapies (approved on February
28,
2006). We are cooperating with the associated investigation, which we have
been
advised is both civil and criminal in nature. The government has called and
will
likely continue to call former and current Genentech employees to appear
before
a grand jury in connection with this investigation. The outcome of this matter
cannot be determined at this time.
On
July 29, 2005, a former Genentech employee, whose employment ended in April
2005, filed a qui tam complaint under seal in the United States District
Court
for the District of Maine against Genentech and Biogen Idec, alleging violations
of the False Claims Act and retaliatory discharge of employment. On December
20,
2005, the United States filed notice of its election to decline intervention
in
the lawsuit. The complaint was subsequently unsealed and we were served on
January 5, 2006. Genentech filed a motion to dismiss the complaint and on
December 14, 2006, the Magistrate Judge assigned to the case issued a
Recommended Decision on that motion, which is subject to review by the District
Court Judge. The Magistrate Judge recommended that the False Claims Act portion
of the complaint be dismissed, leaving as the only remaining claim against
Genentech the plaintiff’s retaliatory discharge claim. Plaintiff, Biogen Idec,
and Genentech each subsequently filed objections with the District Court
Judge
concerning certain aspects of the Magistrate Judge’s Recommended Decision. We
are awaiting the District Court’s decision on the Recommended Decision and the
objections. The outcome of this matter cannot be determined at this
time.
We
and the City of Hope National Medical Center (or “COH”) are parties to a 1976
agreement relating to work conducted by two COH employees, Arthur Riggs and
Keiichi Itakura, and patents that resulted from that work, which are referred
to
as the “Riggs/Itakura Patents.” Since that time, we have entered into license
agreements with various companies to make, use and sell the products covered
by
the Riggs/Itakura Patents. On August 13, 1999, the COH filed a complaint
against
us in the Superior Court in Los Angeles County, California, alleging that
we owe
royalties to the COH in connection with these license agreements, as well
as
product license agreements that involve the grant of licenses under the
Riggs/Itakura Patents. On June 10, 2002, a jury voted to award the COH
approximately $300 million in compensatory damages. On June 24, 2002, a jury
voted to award the COH an additional $200 million in punitive damages. Such
amounts were accrued as an expense in the second quarter of 2002 and are
included in the accompanying Consolidated Balance Sheets in “litigation-related
and other long-term liabilities” at December 31, 2006 and December 31, 2005. We
filed a notice of appeal of the verdict and damages awards with the California
Court of Appeal. On October 21, 2004, the California Court of Appeal affirmed
the verdict and damages awards in all respects. On November 22, 2004, the
California Court of Appeal modified its opinion without changing the verdict
and
denied Genentech’s request for rehearing. On November 24, 2004, we filed a
petition seeking review by the California Supreme Court. On February 2, 2005,
the California Supreme Court granted that petition. The appeal to the California
Supreme Court has been fully briefed and we are waiting to be
24
assigned
an oral argument date. The amount of cash paid, if any, or the timing of
such
payment in connection with the COH matter will depend on the outcome of the
California Supreme Court’s review of the matter, however, it may take longer
than one year to resolve the matter.
We
recorded accrued interest and bond costs of $54
million
in 2006 and 2005 related to the COH trial judgment. In
conjunction with the COH judgment, we posted a surety bond and were required
to
pledge cash and investments of $735 million at December 31, 2005 to secure
the
bond. During the third quarter of 2006, COH requested that we increase the
surety bond value by $50 million to secure the accruing interest, and we
correspondingly increased the pledge amount to secure the bond by $53 million
to
$788 million. These amounts are reflected in “restricted cash and investments”
in the accompanying Consolidated Balance Sheets. We
expect that we will continue to incur interest charges on the judgment and
service fees on the surety bond each quarter through the process of appealing
the COH trial results.
On
April 11, 2003, MedImmune, Inc. (or “MedImmune”) filed a lawsuit against
Genentech, COH, and Celltech R & D Ltd. in the U.S. District Court for the
Central District of California (Los Angeles). The lawsuit relates to U.S.
Patent
No. 6,331,415 (or “the ‘415 patent” or “Cabilly patent”) that we co-own with COH
and under which MedImmune and other companies have been licensed and are
paying
royalties to us. The lawsuit includes claims for violation of antitrust,
patent,
and unfair competition laws. MedImmune is seeking a ruling that the ‘415 patent
is invalid and/or unenforceable, a determination that MedImmune does not
owe
royalties under the ‘415 patent on sales of its Synagis® antibody product, an
injunction to prevent us from enforcing the ‘415 patent, an award of actual and
exemplary damages, and other relief. On January 14, 2004 (amending a December
23, 2003 Order), the U.S. District Court granted summary judgment in our
favor
on all of MedImmune’s antitrust and unfair competition claims. On April 23,
2004, the District Court granted our motion to dismiss all remaining claims
in
the case. On October 18, 2005, the U.S. Court of Appeals for the Federal
Circuit
affirmed the judgment of the District Court in all respects. MedImmune filed
a
petition for certiorari with the United States Supreme Court on November
10,
2005, seeking review of the decision to dismiss certain of its claims. The
Supreme Court granted MedImmune’s petition and the oral argument of this case
before the Supreme Court occurred on October 4, 2006. On January 9, 2007,
the
Supreme Court issued a decision reversing the Federal Circuit’s decision and
remanding the case to the lower courts for further proceedings in connection
with the patent and contract claims. The
outcome of this matter cannot be determined at this time.
On
May 13, 2005, a request was filed by a third party for reexamination of the
‘415
or Cabilly patent. The request sought reexamination on the basis of
non-statutory double patenting over U.S. Patent No. 4,816,567. On July 7,
2005,
the U.S. Patent Office ordered reexamination of the ‘415 patent. On September
13, 2005, the Patent Office mailed an initial non-final Office action rejecting
the claims of the ‘415 patent. We filed our response to the Office action on
November 25, 2005. On December 23, 2005, a second request for reexamination
of
the ‘415 patent was filed by another third party, and on January 23, 2006, the
Patent Office granted that request. On June 6, 2006, the two reexaminations
were
merged into one proceeding. On August 16, 2006, the Patent Office mailed
a
non-final Office action in the merged proceeding, rejecting the claims of
the
‘415 patent based on issues raised in the two reexamination requests. We filed
our response to the Office action on October 30, 2006. On February 16, 2007,
the
Patent Office mailed a final Office action rejecting all thirty-six claims
of
the ‘415 patent. We intend to respond to the final Office action, and, if
necessary, appeal the decision. The
‘415 patent, which expires in 2018, relates to methods we and others use to
make
certain antibodies or antibody fragments, as well as cells and DNA used in
these
methods. We have licensed the ‘415 patent to other companies and derive
significant royalties from those licenses. The claims of the ‘415 patent remain
valid and enforceable throughout the reexamination and
appeals
process.
Because the above-described proceeding is ongoing, the outcome of this matter
cannot be determined at this time.
In
2006, we made development decisions involving our humanized anti-CD20 program.
Our collaborator, Biogen Idec, disagrees with certain of our development
decisions under our 2003 collaboration agreement with Biogen Idec relating
to
humanized anti-CD20 products. We believe that we are permitted under the
agreement to proceed with further trials of certain humanized anti-CD20
antibodies, and Biogen Idec disagrees with our position. We continue to pursue
a
resolution of our differences, and the disputed issues have been submitted
to
arbitration. In the arbitration, Biogen Idec has filed motions for a preliminary
injunction and summary judgment seeking to stop us from proceeding with certain
development activities, including planned clinical trials. A hearing on the
motion for a
25
preliminary
injunction was held on January 30, 2007 and we are waiting on a decision
by the
arbitrators on
that motion. Briefing relating to the motion for summary judgment is ongoing.
Resolution of the arbitration could require that both parties agree to certain
development decisions before moving forward with humanized anti-CD20 antibody
clinical trials, in which case we may have to alter or cancel planned trials
in
order to obtain Biogen Idec’s approval. The outcome of this matter cannot be
determined at this time.
On
March 24, 2004, Dr. Kourosh Dastgheib filed a lawsuit against Genentech in
the
U.S. District Court for the Eastern District of Pennsylvania. The lawsuit
stems
from Dastgheib’s claim that, based on a purported relationship with Genentech in
the mid-1990’s, he is entitled to profits or proceeds from Genentech’s Lucentis
product. Dastgheib has asserted multiple claims for monetary damages, including
a claim under an unjust enrichment theory that he is entitled to the entire
net
present value of projected Lucentis sales, which he claims is between
approximately $1.4 billion and $4.1 billion. On November 8, 2006, a unanimous
jury ruled against Dastgheib and in favor of Genentech on all claims, and
final
judgment was entered in Genentech’s favor. On January 30, 2007, Dastgheib’s
motion for a new trial was denied in its entirety. Because Dastgheib may
still
seek to appeal the judgment to the court of appeals, the final outcome of
this
matter cannot be determined at this time.
Not
applicable.
26
Executive
Officers of the Company
The
executive officers of the Company and their respective ages (as of December
31,
2006) and positions with the Company are as follows:
|
Name
|
Age
|
Position
|
|
|
Arthur
D. Levinson, Ph.D.*
|
56
|
Chairman
and Chief Executive Officer
|
|
|
Susan
D. Desmond-Hellmann, M.D., M.P.H.*
|
49
|
President,
Product Development
|
|
|
Ian
T. Clark*
|
46
|
Executive
Vice President, Commercial Operations
|
|
|
David
A. Ebersman*
|
37
|
Executive
Vice President and Chief Financial Officer
|
|
|
Stephen
G. Juelsgaard, D.V.M., J.D.*
|
58
|
Executive
Vice President, Secretary and Chief Compliance Officer
|
|
|
Richard
H. Scheller, Ph.D.*
|
53
|
Executive
Vice President, Research
|
|
|
Patrick
Y. Yang, Ph.D.*
|
58
|
Executive
Vice President, Product Operations
|
|
|
Robert
L. Garnick, Ph.D.
|
57
|
Senior
Vice President, Regulatory, Quality and Compliance
|
|
|
John
M. Whiting
|
51
|
Vice
President, Finance and Chief Accounting Officer
|
________________________
* Members
of the Executive Committee of the Company.
The
Board of Directors appoints all executive officers annually. There is no
family
relationship between or among any of the executive officers or directors.
Business
Experience
Arthur
D. Levinson, Ph.D.
was appointed Chairman of the Board of Directors of Genentech, Inc. in September
1999 and was elected its Chief Executive Officer and a director of the Company
in July 1995. Since joining the Company in 1980, Dr. Levinson has been a
Senior
Scientist, Staff Scientist and the Director of the Company’s Cell Genetics
Department. Dr. Levinson was appointed Vice President of Research Technology
in
April 1989, Vice President of Research in May 1990, Senior Vice President
of
Research in December 1992, Senior Vice President of Research and Development
in
March 1993 and President in July 1995. Dr. Levinson also serves as a member
of
the Board of Directors of Apple Computer, Inc. and Google, Inc.
Susan
D. Desmond-Hellmann, M.D., M.P.H.
was appointed President,
Product Development of Genentech in March 2004. She previously served as
Executive
Vice President, Development and Product Operations from September 1999 to
March
2004, Chief Medical Officer from December 1996 to March 2004, and as Senior
Vice
President, Development from December 1997 to September 1999, among other
positions, since joining Genentech in March 1995 as a Clinical Scientist.
Prior
to joining Genentech, she held the position of Associate Director at
Bristol-Myers Squibb.
Ian
T. Clark
was appointed Executive Vice
President, Commercial Operations of Genentech in December 2005. He previously
served as Senior
Vice President, Commercial Operations of Genentech from August 2005
to December 2005 and
joined Genentech as
Senior Vice President and General Manager, BioOncology and served
in that role from January 2003 through August 2005. Prior to joining Genentech,
he served as president for Novartis Canada from 2001 to 2003. Before assuming
his post in Canada, he served as chief operating officer for Novartis United
Kingdom from 1999 to 2001.
David
A. Ebersman
was appointed Executive Vice
President of Genentech in December 2005 and Chief Financial Officer in March
2005. Previously, he served as
Senior Vice President, Finance from January 2005 through
March 2005 and Senior
Vice President, Product Operations from May 2001 through January 2005. He
joined
Genentech in February 1994 as a Business Development Analyst and subsequently
served as Manager, Business Development from February 1995 to February 1996,
Director, Business Development from February 1996 to March 1998, Senior
27
Director,
Product Development from March 1998 to February 1999 and Vice President,
Product
Development from February 1999 to May 2001. Prior to joining Genentech, he
held
the position of Research Analyst at Oppenheimer & Company, Inc.
Stephen
G. Juelsgaard, D.V.M., J.D.
was appointed Chief
Compliance Officer of Genentech in June 2005, Executive
Vice President in September 2002, and Secretary in April 1997. He joined
Genentech in July 1985 as Corporate Counsel and subsequently served as Senior
Corporate Counsel from 1988 to 1990, Chief Corporate Counsel from 1990 to
1993,
Vice President, Corporate Law from 1993 to 1994, Assistant Secretary from
1994
to 1997, Senior Vice President from April 1998 to September 2002, and General
Counsel from July 1994 to January 2007.
Richard
H. Scheller, Ph.D.
was appointed Executive Vice President, Research of Genentech in September
2003.
Previously, he served as Senior Vice President, Research from March 2001
to
September 2003. Prior to joining Genentech, he served as Professor of Molecular
and Cellular Physiology and of Biological Sciences at Stanford University
Medical Center from September 1982 to February 2001 and as an investigator
at
the Howard Hughes Medical Institute from September 1990 to February 2001.
He
received his first academic appointment to Stanford University in 1982. He
was
appointed to the esteemed position of professor of Molecular and Cellular
Physiology in 1993 and as an investigator in the Howard Hughes Medical Institute
in 1994.
Patrick
Y. Yang, Ph.D. was
appointed Executive
Vice
President, Product Operations of Genentech in December 2005. Previously,
he
served as Senior Vice President, Product Operations from January 2005 through
December 2005 and Vice President, South San Francisco Manufacturing and
Engineering from December 2003 to January 2005. Prior to joining Genentech,
he
worked for General Electric from 1980 to 1992 in manufacturing and technology
and for Merck & Co. Inc. from 1992 to 2003 in manufacturing. At Merck, he
held several executive positions including Vice President, Supply Chain
Management from 2001 to 2003 and Vice President, Asia/Pacific Manufacturing
Operations from 1997 to 2000.
Robert
L. Garnick, Ph.D.
was appointed Senior Vice President, Regulatory, Quality and Compliance of
Genentech in February 2001. Previously, he served as Vice President, Regulatory
Affairs from February 1998 to February 2001, Vice President, Quality from
April
1994 to February 1998, Senior Director, Quality Control from 1990 to 1994
and
Director, Quality Control from 1988 to 1990. He joined Genentech in August
1984
from Armour Pharmaceutical, where he held various positions.
John
M. Whiting
was appointed Vice President, Finance of Genentech in June 2006, and Chief
Accounting Officer in October 1997. He served as Controller from October
1997 to
June 2006 and as Vice President from January 2001 to June 2006. He previously
served in a variety of financial positions at Genentech from 1989 to 1997.
Prior
to joining Genentech, he served as Senior Audit Manager at Arthur
Young.
28
PART
II
See
“Liquidity and Capital Resources — Cash Used in or Provided by Financing
Activities” in “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” of Part II, Item 7 of this Form 10-K, Note 1,
“Description of Business — Redemption of Our Special Common Stock,” Note 9,
“Relationship with Roche and Related Party Transactions,” and Note 10, “Capital
Stock,” in the Notes to Consolidated Financial Statements of Part II, Item 8 of
this Form 10-K.
Stock
Exchange Listing
Our
Common Stock trades on the New York Stock Exchange under the symbol “DNA.” No
dividends have been paid on the Common Stock. We currently intend to retain
all
future income for use in the operation of our business and for future stock
repurchases and, therefore, do not anticipate paying any cash dividends in
the
near future.
Common
Stockholders
As
of December 31, 2006, there were approximately 2,612 stockholders of record
of
our Common Stock, one of which is Cede & Co., a nominee for Depository Trust
Company (or “DTC”). All of the shares of Common Stock held by brokerage firms,
banks and other financial institutions as nominees for beneficial owners
are
deposited into participant accounts at DTC, and are therefore considered
to be
held of record by Cede & Co. as one stockholder.
Stock
Prices
|
Common
Stock
|
|||||||||||||
|
2006
|
2005
|
||||||||||||
|
High
|
Low
|
High
|
Low
|
||||||||||
|
4th
Quarter
|
$
|
86.93
|
$
|
79.65
|
$
|
100.20
|
$
|
79.87
|
|||||
|
3rd
Quarter
|
86.65
|
76.80
|
94.99
|
79.71
|
|||||||||
|
2nd
Quarter
|
84.72
|
75.58
|
84.10
|
54.68
|
|||||||||
|
1st
Quarter
|
95.16
|
81.15
|
59.00
|
43.90
|
|||||||||
Stock
Repurchases
See
“Liquidity and Capital Resources — Cash Used in or Provided by Financing
Activities” in “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” of Part II, Item 7 of this Form 10-K for information on
our stock repurchases.
29
Performance
Graph
We
show below the cumulative total return to our stockholders during the period
from December 31, 2001 through December 31, 2006 in comparison to the cumulative
return on the Standard & Poor’s 500 Index, the Standard & Poor’s 500
Pharmaceuticals Index and the Standard & Poor’s 500 Biotechnology Index
during that same period.(1)
The results assume that $100 was invested on December 31, 2001.
|
Base
Period
|
Years
Ending
|
||||||||||||||||||
|
December
|
December
|
December
|
December
|
December
|
December
|
||||||||||||||
|
Company
/ Index
|
2001
|
2002
|
2003
|
2004
|
2005
|
2006
|
|||||||||||||
|
GENENTECH,
INC
|
100
|
$
|
61.12
|
$
|
172.48
|
$
|
200.70
|
$
|
341.01
|
$
|
299.10
|
||||||||
|
S&P
500 INDEX
|
100
|
77.90
|
100.25
|
111.15
|
116.61
|
135.03
|
|||||||||||||
|
S&P
500 PHARMACEUTICALS
|
100
|
79.96
|
86.98
|
80.51
|
77.81
|
90.14
|
|||||||||||||
|
S&P
BIOTECHNOLOGY
|
100
|
79.59
|
102.55
|
110.35
|
130.52
|
126.94
|
|||||||||||||
________________________
|
(1)
|
The
total return on investment (change in year end stock price plus
reinvested
dividends) assumes $100 invested on December 31, 2001 in our common
stock,
the Standard & Poor’s 500 Index, the Standard & Poor’s 500
Pharmaceuticals Index and the Standard & Poor’s 500 Biotechnology
Index. The Standard & Poor’s 500 Pharmaceuticals Index was comprised
at December 31, 2006 of Abbott Laboratories, Allergan, Inc., Barr
Pharmaceuticals Inc., Bristol-Myers Squibb Company, Forest Laboratories,
Inc., Johnson & Johnson, King Pharmaceuticals, Inc., Merck & Co.,
Inc., Mylan Laboratories Inc., Lilly (Eli) and Company, Pfizer
Inc.,
Schering-Plough Corporation, Watson Pharmaceuticals, Inc. and Wyeth.
The
Standard & Poor’s 500 Biotechnology Index was comprised at December
31, 2006 of Amgen Inc., Biogen Idec Inc., Genzyme Corporation,
Gilead
Sciences, Inc. and MedImmune, Inc.
|
|
The
information under “Performance Graph” is not deemed filed with the
Securities and Exchange Commission and is not to be incorporated
by
reference in any filing of Genentech under the Securities Act of
1933, as
amended, or the Securities Exchange Act of 1934, as amended, whether
made
before or after the date of this 10-K and irrespective of any general
incorporation language in those
filings.
|
|
30
|
Item
6.
|
The
following selected consolidated financial information has been derived from
the
audited consolidated financial statements. The information below is not
necessarily indicative of results of future operations, and should be read
in
conjunction with Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and Item 1A, “Risk Factors” of this Form
10-K and the consolidated financial statements and related notes thereto
included in Item 8 of this Form 10-K in order to fully understand factors
that
may affect the comparability of the information presented below.
SELECTED
CONSOLIDATED FINANCIAL DATA
(in
millions, except per share amounts)
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Total
operating revenues
|
$
|
9,284
|
$
|
6,633
|
$
|
4,621
|
$
|
3,300
|
$
|
2,584
|
||||||
|
Product
sales
|
7,640
|
5,488
|
3,749
|
2,621
|
2,164
|
|||||||||||
|
Royalties
|
1,354
|
935
|
641
|
501
|
366
|
|||||||||||
|
Contract
revenue
|
290
|
210
|
231
|
178
|
54
|
|||||||||||
|
Income
before cumulative effect of accounting changes
|
$
|
2,113
|
$
|
1,279
|
$
|
785
|
$
|
610
|
$
|
64
|
||||||
|
Cumulative
effect of accounting changes, net of tax
|
-
|
-
|
-
|
(47
|
)(3)
|
-
|
||||||||||
|
Net
income
|
$
|
2,113
|
(1) |
$
|
1,279
|
$
|
785
|
$
|
563
|
(3) |
$
|
64
|
(4) | |||
|
Basic
earnings per share
|
$
|
2.01
|
$
|
1.21
|
$
|
0.74
|
$
|
0.54
|
$
|
0.06
|
||||||
|
Diluted
earnings per share
|
1.97
|
1.18
|
0.73
|
0.53
|
0.06
|
|||||||||||
|
Total
assets
|
$
|
14,842
|
$
|
12,147
|
$
|
9,403
|
(2) |
$
|
8,759
|
(2) |
$
|
6,776
|
||||
|
Long-term
debt
|
2,204
|
(2) |
2,083
|
(2) |
412
|
(2) |
412
|
(2) |
-
|
|||||||
|
Stockholders’
equity
|
9,478
|
7,470
|
6,782
|
6,520
|
5,339
|
|||||||||||
________________________
|
We
have paid no dividends.
|
|
|
All
per share amounts reflect the two-for-one stock split that was
effected in
2004.
|
|
|
Certain
prior year amounts have been reclassified to conform to the current
year
presentation.
|
|
|
(1)
|
Net
income in 2006 includes employee stock-based compensation costs
of $182
million, net of tax, due to our adoption of FAS 123R on a modified
prospective basis on January 1, 2006. No employee stock-based compensation
expense was recognized in reported amounts in any period prior
to January
1, 2006.
|
|
(2)
|
Long-term
debt in 2006 and 2005 includes $1.99 billion related to our debt
issuance
in July 2005, and includes $216 million in 2006 and $94 million
in 2005 in
construction financing obligations related to our agreements with
Slough
and Lonza. Long-term debt in 2005 also reflects the repayment of
$425
million to extinguish the consolidated debt and noncontrolling
interest of
a synthetic lease obligation related to our manufacturing facility
located
in Vacaville, California. Upon adoption of the Financial Accounting
Standards Board Interpretation No. 46 (or “FIN 46”), “Consolidation of
Variable Interest Entities,” in 2003, we consolidated the entity from
which we lease our manufacturing facility located in Vacaville,
California. Accordingly, we included in property, plant and equipment
assets with net book values of $326 million at December 31, 2004
and $348
million at December 31, 2003. We also consolidated the entity’s debt of
$412 million and noncontrolling interest of $13 million, which
amounts are
included in long-term debt and litigation-related and other long-term
liabilities, respectively, at December 31, 2004 and
2003.
|
|
(3)
|
Net
income in 2003 includes the receipt of $113 million in pre-tax
litigation
settlements with Amgen Inc. and Bayer Inc. Net income in 2003 also
reflects our adoption of FIN 46 on July 1, 2003, which resulted
in a $47
million charge, net of $32 million in taxes, (or $0.05 per share)
as a
cumulative effect of an accounting change in 2003.
|
|
(4)
|
Net
income in 2002 includes $544 million of pre-tax litigation-related
special
charges, which are comprised of the COH litigation judgment in
2002, and
accrued interest and bond costs, and certain other litigation-related
matters.
|
31
Overview
The
Company
Genentech
is a leading biotechnology company that discovers, develops, manufactures,
and
commercializes biotherapeutics for significant unmet medical needs. We
commercialize multiple biotechnology products, and also receive royalties
from
companies that are licensed to market products based on our
technology.
Major
Developments in 2006
We
primarily earn revenues and income and generate cash from product sales and
royalty revenues. Our total operating revenues in 2006 were $9.28 billion,
an
increase of 40% from $6.63 billion in 2005. Product sales in 2006 were $7.64
billion, an increase of 39% from $5.49 billion in 2005. Product sales
represented 82% of our operating revenues in 2006 and 83% in 2005. Royalty
revenues were $1.35 billion in 2006, an increase of 45% from $935 million
in
2005. Royalty revenues represented 15% of our operating revenues in 2006
and 14%
in 2005. Our net income in 2006 was $2.11 billion, an increase of 65% from
$1.28
billion in 2005. Net income in 2006 includes the effect of employee stock-based
compensation expense related to employee stock options and employee stock
purchases under Statement of Financial Accounting Standards No. 123 (revised
2004), “Share-Based
Payment”
(or “FAS 123R”), which decreased our net income by $182 million after taxes in
2006.
We
received the following U.S. Food and Drug Administration (or “FDA”)
approvals:
|
·
|
Lucentis
for the treatment of neovascular (wet) age-related macular degeneration
(or “AMD”);
|
|
·
|
Avastin
in combination with intravenous 5-fluorouracil (or “5-FU”)-based
chemotherapy for second-line metastatic colorectal
cancer;
|
|
·
|
Avastin
for use in combination with carboplatin and paclitaxel chemotherapy
for
the first-line treatment of patients with unresectable, locally
advanced,
recurrent or metastatic non-squamous, non-small cell lung cancer
(or
“NSCLC”);
|
|
·
|
Rituxan
for the treatment of patients with active rheumatoid arthritis
(or “RA”)
who have had an inadequate response to tumor necrosis factor antagonist
therapy;
|
|
·
|
Rituxan
for use in first-line treatment of patients with diffuse large
B-cell,
CD20-positive, non-Hodgkin’s
lymphoma (or “DLBCL”);
|
|
·
|
Rituxan
for the first-line treatment of previously untreated patients with
follicular,
CD20-positive, B-cell non-Hodgkin’s
lymphoma in combination with CVP (cyclophosphamide, vincristine,
prednisone) chemotherapy;
|
|
·
|
Rituxan
for the treatment of low-grade, CD20-positive, B-cell non-Hodgkin’s
lymphoma in patients with stable disease or who achieve a partial
or
complete response following first-line treatment with CVP chemotherapy;
and
|
|
·
|
Herceptin
for the adjuvant treatment of HER2-positive node-positive breast
cancer
patients in combination with doxorubicin, cyclophosphamide, and
paclitaxel.
|
32
In
October 2006, we announced our plan to launch the Avastin Patient Assistance
Program in the first quarter of 2007, which is a voluntary program that enables
eligible patients who receive greater than 10,000 milligrams of Avastin over
a
12-month period to receive free Avastin during the remainder of the 12-month
period. Based
on the current wholesale acquisition cost, the 10,000 milligrams is valued
at
$55,000 in gross revenue. Eligible patients include those who are being treated
for an FDA-approved indication and who meet the household income criteria
for
this program. The program will be available for eligible patients who enroll
regardless of whether they are insured. Because the program will apply
retrospectively to patients currently on Avastin for all approved indications,
we deferred approximately $9 million of our fourth quarter 2006 Avastin product
sales to address our estimated free drug commitment to current patients.
See
“Critical Accounting Policies and the Use of Estimates - Revenue Recognition”
below for further discussion.
On
November 9, 2006 we and Tanox Inc. announced that we entered into an agreement
to acquire Tanox, a biotechnology company specializing in the discovery and
development of biotherapeutics based on monoclonal antibody technology, for
$20
per share for a total cash value of approximately $0.9 billion. We and Tanox
have been working together in collaboration with Novartis since 1996 to develop
and commercialize Xolair. The terms of the acquisition have been unanimously
approved by the Boards of Directors of both companies and approved by the
stockholders of Tanox. We received a request for additional information from
the
U.S. Federal Trade Commission (or “second request”) in connection with the
proposed acquisition. The second request extends the waiting period imposed
by
the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (or “Hart-Scott-Rodino
Act”). The transaction is expected to be completed within the first half of
2007, subject to satisfaction of certain closing conditions, including the
absence of a material adverse effect with respect to Tanox and the expiration
or
termination of the waiting period under the Hart-Scott-Rodino Act. Funds
will be
provided from Genentech’s cash on hand at the time of closing. We are currently
evaluating the effects of the acquisition on our results of operations and
financial condition and expect that if the transaction closes a substantial
portion of the purchase price will be expensed as in-process research and
development (or “R&D”).
On
December 8, 2006, Lonza Group Ltd. (or “Lonza”) purchased all the outstanding
shares of Genentech España, our wholly-owned subsidiary, for $150 million. Under
the terms of the agreement, Lonza acquired from us the FDA-licensed Porriño
facility, which has 40,000 liters of biologic manufacturing capacity and
is
currently dedicated to the production of Avastin. Lonza will continue to
produce
Avastin for us at the Porriño facility for the short-term. At the same time, we
entered into a supply agreement with Lonza for the manufacture of certain
of our
products at Lonza’s facility under construction in Singapore, which is currently
expected to receive FDA licensure in 2010. We are committed to fund the
pre-commissioning production qualification costs at that facility, and, upon
FDA
licensure, we are committed to purchase 100 percent of products successfully
manufactured at that facility for a period of three years after commissioning
of
the facility. The total estimated cost of these pre- and post-commissioning
commitments is approximately $440 million. We also received an exclusive
option
to purchase the Lonza Singapore facility during the period from 2007 up to
one
year after FDA licensure for a purchase price of $290 million. Regardless
of
whether the purchase option is exercised, we will be obligated to make a
milestone payment of approximately $70 million if certain performance milestones
are met in connection with the construction of the facility.
In
the fourth quarter of 2006, we received FDA approvals for yield improvement
projects at our manufacturing plants in Vacaville, California related to
the
production of Rituxan and in South San Francisco, California related to the
production of Avastin. In the fourth quarter of 2006, prior to the sale of
our
Porriño facility to Lonza, we received licensure of an additional 20,000 liters
of capacity to manufacture bulk Avastin at that facility. In addition, in
the
first quarter of 2006, the FDA approved the production of bulk Xolair at
Novartis’ production facility in Huningue, France and in the third quarter of
2006, the FDA approved the manufacture of bulk Herceptin at Wyeth’s Andover,
Massachusetts facility. Our manufacturing plant in Oceanside, California,
which
currently has a total capacity of 90,000 liters, is expected to receive FDA
licensure in the first half of 2007.
Our
Strategy and Goals
Our
business objectives for the years 2006 through 2010 include bringing at least
20
new molecules into clinical development, bringing at least 15 major new products
or indications onto the market, becoming the number one U.S.
33
oncology
company in sales, and achieving certain financial growth measures. These
objectives are reflected in our revised Horizon 2010 strategy and goals
summarized on our website at http://www.gene.com. At the end of 2006, we
had 16
new molecules in the early development pipeline and approximately 30 projects
in
late stage research.
Our
near-term growth will depend on our ability to execute on recent product
approvals, including Lucentis for AMD and Avastin for lung cancer, and to
successfully obtain FDA approvals for potential new indications for our existing
products such as Avastin for breast cancer and Rituxan for immunological
disorders. Continued long-term growth will depend on our ability to bring
new
molecules to the market that make a meaningful difference for patients and
provide significant commercial opportunities. With the current highly
competitive marketplace for licensing and mergers and acquisitions, particularly
for late stage product opportunities, we expect the development of our internal
products to provide the majority of our long-term growth.
Economic
and Industry-wide Factors
Our
long-term strategy and goals are challenged by economic and industry-wide
factors that affect our business. The key factors that affect our future
growth
are discussed below:
|
·
|
We
face significant competition in the diseases of interest to us
from
pharmaceutical companies and biotechnology companies. The introduction
of
new competitive products or follow-on biologics, new information
about
existing products or pricing decisions by us or our competitors
may result
in lost market share for us, reduced utilization of our products,
reduced
product sales, and/or lower prices, even for products protected
by
patents.
|
|
·
|
Our
long-term business growth, commercial performance and clinical
success
depend upon our ability to continue to develop and commercialize
important
novel therapeutics to treat unmet medical needs, such as cancer.
We
recognize that the successful development of biotherapeutics is
highly
difficult and uncertain and that it will be challenging for us
to continue
to discover and develop innovative treatments. Our business requires
significant investment in R&D over many years, often for products that
fail during the R&D process. Once a product receives FDA approval, it
remains subject to ongoing FDA regulation, including changes to
the
product label, new or revised regulatory requirements for manufacturing
practices, written advisement to physicians, and/or product recalls
or
withdrawals.
|
|
·
|
We
believe our business model is only sustainable with appropriate
pricing
and reimbursement for our products to offset the costs and risks
of drug
development. The pricing of our products has received negative
press
coverage and public scrutiny. We will continue to meet with patient
groups, payers and other stakeholders in the healthcare system
to
understand their issues and concerns. However, the future reimbursement
environment for our products is
uncertain.
|
|
·
|
As
the Medicare and Medicaid programs are
the largest payers for our products, rules relating to coverage
and
reimbursement continue to represent an important area of focus.
New
regulations relating to hospital and physician payment continue
to be
implemented annually. To
date, we have not seen any detectable effects of the new rules
on our
product sales, and we anticipate minimal effects on our revenues
in
2007.
|
|
·
|
Manufacturing
biotherapeutics is difficult and complex, and requires facilities
specifically designed and validated to run biotechnology production
processes. The manufacture of a biotherapeutic requires developing
and
maintaining a process to reliably manufacture and formulate the
product at
an appropriate scale, obtaining regulatory approval to manufacture
the
product, and is subject to changes in regulatory requirements or
standards
that may require modifications to the manufacturing
process.
|
34
|
·
|
Our
ability to attract and retain highly qualified and talented people
in all
areas of the company, and our ability to maintain our unique culture,
will
be critical to our success over the long-term. We are working diligently
across the company to make sure that we successfully hire, train
and
integrate new employees into the Genentech culture and environment.
In
keeping with our desire to maintain and protect our culture, we
continued
our broad-based stock option program in
2006.
|
|
·
|
Intellectual
property protection of our products is crucial to our business.
Loss of
effective intellectual property protection on one or more products
could
result in lost sales to competing products and may negatively affect
our
sales, royalty revenues and operating results. We are often involved
in
disputes over contracts and intellectual property and we work to
resolve
these disputes in confidential negotiations or litigation. We expect
legal
challenges in this area to continue. We plan to continue to build
upon and
defend our intellectual property
position.
|
Critical
Accounting Policies and the Use of Estimates
The
accompanying discussion and analysis of our financial condition and results
of
operations are based upon our Consolidated Financial Statements and the related
disclosures, which have been prepared in accordance with generally accepted
accounting principles in the United States (or “GAAP”). The preparation of these
Consolidated Financial Statements requires management to make estimates,
assumptions and judgments that affect the reported amounts in our Consolidated
Financial Statements and accompanying notes. These estimates form the basis
for
making judgments about the carrying values of assets and liabilities. We
base
our estimates and judgments on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, and
we
have established internal controls related to the preparation of these
estimates. Actual results and the timing of the results could differ materially
from these estimates.
We
believe the following policies to be critical to understanding our financial
condition, results of operations, and our expectations for 2007 because these
policies require management to make significant estimates, assumptions and
judgments about matters that are inherently uncertain.
Contingencies
We
are currently, and have been, involved in certain legal proceedings,
including patent infringement litigation. We are also involved in licensing
and
contract disputes, and other matters. Refer to Note
8, “Leases, Commitments and Contingencies,” in the Notes to Consolidated
Financial Statements of Part II, Item 8 of
this Form 10-K
for further information on these matters.
We assess the likelihood of any adverse judgments or outcomes for these legal
matters as well as potential ranges of probable losses. We record an estimated
loss as a charge to income if we determine that, based on information available
at the time, the loss is probable and the amount of loss can be reasonably
estimated. Included
in “litigation-related and other long-term liabilities” in the accompanying
Consolidated Balance Sheet at December 31, 2006 is $726 million, which
represents our estimate of the costs for the current resolution of these
matters. The
nature of these matters is highly uncertain and subject to change; as a result,
the amount of our liability for certain of these matters could exceed or
be less
than the amount of our current estimates, depending on the final outcome
of
these matters. An outcome of such matters different than previously estimated
could have a material effect on our financial position or our results of
operations in any one quarter.
Revenue
Recognition
In
October 2006, we announced our plan to launch the Avastin Patient Assistance
Program in the first quarter of 2007, which is a voluntary program that enables
eligible patients who receive greater than 10,000 milligrams of Avastin over
a
12-month period to receive free Avastin during the remainder of the 12-month
period. Based
on the current wholesale acquisition cost, the 10,000 milligrams is valued
at
$55,000 in gross revenue. Eligible patients include those who are being treated
for an FDA-approved indication and who meet the household income criteria
for
this program. The program will be available for eligible patients who enroll
regardless of whether they are insured. We
defer a portion of the Avastin product sales revenue to reflect our estimate
of
the free Avastin commitment to those patients who elect to enroll in the
program. A
maximum amount of $55,000 of gross revenue earned from an
35
enrolled
patient will be recognized ratably over the total number of product vials
used
for infusions from their physicians which were obtained through normal
commercial channels as well as those vials we will deliver directly to their
physician in conjunction with the Avastin Patient Assistance Program. As
a
result of our announced commitment to the program and because retroactive
credit
provisions are applicable for patients currently on Avastin for all FDA-approved
indications, we deferred $9 million of our fourth quarter 2006 Avastin product
sales to reflect our estimate of the free Avastin commitments we incurred
for
patients treated in the fourth quarter of 2006 who will receive free Avastin
later in the course of their therapy.
In
order to make our estimate of the amount of free Avastin to be provided to
patients under the program, we need to estimate several factors, most notably:
the number of patients who are currently being treated for FDA-approved
indications and the start date for their treatment regimen, the extent to
which
doctors and patients may elect to enroll in the program, the number of patients
who will meet the financial eligibility requirements of the program, and
the
duration and extent of treatment for the FDA-approved indications, among
other
factors. We have based our enrollment assumptions on physician surveys and
other
information that we consider relevant. We have analyzed a range of reasonably
possible outcomes, and as of December 31, 2006, the range of reasonably possible
outcomes was estimated to be between $3 million and $20 million, with $9
million
as the most likely outcome in that range. We will continue to update our
estimates in each reporting period as new information becomes available.
If the
actual results underlying this deferred revenue accounting vary significantly
from our estimates, we will need to make adjustments to these estimates,
which
could have a material effect on revenue and earnings in the period of
adjustment.
Product
Sales Allowances
Revenues
from U.S. product sales are recorded net of allowances and accruals for rebates,
healthcare provider contractual chargebacks, prompt pay sales discounts,
product
returns, and wholesaler inventory management allowances, all of which are
established at the time of sale. Sales allowances and accruals are based
on
estimates of the amounts earned or to be claimed on the related sales. The
amounts reflected in our Consolidated Statements of Income as total product
sales allowances, have been relatively consistent at approximately seven
to
eight percent of gross sales. In order to prepare our Consolidated Financial
Statements, we are required to make estimates regarding the amounts earned
or to
be claimed on the related product sales.
Definitions
for the product sales allowance types are as follows:
|
·
|
Rebate
allowances and accruals are comprised of both direct and indirect
rebates.
Direct rebates are contractual price adjustments payable to direct
customers, mainly to wholesalers and specialty pharmacies, that
purchase
products directly from us. Indirect rebates are contractual price
adjustments payable to healthcare providers and organizations such
as
clinics, hospitals, pharmacies, Medicaid and group purchasing
organizations that do not purchase products directly from
us;
|
|
·
|
Prompt
pay sales discounts are credits granted to wholesalers for remitting
payment on their purchases within established cash repayment incentive
periods;
|
|
·
|
Product
return allowances are established in accordance with our Product
Returns
Policy. Our returns policy allows product returns within the period
beginning two months prior to and six months following product
expiration;
|
|
·
|
Wholesaler
inventory management allowances are credits granted to wholesalers
for
compliance with various contractually-defined inventory management
programs. These programs were created to align purchases with underlying
demand for our products and to maintain consistent inventory levels,
typically at two to three weeks of sales depending on the product;
and
|
|
·
|
Healthcare
provider contractual chargebacks are the result of contractual
commitments
by us to provide products to healthcare providers at specified
prices or
discounts.
|
36
We
believe that our estimates related to product returns allowances and wholesaler
inventory management payments are not material amounts, based upon the
historical levels of credits and allowances as a percentage of product sales.
We
believe our estimates related to healthcare provider contractual chargebacks
and
prompt pay sales discounts do not have a high degree of estimation complexity
or
uncertainty as the related amounts are settled within a short period of time.
We
consider rebate allowances and accruals to be the only process that involves
both material amounts, and requires a higher degree of subjectivity and judgment
necessary to account for the rebate allowances or accruals. As a result of
the
uncertainties involved in estimating rebate allowances and accruals, there
is a
likelihood that materially different amounts could be reported under different
conditions or using different assumptions.
Our
rebates are based upon definitive agreements or legal requirements (such
as
Medicaid). These rebates are primarily estimated using historical and other
data, including patient usage, customer buying patterns, applicable contractual
rebate rates and contract performance by the benefit providers. Direct rebates
are accrued at the time of sale and recorded as allowances against trade
accounts receivable; indirect (including Medicaid) rebates are accrued at
the
time of sale and recorded as liabilities. Rebate estimates are evaluated
quarterly and may require changes to better align our estimates with actual
results. As part of this evaluation, we review changes to Medicaid legislation,
changes to State rebate contracts, changes in the level of discounts, and
significant changes in product sales trends. Although rebates are accrued
at the
time of sale, rebates are typically paid out, on average, up to six months
after
the sale. We believe our rebate allowances and accruals estimation process
provides a high degree of confidence in the amounts established and that
the
annual allowance amounts provided for would not vary by more than approximately
3% based on our estimate that our changes in rebate allowances and accruals
estimates related to prior years have not exceeded 3%. To illustrate our
sensitivity to changes in the rebate allowances and accruals process, as
much as
a 10% change in the rebate allowances and accruals provision we recognized
in
2006 (which is in excess of three times the level of variability we have
recently observed for rebates) would have an approximately $13 million effect
on
our income before taxes (or less than $0.01 per share, after tax). The total
rebate allowances and accruals recorded in our Consolidated Balance Sheets
were
$53 million as of December 31, 2006 and $50 million as of December 31, 2005.
All
of the aforementioned categories of allowances and accruals are evaluated
quarterly and adjusted when trends or significant events indicate that a
change
in estimate is appropriate. Such changes in estimate could materially affect
our
results of operations or financial position; however, to date they have not
been
material. However, it is possible that we may need to adjust our estimates
in
future periods. As of December 31, 2006, our Consolidated Balance Sheet
reflected estimated product sales allowance reserves and accruals totaling
approximately $139 million and for the year ended December 31, 2006, our
net
product sales were approximately $7,640 million.
Royalties
For
substantially all of our agreements with licensees, we estimate royalty revenue
and royalty receivables in the periods these royalties are earned, in advance
of
collection. Our estimate of royalty revenue and receivables in those instances
is based upon communication with some licensees, historical information and
forecasted sales trends. Differences between actual revenues and estimated
royalty revenues are adjusted for in the period in which they become known,
typically the following quarter. Historically, such adjustments have not
been
material to our consolidated financial condition or results of
operations.
Income
Taxes
Income
tax expense is based on income before taxes and is computed using the liability
method. Deferred tax assets and liabilities are determined based on the
difference between the financial statement and tax basis of assets and
liabilities using tax rates projected to be in effect for the year in which
the
differences are expected to reverse. Significant estimates are required in
determining our provision for income taxes. Some of these estimates are based
on
interpretations of existing tax laws or regulations. Various internal and
external factors may have favorable or unfavorable effects on our future
effective income tax rate. These factors include, but are not limited to,
changes in tax laws, regulations and/or rates, changing interpretations of
existing tax laws or regulations, changes in estimates of prior years’ items,
past and future levels of R&D spending, and changes in overall levels of
income before taxes.
37
Inventories
Inventories
include currently marketed products manufactured under a new process or at
facilities awaiting regulatory approval. These inventories are capitalized
based
on management’s judgment of probable near term regulatory approval. The
valuation of inventory requires us to estimate the value of inventory that
may
become expired prior to use or that may fail to be released for commercial
sale.
The determination of obsolete inventory requires us to estimate the future
demands for our products, and in the case of pre-approval inventories, to
estimate the regulatory approval date for the product or for the licensure
of
either the manufacturing facility or the new manufacturing process. We may
be
required to expense previously capitalized inventory costs upon a change
in our
judgment, due to, among other potential factors, a denial or delay of approval
of a product or the licensure of either a manufacturing facility or a new
manufacturing process by the necessary regulatory bodies, or new information
that suggests that the inventory will not be saleable.
Employee
Stock-Based Compensation—Adoption of FAS 123R
On
January 1, 2006, we began accounting for employee stock-based compensation
in
accordance with FAS 123R. Under the provisions of FAS 123R, employee
stock-based compensation is estimated at the date of grant based on the employee
stock award’s fair value using the Black-Scholes option-pricing model and is
recognized as expense ratably over the requisite service period in a manner
similar to other forms of compensation paid to employees. The Black-Scholes
option-pricing model requires the use of certain subjective assumptions.
The
most significant of these assumptions are our estimates of the expected
volatility of the market price of our stock and the expected term of the
award.
Due to the redemption of our Special Common Stock in June 1999 (or “Redemption”)
by Roche Holdings, Inc. (or “Roche”), there is limited historical information
available to support our estimate of certain assumptions required to value
our
stock options. When establishing an estimate of the expected term of an award,
we consider the vesting period for the award, our recent historical experience
of employee stock option exercises (including forfeitures), the expected
volatility, and a comparison to relevant peer group data. As required under
the
accounting rules, we review our valuation assumptions at each grant date
and, as
a result, our valuation assumptions used to value employee stock-based awards
granted in future periods may change. As of December 31, 2006, total
compensation cost related to unvested stock options not yet recognized was
$839
million, which is expected to be allocated to expense and production costs
over
a weighted-average period of 28 months. For the year ended December 31, 2006,
employee stock-based compensation expense, net of tax, was approximately
$182
million, or $0.17 per diluted share. For 2007, employee stock-based compensation
is expected to be in the range of $0.23 to $0.25 per diluted share, of which
$0.04 represents employee stock-based compensation expense as a component
of
cost of sales, which had previously been capitalized in
inventory.
38
Results
of Operations
(In
millions, except per share amounts)
|
Annual
Percentage Change
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
||||||||||||
|
Product
sales
|
$
|
7,640
|
$
|
5,488
|
$
|
3,749
|
39
|
%
|
46
|
%
|
||||||
|
Royalties
|
1,354
|
935
|
641
|
45
|
46
|
|||||||||||
|
Contract
revenue
|
290
|
210
|
231
|
38
|
(9
|
)
|
||||||||||
|
Total
operating revenues
|
9,284
|
6,633
|
4,621
|
40
|
44
|
|||||||||||
|
Cost
of sales
|
1,181
|
1,011
|
673
|
17
|
50
|
|||||||||||
|
Research
and development
|
1,773
|
1,262
|
948
|
40
|
33
|
|||||||||||
|
Marketing,
general and administrative
|
2,014
|
1,435
|
1,088
|
40
|
32
|
|||||||||||
|
Collaboration
profit sharing
|
1,005
|
823
|
594
|
22
|
39
|
|||||||||||
|
Recurring
charges related to redemption
|
105
|
123
|
145
|
(15
|
)
|
(15
|
)
|
|||||||||
|
Special
items: litigation-related
|
54
|
58
|
37
|
(7
|
)
|
57
|
||||||||||
|
Total
costs and expenses
|
6,132
|
4,712
|
3,485
|
30
|
35
|
|||||||||||
|
Operating
income
|
3,152
|
1,921
|
1,136
|
64
|
69
|
|||||||||||
|
Other
income (expense):
|
||||||||||||||||
|
Interest
and other income (expense), net
|
325
|
142
|
91
|
129
|
56
|
|||||||||||
|
Interest
expense
|
(74
|
)
|
(50
|
)
|
(7
|
)
|
48
|
614
|
||||||||
|
Total
other income, net
|
251
|
92
|
84
|
173
|
10
|
|||||||||||
|
Income
before taxes
|
3,403
|
2,013
|
1,220
|
69
|
65
|
|||||||||||
|
Income
tax provision
|
1,290
|
734
|
435
|
76
|
69
|
|||||||||||
|
Net
income
|
$
|
2,113
|
$
|
1,279
|
$
|
785
|
65
|
63
|
||||||||
|
Earnings
per share:
|
||||||||||||||||
|
Basic
|
$
|
2.01
|
$
|
1.21
|
$
|
0.74
|
66
|
64
|
||||||||
|
Diluted
|
$
|
1.97
|
$
|
1.18
|
$
|
0.73
|
67
|
62
|
||||||||
|
Pretax
operating margin
|
34
|
%
|
29
|
%
|
25
|
%
|
||||||||||
|
COS
as a % of product sales
|
15
|
18
|
18
|
|||||||||||||
|
R&D
as a % of operating revenues
|
19
|
19
|
21
|
|||||||||||||
|
MG&A
as a % of operating revenues
|
22
|
22
|
24
|
|||||||||||||
|
NI
as a % of operating revenues
|
23
|
19
|
17
|
|||||||||||||
|
Tax
rate
|
38
|
36
|
36
|
|||||||||||||
________________________
Percentages
in this table and throughout our discussion and analysis of financial condition
and results of operations may reflect rounding adjustments.
Total
Operating Revenues
Total
operating revenues increased 40% to $9,284 million in 2006 and increased
44% to
$6,633 million in 2005. These
increases were primarily due to higher product sales and royalty revenue,
and
are further discussed below.
39
Total
Product Sales
(In
millions)
|
Annual
Percentage Change
|
||||||||||||||||
|
Product
Sales
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
|||||||||||
|
Net
U.S. Product Sales
|
||||||||||||||||
|
Avastin
|
$
|
1,746
|
$
|
1,133
|
$
|
545
|
54
|
%
|
108
|
%
|
||||||
|
Rituxan
|
2,071
|
1,832
|
1,574
|
13
|
16
|
|||||||||||
|
Herceptin
|
1,234
|
747
|
479
|
65
|
56
|
|||||||||||
|
Lucentis
|
380
|
-
|
-
|
-
|
-
|
|||||||||||
|
Xolair
|
425
|
320
|
188
|
33
|
70
|
|||||||||||
|
Tarceva
|
402
|
275
|
13
|
46
|
*
|
|||||||||||
|
Nutropin
products
|
378
|
370
|
349
|
2
|
6
|
|||||||||||
|
Thrombolytics
|
243
|
218
|
194
|
11
|
12
|
|||||||||||
|
Pulmozyme
|
199
|
186
|
157
|
7
|
18
|
|||||||||||
|
Raptiva
|
90
|
79
|
52
|
14
|
52
|
|||||||||||
|
Total
U.S. product sales
|
7,169
|
5,162
|
3,551
|
39
|
45
|
|||||||||||
|
Net
product sales to collaborators
|
471
|
326
|
198
|
44
|
65
|
|||||||||||
|
Total
product sales
|
$
|
7,640
|
$
|
5,488
|
$
|
3,749
|
39
|
46
|
||||||||
________________________
|
*
|
Calculation
not meaningful.
|
|
The
values shown above are exact; therefore, the totals may not appear
to sum
due to rounding.
|
Total
net product sales increased 39% to $7,640 million in 2006 and increased 46%
to
$5,488 million in 2005.
Net U.S. sales increased 39%
to $7,169 million in 2006
and increased 45%
to $5,162 million in 2005.
These increases in U.S. sales were due to higher sales across all products,
in
particular higher sales of our oncology products and sales of Lucentis in
2006.
U.S. oncology sales accounted for 76% of U.S. product sales in 2006 compared
to
77% in 2005. Increased U.S. sales volume accounted for 89%,
or $1,785
million, of the increase in U.S. net product sales in 2006, and 88%,
or $1,411
million in 2005.
The increased U.S. sales volume in 2006 also included new product shipments
of
Lucentis.
Changes in net U.S. sales prices across the portfolio accounted for most
of the
remainder of the increases in U.S. net product sales in 2006 and 2005.
Effective
July 1, 2006, we made changes to our distribution model for Avastin, Herceptin
and Rituxan and renegotiated our distribution agreements with a number of
our
major wholesalers. As part of these changes, the time at which we recognize
products sales revenue for domestic product shipments changed from the time
at
which we ship our products to the time at which our products arrive at the
designated receiving location. These distribution changes did not have a
material effect on our 2006 results of operations.
Our
references to market research and market adoption and penetration by treatment
regimen are derived from our analyses of market tracking studies and surveys
we
undertake with physicians. We use statistical analyses to extrapolate the
data
we obtain.
Avastin
Net
U.S. sales of Avastin increased 54%
to $1,746 million in 2006 and 108% to $1,133 million in 2005.
Net U.S. sales in 2006 reflect $9 million of deferred revenue resulting from
the
announcement of our Avastin Patient Assistance Program and our estimated
free
drug commitment for patients currently on Avastin for an FDA-approved
indication. The increase in sales in 2006 was primarily a result of increased
use of Avastin in metastatic NSCLC,
approved on October 11, 2006, and metastatic
breast
cancer,
an unapproved use
of Avastin. In addition, the increase reflects modest gains
in the treatment of first-line metastatic colorectal cancer (or “CRC”), for
which
Avastin is approved. Growth
in the use of Avastin for the treatment of metastatic NSCLC was due to greater
pre-launch adoption and post-launch penetration rates during 2006 as compared
to
2005. In first-line metastatic NSCLC we estimate that Avastin penetration
was
26% among all first-line NSCLC patients in the fourth quarter of 2006. In
first-line metastatic CRC, we estimate that Avastin penetration was up slightly
to 72% during 2006 as compared to
40
2005;
however, over the course of 2006 we observed a flattening in penetration,
duration and dose. These
increases were partially offset by declining revenues
in metastatic renal
cell carcinoma (or “RCC”) and metastatic pancreatic cancer,
both unapproved uses. As
a result of competing products that have entered the market since the first
quarter of 2006, we have seen a decline in the adoption of Avastin in metastatic
RCC (an unapproved use). Revenues from metastatic pancreatic cancer have
also
declined following our June 2006 announcement that we halted a Phase III
trial
of Avastin in combination with chemotherapy for the first-line treatment
of
advanced pancreatic cancer because of failure to meet the primary endpoint
of
overall survival.
Growth in 2005 relative to 2004 was primarily a result of increased use of
Avastin in CRC. There
were no price increases in 2006 or 2005.
We
anticipate that the major driver of Avastin growth for 2007 will come from
use
in the first-line treatment of metastatic NSCLC.
In
September 2006, we received a Complete Response Letter from the FDA for the
sBLA
for Avastin with chemotherapy in first-line metastatic breast cancer. The
FDA
has requested a substantial safety and efficacy update from the E2100 trial,
including an independent review of patient scans for progression free survival,
the study’s primary endpoint. We are currently addressing the FDA’s requests and
based on the scope of their request, we anticipate we will be able to resubmit
the application to the FDA in mid-2007. A new six-month review period will
begin
once the additional information is submitted to the FDA.
On
February 21, 2007, we announced that a Roche-sponsored Phase III study
evaluating two different doses of Avastin in combination with gemcitabine
and
cisplatin chemotherapy met the primary endpoint of prolonging progression-free
survival (or “PFS”) in patients with previously untreated, advanced NSCLC. This
study evaluated a 15 mg/kg/every 3 weeks dose of Avastin (the dose approved
in
the U.S. for use in combination with carboplatin and paclitaxel) and a lower
dose of 7.5 mg/kg/every 3 weeks (a dose not approved for use in the U.S.).
Both
doses of Avastin significantly improved PFS compared to chemotherapy alone
as
assessed by trial investigators. Although the study was not designed to compare
the Avastin doses, a similar treatment effect in PFS was observed between
the
two arms.
Rituxan
Net
U.S. sales of Rituxan increased 13%
to $2,071 million in 2006 and
16%
to $1,832 million in 2005.
Rituxan’s channel inventory finished the year at the upper level of our target
range, adding approximately $10 million to $12 million to 2006 sales.
Sales
growth in 2006 resulted from increased use of Rituxan in rheumatoid arthritis,
approved on February 28, 2006, as well as Rituxan following chemotherapy
in
combined NHL, including areas of unapproved use, and chronic lymphocytic
leukemia (or “CLL”), an unapproved use. We estimate that Rituxan’s overall
adoption rate in combined markets of NHL and CLL remained flat at 82% at
the end
of 2006 and at the end of 2005. Also contributing to the increases in product
sales were price increases effective on July 6, 2005, October 5, 2005, March
29,
2006, and October 5, 2006.
The
sales growth in 2005 resulted from increased physician adoption for treatment
of
indolent NHL with ongoing use of Rituxan following induction therapy, treatment
of aggressive NHL, and treatment of CLL (unapproved uses of Rituxan in 2005).
Net
U.S. sales in 2005 included $10 million for a reorder to replace a shipment
that
was destroyed while in transit to a wholesaler. Also
contributing to the increases in product sales were price increases in 2005
noted above.
Rituxan
was approved for the treatment of adult patients with moderately-to-severely
active RA in the first quarter of 2006. It
remains difficult to precisely determine the sales split between Rituxan
use in
oncology and immunology settings since many treatment centers treat both
types
of patients.
Herceptin
Net
U.S. sales of Herceptin increased
65% to $1,234 million in 2006 and 56% to $747 million in 2005.
The sales growth in 2006 and 2005 was primarily the result of increased use
of
Herceptin in the treatment of early stage HER2-positive breast cancer (approved
on November 16, 2006), increased use in the treatment of first-line
HER2-positive
41
metastatic
breast cancer, and increased cumulative duration of therapy relative to the
comparable periods in 2005 and 2004. In first-line HER2-positive metastatic
breast cancer patients, we estimate Herceptin’s penetration remained flat at 70%
at the end of 2006 as adoption was also 70% at the end of 2005. While use
in
early stage breast cancer patients increased in 2006 relative to 2005, we
believe usage in this setting flattened in the second half of 2006. We estimate
Herceptin’s penetration in the adjuvant setting was 62% at the end of 2006 as
compared to 43% adoption at the end of 2005. Also contributing, to a lesser
extent, to the increases in product sales were price increases effective
on
February 24, 2005, March 29, 2006, and October 3, 2006.
Lucentis
We
received FDA approval to market Lucentis for the treatment of AMD on June
30,
2006.
Net U.S. sales of $380 million in 2006 were driven by high demand among existing
AMD patients previously on other therapies and by newly diagnosed patients.
We
estimate that as of December 31, 2006 approximately 75 percent of Lucentis
patients were AMD patients previously on other therapies that were switched
to
Lucentis and the remaining 25 percent were newly diagnosed patients. Our
market
research indicates that at six months post launch approximately 55 percent
of
newly diagnosed patients were treated with Lucentis. Sales growth in 2007
may be
negatively impacted by (i) a decrease in existing AMD patients switching
to
Lucentis from other therapies, as we believe most of the existing AMD patients
were switched to Lucentis or have chosen not to change therapies; (ii) less
frequent dosing of existing patients who have completed their first four
months
of treatment; and (iii) continued use of Avastin in this setting.
Xolair
Net
U.S. sales of Xolair increased 33% to $425
million in 2006 and 70% to $320 million in 2005.
Sales growth in 2006 and 2005 were driven by increased penetration in the
asthma
market and, to a lesser extent, price increases effective on July 21, 2005,
April 4, 2006, and October 17, 2006.
On
February 21, 2007, the FDA announced it requested that Genentech strengthen
the
existing warning on the potential risk for anaphylaxis in patients receiving
Xolair by adding a boxed warning to the product label and implementing a
Risk
Mitigation Action Plan, including providing a medication guide for patients.
Genentech and Novartis will be working with FDA on its request.
Tarceva
Net
U.S. sales of Tarceva increased 46% to $402
million in 2006. Net U.S. sales in 2005 were $275
million after the product launch in November 2004. The increase in product
sales
in 2006 was primarily due to price increases effective on April 5, 2005,
November 9, 2005, and November 14, 2006. Also affecting our product sales
was
growth in penetration and duration of treatment in both second-line NSCLC
and
first-line pancreatic cancer; however, penetration in second-line NSCLC
decreased in the second half of 2006. We estimate Tarceva’s penetration in
second-line NSCLC averaged 30% in 2006 compared to 24% in 2005. We estimate
Tarceva’s penetration in the first-line pancreatic cancer setting was 40% at the
end of 2006 as compared to 24% at
the end of 2005. Future
sales growth in NSCLC will depend on gains in penetration against chemotherapy
within select second-line NSCLC patient subsets, increased patient compliance
with prescribed therapy, continuing recent gains in duration of therapy,
and
reducing obstacles for patient access to therapy.
Nutropin
Products
Combined
net U.S. sales of our Nutropin products increased 2% to
$378 million in 2006 and
6%
to $370 million in 2005. The
increases in 2006 and 2005 were primarily due to price increases effective
on
March 3, 2005 and January 10, 2006. The 2006 increase in price was partially
offset by a decrease in sales volume in 2006 compared to 2005, resulting
from
declining new patient market share and the loss of managed care product
placement due to price discounting by competitors.
42
Thrombolytics
Combined
net U.S. sales of our three thrombolytics products, Activase, Cathflo Activase,
and TNKase, increased 11% to
$243 million in 2006 and
12%
to $218 million in 2005.
Sales
growth in 2006 and 2005 was due to growth in Cathflo Activase sales in the
catheter clearance market and increased Activase sales in the acute ischemic
stroke market. Also contributing to the increases in product sales were price
increases effective on January 11, 2005, February 14, 2006, and July 6,
2006.
Pulmozyme
Net
U.S. sales of Pulmozyme increased 7% to
$199 million in 2006 and
18%
to $186 million in 2005.
The sales growth in both 2006 and 2005 represents
price increases effective on April 26, 2005 and June 29, 2006, as well as
a
focus on aggressive treatment of cystic fibrosis early in the course of the
disease.
Raptiva
Net
U.S. sales of Raptiva increased 14% to
$90 million in 2006 and
52% to
$79 million in 2005.
The growth in 2006 was primarily due to price increases effective on April
21,
2005, November 17, 2005, and August 10, 2006.
Sales
to Collaborators
Product
sales to collaborators, the majority of which were for non-U.S. markets,
increased 44% to
$471
million in 2006 and 65%
to $326
million in 2005. The increase in 2006 was primarily due to higher sales of
Herceptin, Avastin and Rituxan to F. Hoffmann-La Roche. The increase in 2005
was
primarily due to sales of Avastin and Rituxan to F. Hoffmann-La Roche and
sales
of product manufactured under a contract with a third party. In January 2007,
Novartis received European Union approval for Lucentis for the treatment of
patients with wet AMD. For 2007, we expect sales to collaborators to
approximately double relative to 2006 levels.
Royalties
Royalty
revenues increased 45% to
$1,354 million in 2006 and
46%
to $935 million in 2005.
The increases were due to higher sales by F. Hoffmann-La Roche of Herceptin,
Avastin and Rituxan in 2006, and Herceptin and Rituxan in 2005; and higher
sales
by various other licensees on other products. Of the overall royalties
recognized, royalty revenue from F. Hoffmann-La Roche represented approximately
62% in 2006, 53% in 2005, and 52% in 2004. Also contributing to the increase
in
2005 was a new license arrangement with ImClone Systems, Inc. under which
we
receive royalties on sales of ERBITUX®. We received a one-time payment in the
first quarter of 2005 relating to royalties on ERBITUX® sales from the period
between launch of the product in 2004 and the signing of the agreement in
January 2005. Royalties from other licensees include royalty revenue on our
patents, including our Cabilly patents noted below.
We
have confidential licensing agreements with a number of companies on U.S.
Patent
No. 6,331,415 and No. 4,816,567 (or the “Cabilly patents”), under which we
receive royalty revenue on sales of products that are covered by one or more
of
the Cabilly patents. The ‘567 patent expired in March 2006, while the ‘415
patent expires in December 2018. The licensed products for which we receive
the
most significant Cabilly royalties are Humira®, Remicade®, Synagis®, and
ERBITUX®. Cabilly royalties affect three lines on our Consolidated Statement of
Income: (i) We record gross royalties we receive from Cabilly patent
licensees as royalty revenue; (ii) On royalties we receive from Cabilly
licensees, we in turn pay City of Hope National Medical Center (or “COH”) a
percentage of our royalty revenue and these payments to COH are recorded
with
our marketing, general and administrative (or “MG&A”) expenses as royalty
expense; (iii) We pay royalty expenses directly to COH on sales of our products
that are covered by the Cabilly patents and these payments to COH are recorded
in cost of sales. The overall net pre-tax contribution from revenues and
expenses related to the Cabilly patents was approximately $105 million in
2006,
or approximately $0.06 per diluted share, and $70 million in 2005, or
approximately $0.04 per diluted share, excluding the effects of the one-time
licensee payment we recorded in the first quarter of 2005 as discussed above.
See also
43
Note
8, “Leases, Commitments and Contingencies,” in the Notes to Consolidated
Financial Statements of Part II, Item 8 of this Form 10-K
for further information on our Cabilly patent reexaminations.
Cash
flows from royalty revenues include amounts denominated in foreign currencies.
We currently enter into foreign currency option and forward contracts to
hedge
these foreign currency cash flows. These options and forwards are due to
expire
in 2007 through 2008. See also Note 2, “Summary of Significant Accounting
Policies,” and Note 4, “Investments Securities and Financial Instruments —
Derivative Financial Instruments,” in the Notes
to Consolidated Financial Statements of Part II, Item 8 of this Form
10-K.
For
2007, we expect royalty revenue to increase approximately 25%
over 2006 levels of $1,354 million; however, royalties are difficult to forecast
because of the number of products involved.
Contract
Revenues
Contract
revenues increased 38%
to $290 million in 2006, and decreased
9%
to $210 million in 2005.
The increase in
2006 was primarily due
to higher contract revenues from Hoffmann-La Roche driven by higher
reimbursements related to R&D development efforts on Avastin and
manufacturing plant start-up costs, and a Herceptin milestone payment. Also
contributing to the increase in 2006 were higher reimbursements from Biogen
Idec
related to R&D development efforts on Rituxan (RA and other immunology
indications). The decrease in 2005 was mainly due to lower contract revenues
from our collaborators, including OSI and XOMA, Ltd. (or “XOMA”). Due to the
commercialization of Tarceva in November 2004, subsequent development efforts
on
this product were included in net operating profit sharing with OSI, which
was
reflected in the collaboration profit sharing line. In January 2005, we
restructured our Raptiva collaboration arrangement with XOMA, whereby XOMA
is no
longer obligated to co-develop Raptiva, and we no longer earn contract revenue
on the development of Raptiva. These decreases were partially offset by higher
reimbursements in 2005 on R&D development efforts related to our Rituxan
collaboration with Biogen Idec. See “Related Party Transactions” below for more
information on contract revenue from F. Hoffmann-La Roche.
Contract
revenues vary each quarter and are dependent on a number of factors, including
the timing and level of reimbursements from ongoing development efforts,
milestones and opt-in payments received, and new contract arrangements. For
2007, we expect contract revenues to decrease by approximately 15% as compared
to $290 million in 2006.
Cost
of Sales
Cost
of sales (or “COS”)
as a percentage of net product sales was 15% in 2006 as compared to 18% in
both
2005 and 2004. COS in 2006 and 2005 was favorably affected by increased sales
of
our higher margin products, primarily Lucentis, Avastin, Herceptin and Rituxan
in 2006 and Avastin, Herceptin and Rituxan in 2005. COS in 2005 was also
favorably affected by a reversal of a royalty accrual of $7 million, partially
offset by charges of $41 million in payments to Amgen Inc. (or “Amgen”) and
another collaborator to cancel and amend certain future manufacturing
obligations, higher production costs, and
a $20 million one-time royalty cost associated with a sales milestone that
we
owed a collaborator.
In
2007, we will begin recording employee stock-based compensation expense in
the
cost of sales line related to products sold for which employee stock-based
compensation expense was previously capitalized as part of inventory costs
upon
implementation of FAS 123R on January 1, 2006.
Research
and Development
Research
and development (or “R&D”) expenses increased 40% to $1,773 million in 2006,
and increased 33% to $1,262 million in 2005.
R&D as a percentage of total operating revenues was 19% in 2006 and 2005,
and 21% in 2004. The year-over-year decline in this ratio reflects the increase
in operating revenues.
44
The
major components of R&D expenses were as follows (in
millions):
|
Annual
Percentage Change
|
||||||||||||||||
|
Research
and Development
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
|||||||||||
|
Product
development (including post-marketing)
|
$
|
1,269
|
$
|
935
|
$
|
668
|
36
|
%
|
40
|
%
|
||||||
|
Research
|
326
|
235
|
218
|
39
|
8
|
|||||||||||
|
In-licensing
|
178
|
92
|
62
|
93
|
48
|
|||||||||||
|
Total
|
$
|
1,773
|
$
|
1,262
|
$
|
948
|
40
|
33
|
||||||||
Product
development: Product
development expenses include costs of conducting clinical trials, activities
to
support regulatory filings, and post-marketing expenses, which include Phase
IV
and investigator-sponsored trials and product registries. Such costs include
costs of personnel, drug supply costs, research fees charged by outside
contractors, co-development costs, and facility expenses, including
depreciation. Total development expenses increased 36% to $1,269 million
in 2006
and 40% to $935 million in 2005. See “Products in Development” in the Business
section of Part I, Item 1 of this Form 10-K for further information regarding
our development pipeline.
The
increase in 2006 expense was primarily driven by: (i) $184 million
higher development expenses due to
increased activity across our entire product portfolio, including increased
spending on clinical programs, including late-stage clinical trials for Avastin,
Rituxan Immunology, humanized anti-CD20, and other programs, early stage
projects and higher clinical manufacturing expenses in support of our clinical
trials; and (ii) a $37 million increase in post-marketing expense related
to
studies of Avastin, Lucentis, Rituxan Immunology and Xolair.
In addition, development expenses in 2006 included $113 million of employee
stock-based compensation expense related to FAS 123R.
The
increase in 2005 expense was primarily driven by: (i) $222 million higher
development expenses due to an increase in clinical programs including our
broad
Avastin development program, Rituxan Immunology, Lucentis, anti-HER2 and
BR3-Fc
for rheumatoid arthritis; higher clinical manufacturing start-up costs
associated with new contract sites, including costs related to testing the
Herceptin manufacturing process at Wyeth, increased clinical manufacturing
of
our anti-CD20 molecule, and various new molecular entities including
Apo2L/TRAIL; and increased headcount and related expenses and higher
depreciation and facility expenses; and (ii) a $45 million increase in
post-marketing expense related to studies of Avastin, Rituxan Immunology,
Lucentis and Nutropin.
Research: Research
includes expenses associated with research and testing of our product candidates
prior to reaching the development stage. Such expenses primarily include
the
costs of internal personnel, outside contractors, facilities, including
depreciation, and lab supplies. Personnel costs primarily include salary,
benefits, recruiting and relocation costs. Research expenses increased 39%
to
$326 million in 2006 and 8% to $235 million
in 2005. The primary driver of the increase in both years was an increase
in
internal personnel and related expenses, and outside contractors for research
and testing of product candidates. In addition, research expenses in 2006
included $27 million of employee stock-based compensation expense related
to FAS
123R.
In-licensing: In-licensing
includes costs incurred to acquire licenses to develop and commercialize
various
technologies and molecules. In-licensing expenses increased 93%
to $178 million in 2006 and 48% to $92 million in 2005. The increase in 2006
primarily related to new
in-licensing collaborations with (i) Exelixis to co-develop a small-molecule
inhibitor of methyl ethyl keyton (or “MEK”), (ii) AC Immune to research and
develop anti-beta-amyloid antibodies for the potential treatment of Alzheimer’s
and other diseases, (iii) Inotek Pharmaceuticals Corporation to discover,
develop, manufacture and commercialize inhibitors of poly (ADP-ribose)
polymerase (or “PARP”) for the potential treatment of cancer, and (iv) CGI
Pharmaceuticals to research, develop, manufacture, and commercialize
therapeutics for the potential treatment of cancer and immunological
disorders.
The increase in 2005 was primarily due to the expansion of research
collaborations.
For
2007, we expect R&D absolute dollar spending to increase over 2006 levels
due to continued investment in our late stage pipeline, and the addition
of new
molecules and indications to the early stage pipeline.
45
Marketing,
General and Administrative
Overall
marketing, general and administrative (or “MG&A”) expenses increased
40%
to $2,014 million
in 2006 and 32%
to $1,435 million in 2005.
MG&A as a percentage of total operating revenues was 22% in 2006 and 2005,
and 24% in 2004. The decline in this ratio since 2004 primarily reflects
the
increase in operating revenues.
The
increase in 2006 expense was primarily due to: (i)
an increase of $149 million in marketing and sales spending primarily in
support
of launch activities related to Lucentis for AMD and Rituxan for RA; (ii)
an
increase of $84 million in marketing and sales spending on Avastin primarily
in
support of launch activities for NSCLC, a recently approved indication, and
pre-launch activities for a potential breast cancer indication; (iii) a $47
million increase resulting from ongoing marketing efforts with established
products, primarily Herceptin, partially offset by a $40 million decrease
in
Raptiva marketing costs; (iv) an increase of $131 million in support of our
continued corporate growth including headcount growth and headcount related
expenses, charitable donations, of which $26 million related to increased
donations to independent public charities that provide co-pay assistance
to
eligible patients, and legal costs; and (v) an increase of $39 million in
royalty expense, primarily to Biogen Idec resulting from higher Hoffmann-La
Roche sales of Rituxan.
In addition, MG&A expenses in 2006 included $169 million of employee
stock-based compensation expense related to FAS 123R.
The
increase in 2005 expense was primarily due to: (i) an increase of $121 million
primarily in support of the launch of Tarceva and higher marketing costs
for
Avastin, Xolair and Raptiva; (ii) an increase of $89 million primarily due
to
pre-launch costs associated with pipeline products, including Rituxan RA
and
Lucentis and other pipeline product investments; (iii) an increase of $19
million resulting from ongoing marketing efforts with established products,
primarily Herceptin; (iv) an increase of $79 million in general corporate
expenses to support our continued growth and higher legal costs; and (v)
$39
million in increased charitable donations, of which $21 million was donated
to
various independent, third party, public charities that provide co-pay
assistance to eligible patients, and $13 million was donated to the Genentech
Foundation, which primarily funds health science education.
For
2007, we expect MG&A expense to increase primarily driven by higher costs in
support of recently launched products and anticipated launches of potential
new
product indications, including those for Avastin, and continued support of
our
corporate growth and infrastructure needs.
Collaboration
Profit Sharing
Collaboration
profit sharing expenses increased 22%
to $1,005 million in 2006 and 39%
to $823 million in 2005 due
to higher sales of Rituxan, Tarceva and Xolair and the related profit sharing
expenses. Our collaboration profit sharing expenses are expected to grow
in
2007, consistent with our expectations of higher sales for the respective
products.
The
following table summarizes the amounts resulting from the respective profit
sharing collaborations, for the periods presented (in
millions):
|
Annual
Percentage Change
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
||||||||||||
|
U.S.
Rituxan profit sharing expense
|
$
|
672
|
$
|
603
|
$
|
518
|
11
|
%
|
16
|
%
|
||||||
|
U.S.
Tarceva profit sharing expense
|
146
|
83
|
-
|
76
|
-
|
|||||||||||
|
U.S.
and ex-U.S. Xolair profit sharing expense
|
187
|
137
|
76
|
36
|
80
|
|||||||||||
|
Total
collaboration profit sharing expense
|
$
|
1,005
|
$
|
823
|
$
|
594
|
22
|
39
|
||||||||
Currently,
our most significant collaboration profit sharing agreement is with Biogen
Idec,
with whom we co-promote Rituxan in the U.S. Under the collaboration agreement,
Biogen Idec granted us a worldwide license to develop, commercialize and
market
Rituxan in multiple indications. In exchange for these worldwide rights,
Biogen
Idec has co-promotion rights in the U.S. and a contractual arrangement under
which we share a portion of the pretax U.S. co-promotion profits of Rituxan
and
royalty revenue on sales of Rituxan by collaborators. In June 2003, we
46
amended
and restated the collaboration agreement with Biogen Idec to include the
development and commercialization of one or more anti-CD20 antibodies targeting
B-cell disorders, in addition to Rituxan, for a broad range of indications.
Under
the amended and restated collaboration agreement, our share of the current
pretax U.S. co-promotion profit sharing formula is approximately 60% of
operating profits and Biogen Idec’s share is approximately 40% of operating
profits. For each calendar year or portion thereof following the approval
date
of the first new anti-CD20 product, over a period of transition, our share
of
the pretax U.S. co-promotion profits will change to approximately 70% of
operating profits and Biogen Idec’s share will be approximately 30% of operating
profits.
Collaboration
profit sharing expense, exclusive of research and development expenses, related
to Biogen Idec for the years ended December 31, 2006, 2005 and 2004, consisted
of the following commercial activity (in
millions):
|
Annual
Percentage Change
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
||||||||||||
|
Product
sales, net
|
$
|
2,071
|
$
|
1,832
|
$
|
1,574
|
13
|
%
|
16
|
%
|
||||||
|
Combined
commercial costs and expenses
|
489
|
390
|
316
|
25
|
23
|
|||||||||||
|
Combined
co-promotion profits
|
$
|
1,582
|
$
|
1,442
|
$
|
1,258
|
10
|
15
|
||||||||
|
Amount
due to Biogen Idec for their share of co-promotion profits - included
in
collaboration profit sharing expense
|
$
|
672
|
$
|
603
|
$
|
518
|
11
|
16
|
||||||||
Biogen
Idec’s relative share of combined commercial costs determines the amount shown
as collaboration profit sharing expense,
exclusive of research and development expenses.
Total
revenue and expenses related to our collaboration with Biogen Idec included
the
following (in
millions):
|
Annual
Percentage Change
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
||||||||||||
|
Contract
revenue
|
$
|
79
|
$
|
59
|
$
|
41
|
34
|
%
|
44
|
%
|
||||||
|
Co-promotion
profit sharing expense
|
$
|
672
|
$
|
603
|
$
|
518
|
11
|
16
|
||||||||
|
Royalty
expense on ex-U.S. sales of Rituxan and other patent costs - included
in
MG&A expense
|
$
|
175
|
$
|
139
|
$
|
119
|
26
|
17
|
||||||||
Recurring
Charges Related to Redemption
We
record recurring charges related to the June 1999 redemption of our Special
Common Stock and push-down accounting (see discussion below in “Relationship
with Roche — Redemption of Our Special Common Stock”). These charges were
comprised of the amortization of Redemption-related other intangible assets
in
the periods presented.
Special
Items: Litigation-Related
We
recorded accrued interest and bond costs related to the COH trial judgment
of
$54 million each year in 2006, 2005 and 2004.
We expect that we will continue to incur interest charges on the judgment
and
service fees on the surety bond each quarter through the process of appealing
the COH trial results.
The amount of cash paid, if any, or the timing of such payment in connection
with the COH matter will depend on the outcome of the California Supreme
Court’s
review of the matter; however, it may take longer than one year to resolve
this
matter. See
Note 8, “Leases, Commitments and Contingencies,” in the Notes to Consolidated
Financial Statements of Part II, Item 8 of this Form 10-K for further
information regarding our litigation. Also included in this line in 2005
is a
charge related
47
to
a litigation settlement, net of amounts received on a separate litigation
settlement. Also, included
in this line in 2004 is a released accrual as a result of the resolution
of a
separate litigation matter.
Operating
Income
Operating
income increased
64% to $3,152 million in 2006 and increased
69% to $1,921 million
in 2005.
Our operating income as a percentage of operating revenues (or “pretax operating
margin”) was 34% in 2006, 29% in 2005 and 25% in 2004.
Other
Income (Expense)
The
components of “other income (expense)” are as follows (in
millions):
|
Annual
Percentage Change
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2006/2005
|
2005/2004
|
||||||||||||
|
Gains
on sales of biotechnology equity securities, net
|
$
|
93
|
$
|
9
|
$
|
13
|
933
|
%
|
(31
|
)%
|
||||||
|
Write-down
of biotechnology debt and equity securities
|
(4
|
)
|
(10
|
)
|
(12
|
)
|
(60
|
)
|
(17
|
)
|
||||||
|
Interest
income
|
230
|
143
|
90
|
61
|
59
|
|||||||||||
|
Interest
expense
|
(74
|
)
|
(50
|
)
|
(7
|
)
|
48
|
614
|
||||||||
|
Other
miscellaneous income
|
6
|
-
|
-
|
-
|
-
|
|||||||||||
|
Total
other income, net
|
$
|
251
|
$
|
92
|
$
|
84
|
173
|
10
|
||||||||
Other
income, net, increased 173%
to $251 million in 2006, and
increased 10%
to $92 million in 2005.
The components of other income (expense) have changed primarily due to gains on
sales of biotechnology equity securities resulting from Amgen’s acquisition of
Abgenix, Pfizer’s acquisition of Rinat, Stiefel Laboratories acquisition of
Connetics Corporation, and Astra Zeneca’s acquisition of Cambridge Antibody and
the effects of our debt issuance in July 2005. Interest expense increased
in
2006 and 2005 due to the new debt service costs, and in 2006 investment income
increased as a result of the higher average cash balances maintained and
higher
yields. In 2007, we expect other income, net, to be approximately 60% lower
than
2006 levels, although this may vary with fluctuations in interest rates and
unexpected acquisition-related gains from our biotechnology equity
portfolio.
Income
Tax Provision
The
effective income tax rate was 38% in 2006 and 36% in 2005 and 2004. The
effective tax rate in 2006 was higher than 2005 and 2004 primarily due to
new
Final Regulations issued by the U.S. Department of Treasury, which required
a
$34 million reduction in research credits claimed in prior years. The increase
in the 2006 effective income tax rate also resulted from higher income before
taxes in 2006. The effective income tax rate in 2005 was comparable to 2004
but
included a $39 million benefit for increased research credits resulting from
new
Temporary Regulations issued by the U.S. Department of Treasury in 2005.
The
additional benefit in 2005 was partially offset by changes in estimates of
prior
years’ research credits and by higher income before taxes in 2005.
We
anticipate that our annual 2007 effective income tax rate will be approximately
36%, excluding the effect of the potential Tanox acquisition. Various factors
may have favorable or unfavorable effects on our effective income tax rate
during 2007 and in subsequent years. These factors include, but are not limited
to, interpretations of existing tax laws, changes in tax laws and rates,
changes
in estimates to prior years’ items, past and future levels of R&D spending,
and changes in overall levels of income before taxes, all of which may result
in
periodic revisions to our effective income tax rate.
48
Relationship
with Roche
As
a result of the June 1999 redemption of our Special Common Stock (“the
Redemption”) and subsequent public offerings, we amended our certificate of
incorporation and bylaws, amended our licensing and marketing agreement with
F.
Hoffmann-La Roche Ltd (or “Hoffmann-La Roche”), an affiliate of Roche, and
entered into or amended certain agreements with Roche, which are discussed
below:
Affiliation
Arrangements
Our
board of directors consists of three Roche directors, three independent
directors nominated by a nominating committee currently controlled by Roche,
and
one Genentech employee. However, under our bylaws, Roche has the right to
obtain
proportional representation on our board at any time.
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 agree 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 deferred compensation
plans.
|
49
Licensing
Agreements
We
have a July 1999 amended and restated licensing and marketing agreement with
Hoffmann-La Roche and its affiliates granting an option to license, use and
sell
our products in non-U.S. markets. The major provisions of that agreement
include
the following:
|
·
|
Hoffmann-La
Roche’s option expires in 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 Application (or “IND”) for a product, (2) completion of the first
Phase II trial for a product or (3) if Hoffmann-La Roche previously
paid
us a fee of $10 million to extend its option on a product, completion
of a
Phase III trial for that product;
|
|
·
|
if
Hoffmann-La Roche exercises its option to license a product, it
has agreed
to reimburse Genentech for development costs as follows: (1) if
exercise occurs at the time of our decision to file an IND is filed,
Hoffmann-La Roche will pay 50% of development costs incurred prior
to the
filing and 50% of development costs subsequently incurred, (2) if
exercise occurs at the completion of the first Phase II trial,
Hoffmann-La
Roche will pay 50% of development costs incurred through completion
of the
trial, 75% of development costs subsequently incurred for the initial
indications, and 50% of subsequent development costs for new indications,
formulations or dosing schedules, (3) if the exercise occurs at the
completion of a Phase III trial, Hoffmann-La Roche will pay 50%
of
development costs incurred through completion of Phase II, 75%
of
development costs incurred through completion of Phase III, and
75% of
development costs subsequently incurred, and $5 million of the
option
extension fee paid by Hoffmann-La Roche to preserve its right to
exercise
its option at the completion of a Phase III trial will be credited
against
the total development costs payable to Genentech upon the exercise
of the
option, and (4) each of Genentech and Hoffmann-La Roche have the
right to
“opt-out” of developing an additional indication for a product for which
Hoffmann-La Roche exercised its option, and would not share the
costs or
benefits of the additional indication, but could “opt-back-in” within 30
days of decision to file for approval of the indication by paying
twice
what they would have owed for development of the indication if
they had
not opted out;
|
|
·
|
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 or completion
of the first Phase II trial, a royalty of 12.5% on the first $100
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 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 a Phase III trial, a royalty of 15%
on its
sales of that product 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; however, $5 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
million.
|
We
have further amended this licensing and marketing agreement with Hoffmann-La
Roche to delete or add certain Genentech products under Hoffmann-La Roche’s
commercialization and marketing rights for Canada.
We
also have a July 1998 licensing and marketing agreement relating to anti-HER2
antibodies (Herceptin and Omnitarg) with Hoffmann-La Roche, providing them
with
exclusive marketing rights outside of the U.S. Under the agreement, Hoffmann-La
Roche funds one-half the global development costs incurred in connection
with
developing
50
anti-HER2
antibody products under the agreement. Either Genentech or Hoffmann-La Roche
has
the right to “opt-out” of developing an additional indication for a product and
would not share the costs or benefits of the additional indication, but could
“opt-back-in” with 30 days of decision to file for approval of the indication by
paying twice what would have been owed for development of the indication
if no
opt-out had occurred. Hoffmann-La Roche has also agreed to make royalty payments
of 20% on aggregate net product sales outside the U.S. up to $500 million
in
each calendar year and 22.5% on such sales in excess of $500 million in each
calendar year.
Research
Collaboration Agreement
We
have an April 2004 research collaboration agreement with Hoffmann-La Roche
that
outlines the process by which Hoffmann-La Roche and Genentech may agree to
conduct and share in the costs of joint research on certain molecules. The
agreement further outlines how development and commercialization efforts
will be
coordinated with respect to select molecules, including the financial provisions
for a number of different development and commercialization scenarios undertaken
by either or both parties.
Tax
Sharing Agreement
We
have a tax sharing