UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
________________________
FORM
10-Q
________________________
|
(Mark
One)
|
|
|
þ
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
|
For
the quarterly period ended June 30, 2008
|
|
|
|
or
|
|
o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
|
For
the transition period from to .
Commission
File Number: 1-9813
GENENTECH,
INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
(State
or other jurisdiction of incorporation or organization)
|
94-2347624
(I.R.S.
Employer Identification Number)
|
1 DNA
Way, South San Francisco, California 94080-4990
(Address
of principal executive offices and Zip Code)
(650) 225-1000
(Registrant’s
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
|
Large
accelerated filer þ
|
Accelerated
filer o
|
|
Non-accelerated
filer o (Do not
check if a smaller reporting company)
|
Smaller
reporting company o
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
Indicate
the number of shares outstanding of each of the issuer’s classes of Common
Stock, as of the latest practicable date.
|
Class
|
Number of Shares
Outstanding
|
|
Common
Stock $0.02 par value
|
1,055,649,792 Outstanding
at July 31, 2008
|
GENENTECH,
INC.
TABLE
OF CONTENTS
|
|
|
Page
No.
|
|
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PART
I—FINANCIAL INFORMATION
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|
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Item
1.
|
Financial
Statements (unaudited)
|
3
|
|
|
|
|
|
|
Condensed
Consolidated Statements of Income—
for
the three months and six months ended June 30, 2008 and
2007
|
3
|
|
|
|
|
|
|
Condensed
Consolidated Statements of Cash Flows—
for
the six months ended June 30, 2008 and 2007
|
4
|
|
|
|
|
|
|
Condensed
Consolidated Balance Sheets—
June
30, 2008 and December 31, 2007
|
5
|
|
|
|
|
|
|
Notes
to Condensed Consolidated Financial Statements
|
6–17
|
|
|
|
|
|
|
Report
of Independent Registered Public Accounting Firm
|
18
|
|
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|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
19–45
|
|
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|
|
|
Item
3.
|
Quantitative and Qualitative
Disclosures About Market Risk
|
46
|
|
|
|
|
|
Item
4.
|
Controls
and Procedures
|
46
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PART
II—OTHER INFORMATION
|
|
|
|
|
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|
Item
1.
|
Legal
Proceedings
|
47
|
|
|
|
|
|
Item
1A.
|
Risk
Factors
|
47–60
|
|
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
60–61
|
|
|
|
|
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
61–62
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|
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|
Item
6.
|
Exhibits
|
62
|
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|
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SIGNATURES
|
63
|
In
this report, “Genentech,” “we,” “us,” and “our” refer to Genentech,
Inc. and its consolidated subsidiaries. “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. (RHI) 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); Genentech®;
Herceptin®
(trastuzumab) anti-HER2 antibody; Lucentis®
(ranibizumab) 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;
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 registered trademark of OSI Pharmaceuticals, Inc.; and
Xolair®
(omalizumab) anti-IgE antibody is a registered trademark of Novartis AG. This
report also includes other trademarks, service marks, and trade names of other
companies.
GENENTECH,
INC.
(In
millions, except per share amounts)
(Unaudited)
|
|
|
Three
Months
|
|
|
Six
Months
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales (including amounts from related parties:
three
months—2008–$146; 2007–$256;
six
months—2008–$286; 2007–$522)
|
|
$ |
2,536 |
|
|
$ |
2,443 |
|
|
$ |
4,915 |
|
|
$ |
4,773 |
|
|
Royalties
(including amounts from related parties:
three
months—2008–$451; 2007–$296;
six
months—2008–$874; 2007–$557)
|
|
|
629 |
|
|
|
484 |
|
|
|
1,244 |
|
|
|
903 |
|
|
Contract
revenue (including amounts from related parties:
three
months—2008–$35; 2007–$34;
six
months—2008–$66; 2007–$104)
|
|
|
71 |
|
|
|
77 |
|
|
|
140 |
|
|
|
171 |
|
|
Total
operating revenue
|
|
|
3,236 |
|
|
|
3,004 |
|
|
|
6,299 |
|
|
|
5,847 |
|
|
Costs
and expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales (including amounts for related parties:
three
months—2008–$90; 2007–$140;
six
months—2008–$156; 2007–$265)
|
|
|
441 |
|
|
|
429 |
|
|
|
831 |
|
|
|
821 |
|
|
Research
and development (including amounts associated with related party
collaborations:
three
months—2008–$89; 2007–$79;
six
months—2008–$168; 2007–$147)
(including
amounts where reimbursement was recorded as contract revenue:
three
months—2008–$47; 2007–$60;
six
months—2008–$97; 2007–$106)
|
|
|
649 |
|
|
|
603 |
|
|
|
1,266 |
|
|
|
1,213 |
|
|
Marketing,
general and administrative
|
|
|
559 |
|
|
|
532 |
|
|
|
1,076 |
|
|
|
1,023 |
|
|
Collaboration
profit sharing (including related party amounts:
three
months—2008–$48; 2007–$49;
six
months—2008–$89; 2007–$96)
|
|
|
313 |
|
|
|
277 |
|
|
|
592 |
|
|
|
529 |
|
|
Recurring
amortization charges related to redemption and acquisition
|
|
|
43 |
|
|
|
26 |
|
|
|
86 |
|
|
|
52 |
|
|
Special
items: litigation-related
|
|
|
2 |
|
|
|
13 |
|
|
|
(300 |
) |
|
|
26 |
|
|
Total
costs and expenses
|
|
|
2,007 |
|
|
|
1,880 |
|
|
|
3,551 |
|
|
|
3,664 |
|
|
Operating
income
|
|
|
1,229 |
|
|
|
1,124 |
|
|
|
2,748 |
|
|
|
2,183 |
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income, net
|
|
|
93 |
|
|
|
75 |
|
|
|
166 |
|
|
|
149 |
|
|
Interest
expense
|
|
|
(15 |
) |
|
|
(17 |
) |
|
|
(32 |
) |
|
|
(35 |
) |
|
Total
other income, net
|
|
|
78 |
|
|
|
58 |
|
|
|
134 |
|
|
|
114 |
|
|
Income
before taxes
|
|
|
1,307 |
|
|
|
1,182 |
|
|
|
2,882 |
|
|
|
2,297 |
|
|
Income
tax provision
|
|
|
525 |
|
|
|
435 |
|
|
|
1,118 |
|
|
|
844 |
|
|
Net
income
|
|
$ |
782 |
|
|
$ |
747 |
|
|
$ |
1,764 |
|
|
$ |
1,453 |
|
|
Earnings
per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.74 |
|
|
$ |
0.71 |
|
|
$ |
1.68 |
|
|
$ |
1.38 |
|
|
Diluted
|
|
$ |
0.73 |
|
|
$ |
0.70 |
|
|
$ |
1.65 |
|
|
$ |
1.36 |
|
|
Shares
used to compute basic earnings per share
|
|
|
1,051 |
|
|
|
1,053 |
|
|
|
1,052 |
|
|
|
1,053 |
|
|
Shares
used to compute diluted earnings per share
|
|
|
1,064 |
|
|
|
1,070 |
|
|
|
1,066 |
|
|
|
1,071 |
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(In
millions)
(Unaudited)
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
1,764 |
|
|
$ |
1,453 |
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
285 |
|
|
|
215 |
|
|
Employee
stock-based compensation
|
|
|
208 |
|
|
|
203 |
|
|
Deferred
income taxes
|
|
|
217 |
|
|
|
(103 |
) |
|
Deferred
revenue
|
|
|
(7 |
) |
|
|
(29 |
) |
|
Litigation-related
special items
|
|
|
(300 |
) |
|
|
26 |
|
|
Excess
tax benefit from stock-based compensation arrangements
|
|
|
(32 |
) |
|
|
(127 |
) |
|
Gain
on sales of securities available-for-sale and other
|
|
|
(52 |
) |
|
|
(12 |
) |
|
Write-downs
of securities available-for-sale and other
|
|
|
41 |
|
|
|
4 |
|
|
Loss
on property and equipment dispositions
|
|
|
3 |
|
|
|
30 |
|
|
Changes
in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Receivables
and other current assets
|
|
|
(59 |
) |
|
|
(115 |
) |
|
Inventories
|
|
|
83 |
|
|
|
(180 |
) |
|
Investments
in trading securities
|
|
|
(16 |
) |
|
|
(72 |
) |
|
Accounts
payable, other accrued liabilities, and other long-term
liabilities
|
|
|
(455 |
) |
|
|
132 |
|
|
Accrued
litigation
|
|
|
(476 |
) |
|
|
– |
|
|
Net
cash provided by operating activities
|
|
|
1,204 |
|
|
|
1,425 |
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
Purchases
of securities available-for-sale
|
|
|
(953 |
) |
|
|
(465 |
) |
|
Proceeds
from sales of securities available-for-sale
|
|
|
837 |
|
|
|
335 |
|
|
Proceeds
from maturities of securities available-for-sale
|
|
|
159 |
|
|
|
261 |
|
|
Capital
expenditures
|
|
|
(398 |
) |
|
|
(475 |
) |
|
Change
in other intangible and long-term assets
|
|
|
24 |
|
|
|
(8 |
) |
|
Net
cash used in investing activities
|
|
|
(331 |
) |
|
|
(352 |
) |
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
|
Stock
issuances
|
|
|
228 |
|
|
|
276 |
|
|
Stock
repurchases
|
|
|
(756 |
) |
|
|
(666 |
) |
|
Excess
tax benefit from stock-based compensation arrangements
|
|
|
32 |
|
|
|
127 |
|
|
Net
cash used in financing activities
|
|
|
(496 |
) |
|
|
(263 |
) |
|
Net
increase in cash and cash equivalents
|
|
|
377 |
|
|
|
810 |
|
|
Cash
and cash equivalents at beginning of period
|
|
|
2,514 |
|
|
|
1,250 |
|
|
Cash
and cash equivalents at end of period
|
|
$ |
2,891 |
|
|
$ |
2,060 |
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
cash flow data
|
|
|
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
|
|
|
Income
taxes
|
|
$ |
1,030 |
|
|
$ |
806 |
|
|
Interest
|
|
|
31 |
|
|
|
31 |
|
|
Non-cash
investing and financing activities
|
|
|
|
|
|
|
|
|
|
Capitalization
of construction in progress related to financing lease
transactions
|
|
|
75 |
|
|
|
101 |
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(In
millions)
(Unaudited)
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
Current
assets
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
2,891 |
|
|
$ |
2,514 |
|
|
Short-term
investments
|
|
|
1,614 |
|
|
|
1,461 |
|
|
Restricted
cash and investments
|
|
|
788 |
|
|
|
788 |
|
|
Accounts
receivable—product sales (net of allowances of:
2008–$145;
2007–$116; including amounts from related parties:
2008–$46;
2007–$2)
|
|
|
889 |
|
|
|
847 |
|
|
Accounts
receivable—royalties (including amounts from related
parties:
2008–$570;
2007–$463)
|
|
|
732 |
|
|
|
620 |
|
|
Accounts
receivable—other (including amounts from related parties:
2008–$96;
2007–$233)
|
|
|
200 |
|
|
|
299 |
|
|
Inventories
|
|
|
1,406 |
|
|
|
1,493 |
|
|
Deferred
tax assets
|
|
|
385 |
|
|
|
614 |
|
|
Prepaid
expenses
|
|
|
129 |
|
|
|
100 |
|
|
Other
current assets
|
|
|
19 |
|
|
|
17 |
|
|
Total
current assets
|
|
|
9,053 |
|
|
|
8,753 |
|
|
Long-term
marketable debt and equity securities
|
|
|
1,832 |
|
|
|
2,090 |
|
|
Property,
plant and equipment, net
|
|
|
5,266 |
|
|
|
4,986 |
|
|
Goodwill
|
|
|
1,577 |
|
|
|
1,577 |
|
|
Other
intangible assets
|
|
|
1,083 |
|
|
|
1,168 |
|
|
Other
long-term assets
|
|
|
308 |
|
|
|
366 |
|
|
Total
assets
|
|
$ |
19,119 |
|
|
$ |
18,940 |
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders’ equity
|
|
|
|
|
|
|
|
|
|
Current
liabilities
|
|
|
|
|
|
|
|
|
|
Accounts
payable (including amounts to related parties:
2008–$8;
2007–$2)
|
|
$ |
223 |
|
|
$ |
420 |
|
|
Commercial
paper
|
|
|
599 |
|
|
|
599 |
|
|
Deferred
revenue (including amounts from related parties:
2008–$67;
2007–$63)
|
|
|
81 |
|
|
|
73 |
|
|
Taxes
payable
|
|
|
7 |
|
|
|
173 |
|
|
Accrued
litigation
|
|
|
– |
|
|
|
776 |
|
|
Other
accrued liabilities (including amounts to related
parties:
2008–$218;
2007–$230)
|
|
|
1,795 |
|
|
|
1,877 |
|
|
Total
current liabilities
|
|
|
2,705 |
|
|
|
3,918 |
|
|
Long-term
debt
|
|
|
2,475 |
|
|
|
2,402 |
|
|
Deferred
revenue (including amounts from related parties:
2008–$374;
2007–$384)
|
|
|
404 |
|
|
|
418 |
|
|
Other
long-term liabilities
|
|
|
250 |
|
|
|
297 |
|
|
Total
liabilities
|
|
|
5,834 |
|
|
|
7,035 |
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
21 |
|
|
|
21 |
|
|
Additional
paid-in capital
|
|
|
10,878 |
|
|
|
10,695 |
|
|
Accumulated
other comprehensive income
|
|
|
105 |
|
|
|
197 |
|
|
Retained
earnings
|
|
|
2,281 |
|
|
|
992 |
|
|
Total
stockholders’ equity
|
|
|
13,285 |
|
|
|
11,905 |
|
|
Total
liabilities and stockholders’ equity
|
|
$ |
19,119 |
|
|
$ |
18,940 |
|
See
Notes to Condensed Consolidated Financial Statements.
GENENTECH,
INC.
(Unaudited)
|
Note
1.
|
Summary
of Significant Accounting Policies
|
Basis
of Presentation
We
prepared the Condensed Consolidated Financial Statements following the
requirements of the United States (U.S.) Securities and Exchange Commission for
interim reporting. As permitted under those rules, certain footnotes or other
financial information that are normally required by U.S. generally accepted
accounting principles (GAAP) can be condensed or omitted. The information
included in this Quarterly Report on Form 10-Q should be read in conjunction
with the consolidated financial statements and accompanying notes included in
our Annual Report on Form 10-K for the year ended December 31, 2007. In the
opinion of management, the financial statements include all adjustments,
consisting only of normal and recurring adjustments, considered necessary for
the fair presentation of our financial position and operating
results.
Revenue,
expenses, assets, and liabilities can vary during each quarter of the year.
Therefore, the results and trends in these interim financial statements may not
be the same as those reported for the full year or any future
period.
Principles
of Consolidation
The
consolidated financial statements include the accounts of Genentech and all of
our wholly owned subsidiaries. Material intercompany accounts and transactions
have been eliminated.
Use
of Estimates
The
preparation of financial statements in conformity with GAAP requires management
to make judgments, assumptions, and estimates that affect the amounts reported
in our Condensed Consolidated Financial Statements and accompanying notes.
Actual results could differ materially from the estimates.
Recent
Accounting Pronouncements
In
February 2008, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Position (FSP) No. 157-2, which delays the effective date of FASB
Statement of Financial Accounting Standard (FAS) No. 157, “Fair Value Measurements” (FAS 157) for non-financial
assets and non-financial liabilities, except for items that are recognized or
disclosed at fair value on a recurring basis (items that are remeasured at least
annually). The FSP defers the effective date of FAS 157 for non-financial assets
and non-financial liabilities until our fiscal year beginning on January 1,
2009. We do not expect the adoption of this FSP to have a material effect on our
consolidated financial statements.
In
March 2008, the FASB issued FAS No. 161, “Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No.
133” (FAS 161).
FAS 161 requires us to provide greater transparency about how and why we use
derivative instruments, how the instruments and related hedged items are
accounted for under FAS 133, and how the instruments and related hedged items
affect our financial position, results of operations, and cash flows. FAS 161 is
effective for us beginning on January 1, 2009. We do not expect the adoption of
FAS 161 to have a material effect on our consolidated financial statements, but
we will be required to expand our disclosure regarding our derivative
instruments.
Revenue
Recognition
We
recognize revenue from the sale of our products, royalties earned, and contract
arrangements. Certain of our revenue arrangements that contain multiple elements
are divided into separate units of accounting if certain criteria are met,
including whether the delivered element has standalone value to the customer and
whether there is objective
and
reliable evidence of the fair value of the undelivered items. The consideration
we receive is allocated among the separate units based on their respective fair
values, and the applicable revenue recognition criteria are applied to each of
the separate units. Advance payments received in excess of amounts earned are
classified as deferred revenue until earned.
The
Avastin Patient Assistance Program is a voluntary program that enables eligible
patients who have received 10,000 milligrams (mg) of Avastin in a 12-month
period to receive free Avastin in excess of the 10,000 mg during the remainder
of the 12-month period. Based on the current wholesale acquisition cost, 10,000
mg is valued at $55,000 in gross revenue. We defer a portion of our gross
Avastin product sales revenue to reflect our estimate of the commitment to
supply free Avastin to patients who elect to enroll in the program. To calculate
our deferred revenue, we estimate several factors, most notably: the number
of patients who are currently being treated for U.S. Food and Drug
Administration (FDA)-approved indications and the start date of their
treatment regimen, the extent to which patients may elect to enroll in the
program, the number of patients who meet the financial eligibility requirements
of the program, and the duration and extent of treatment for the FDA-approved
indications, among other factors. We will continue to update our estimates for
each reporting period as new information becomes available. Based on these
estimates, we defer a portion of the Avastin revenue on product vials sold
through normal commercial channels. The deferred revenue is recognized when free
Avastin vials are delivered or after the associated patient eligibility period
has passed.
Earnings
Per Share
Basic
earnings per share (EPS) are computed based on the weighted-average number of
shares of our Common Stock outstanding. Diluted EPS are computed based on the
weighted-average number of shares of our Common Stock and other dilutive
securities.
The
following is a reconciliation of the numerators and denominators of the basic
and diluted EPS computations (in millions):
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
782 |
|
|
$ |
747 |
|
|
$ |
1,764 |
|
|
$ |
1,453 |
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding used to compute basic earnings per
share
|
|
|
1,051 |
|
|
|
1,053 |
|
|
|
1,052 |
|
|
|
1,053 |
|
|
Effect
of dilutive stock options
|
|
|
13 |
|
|
|
17 |
|
|
|
14 |
|
|
|
18 |
|
|
Weighted-average
shares outstanding and dilutive securities used to compute diluted
earnings per share
|
|
|
1,064 |
|
|
|
1,070 |
|
|
|
1,066 |
|
|
|
1,071 |
|
Outstanding
employee stock options to purchase 49 million shares of our Common Stock were
excluded from the computation of diluted EPS for the second quarter and first
six months of 2008 because the effect would have been
anti-dilutive.
Comprehensive
Income
Comprehensive
income comprises net income and other comprehensive income (OCI). OCI includes
certain changes in stockholders’ equity that are excluded from net income.
Specifically, we include in OCI changes in the estimated fair value of
derivatives designated as effective cash flow hedges, unrealized gains and
losses on our securities available-for-sale, and the gains or losses and prior
service costs or credits related to our post-retirement benefit plan that arise
during the period but are not recognized as components of net periodic benefit
cost.
The
components of accumulated OCI, net of taxes, were as follows (in millions):
|
|
|
|
|
|
|
|
|
Net
unrealized gains on securities available-for-sale
|
|
$ |
161 |
|
|
$ |
219 |
|
|
Net
unrealized losses on cash flow hedges
|
|
|
(48 |
) |
|
|
(14 |
) |
|
Accumulated
changes in post-retirement benefit obligation
|
|
|
(8 |
) |
|
|
(8 |
) |
|
Accumulated
other comprehensive income
|
|
$ |
105 |
|
|
$ |
197 |
|
The
activity in comprehensive income, net of income taxes, was as follows (in millions):
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
782 |
|
|
$ |
747 |
|
|
$ |
1,764 |
|
|
$ |
1,453 |
|
|
Decrease in
unrealized gains on securities available-for-sale
|
|
|
(44 |
) |
|
|
(14 |
) |
|
|
(58 |
) |
|
|
(10 |
) |
|
Decrease
(increase) in unrealized losses on cash flow hedges
|
|
|
26 |
|
|
|
8 |
|
|
|
(34 |
) |
|
|
11 |
|
|
Comprehensive
income, net of income taxes
|
|
$ |
764 |
|
|
$ |
741 |
|
|
$ |
1,672 |
|
|
$ |
1,454 |
|
The
decrease in net unrealized losses on cash flow hedges during the second quarter
of 2008 was primarily due to the strengthening of the U.S. dollar during this
period. The increase in net unrealized losses on cash flow hedges during the
first six months of 2008 was primarily due to the overall weakening of the U.S.
dollar during this period, despite the strengthening that occurred during the
second quarter. In the periods in which the hedged transaction affects earnings,
any gains or losses on cash flow hedges will be offset by revenue denominated in
the underlying foreign currency.
Fair
Value of Financial Instruments
The
fair value of our financial instruments reflects the amounts that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (exit price).
The fair value estimates presented in this report reflect the information
available to us as of June 30, 2008 and December 31, 2007. See Note 4, “Fair
Value Measurements.”
Derivative
Instruments
Our
derivative instruments, designated as cash flow hedges, consist of foreign
currency exchange options and forwards. As of June 30, 2008, unrealized net
losses of approximately $50 million were expected to be reclassified from
accumulated OCI to earnings within the next 12 months. If realized, these
amounts are expected to be offset by increases in the underlying
foreign-currency-denominated royalty revenue over this same 12-month
period.
|
Note
2.
|
Employee
Stock-Based Compensation
|
Stock-Based
Compensation Expense under FAS 123R
The
components of employee stock-based compensation expense recognized under FAS No.
123(R), “Share-Based Payment” (FAS 123R), were as follows
(in
millions):
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
$ |
18 |
|
|
$ |
16 |
|
|
$ |
41 |
|
|
$ |
33 |
|
|
Research
and development
|
|
|
38 |
|
|
|
39 |
|
|
|
80 |
|
|
|
77 |
|
|
Marketing,
general and administrative
|
|
|
41 |
|
|
|
47 |
|
|
|
87 |
|
|
|
93 |
|
|
Total
employee stock-based compensation expense
|
|
$ |
97 |
|
|
$ |
102 |
|
|
$ |
208 |
|
|
$ |
203 |
|
As
of June 30, 2008, total compensation cost related to unvested stock options not
yet recognized was $661 million, which
is expected to be allocated to expense and production costs over a
weighted-average period of 31 months. The portion
allocated to production costs will be recognized as cost of sales (COS) when the
related products are estimated to be sold.
The
carrying value of inventory on our Condensed Consolidated Balance Sheets as of
June 30, 2008 and December 31, 2007 included employee stock-based compensation
costs of $68 million and $72 million, respectively.
Valuation
Assumptions
The
employee stock-based compensation expense recognized under FAS 123R was
determined using the Black-Scholes option valuation model. Option valuation
models require the input of subjective assumptions, and these assumptions can
vary over time. The weighted-average assumptions used were as
follows:
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Risk-free
interest rate
|
|
|
3.3 |
% |
|
|
4.8 |
% |
|
|
3.0 |
% |
|
|
4.7 |
% |
|
Dividend
yield
|
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
|
0.0 |
% |
|
Expected
volatility
|
|
|
25.0 |
% |
|
|
27.0 |
% |
|
|
25.0 |
% |
|
|
27.0 |
% |
|
Expected
term (years)
|
|
|
5.0 |
|
|
|
4.6 |
|
|
|
5.0 |
|
|
|
4.6 |
|
Due
to the redemption of our Special Common Stock in June 1999 by Roche Holdings,
Inc. (RHI), there is limited historical information available to support our
estimate of certain assumptions required to value our employee stock options. In
developing our estimate of expected term, we have assumed that our recent
historical stock option exercise experience is a relevant indicator of future
exercise patterns. We base our determination of expected volatility
predominantly on the implied volatility of our traded options with consideration
of our historical volatilities and the volatilities of comparable
companies.
|
Note
3.
|
Condensed
Consolidated Financial Statement
Detail
|
Inventories
The
components of inventories were as follows (in millions):
|
|
|
|
|
|
|
|
|
Raw
materials and supplies
|
|
$ |
125 |
|
|
$ |
119 |
|
|
Work-in-process
|
|
|
1,113 |
|
|
|
1,062 |
|
|
Finished
goods
|
|
|
168 |
|
|
|
312 |
|
|
Total
|
|
$ |
1,406 |
|
|
$ |
1,493 |
|
Included
in work-in-process as of June 30, 2008 were approximately $21 million
of inventories manufactured through a process that is awaiting regulatory
licensure.
|
Note
4.
|
Fair
Value Measurements
|
On January
1, 2008, we adopted FAS 157, which established a framework for measuring fair
value under GAAP and clarified the definition of fair value within that
framework. FAS 157 does not require assets and liabilities that were previously
recorded at cost to be recorded at fair value. For assets and liabilities that
are already required to be disclosed at fair value, FAS 157 introduced, or
reiterated, a number of key concepts that form the foundation of the fair value
measurement approach to be used for financial reporting purposes. The fair value
of our financial instruments reflects the amounts that we estimate we would
receive in connection with the sale of an asset or paid in connection with the
transfer of a liability in an orderly transaction between market participants at
the measurement date (exit price). FAS 157 also established a fair value
hierarchy that prioritizes the inputs used in valuation
techniques
into the following three levels:
Level
1—quoted prices in active markets for identical assets and
liabilities
Level
2—observable inputs other than quoted prices in active markets for identical
assets and liabilities
Level
3—unobservable inputs
The
adoption of FAS 157 did not have an effect on our financial condition or results
of operations, but FAS 157 introduced new disclosures about how we value certain
assets and liabilities. Much of the disclosure focuses on the inputs used to
measure fair value, particularly in instances in which the measurement uses
significant unobservable (Level 3) inputs. A substantial majority of our
financial instruments are valued using quoted prices in active markets or are
based on other observable inputs.
The
following table sets forth the fair value of our financial assets and
liabilities measured on a recurring basis, including those that are pledged as
collateral or are restricted. Assets and liabilities are measured on a
recurring basis if they are remeasured at least annually.
|
|
|
|
|
|
|
|
|
(In
millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
2,891 |
|
|
$ |
– |
|
|
$ |
2,514 |
|
|
$ |
– |
|
|
Restricted
cash
|
|
|
788 |
|
|
|
– |
|
|
|
788 |
|
|
|
– |
|
|
Short-term
investments
|
|
|
1,614 |
|
|
|
– |
|
|
|
1,461 |
|
|
|
– |
|
|
Long-term
marketable debt securities
|
|
|
1,458 |
|
|
|
– |
|
|
|
1,674 |
|
|
|
– |
|
|
Total
fixed income investment portfolio
|
|
|
6,751 |
|
|
|
– |
|
|
|
6,437 |
|
|
|
– |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
marketable equity securities
|
|
|
374 |
|
|
|
– |
|
|
|
416 |
|
|
|
– |
|
|
Total
derivative financial instruments
|
|
|
28 |
|
|
|
82 |
|
|
|
30 |
|
|
|
19 |
|
|
Total
|
|
$ |
7,153 |
|
|
$ |
82 |
|
|
$ |
6,883 |
|
|
$ |
19 |
|
The
following table sets forth the fair value of our financial assets and
liabilities that were measured on a recurring basis as of June 30, 2008 (in millions).
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
1,939 |
|
|
$ |
952 |
|
|
$ |
– |
|
|
$ |
2,891 |
|
|
Trading
securities
|
|
|
84 |
|
|
|
947 |
|
|
|
2 |
|
|
|
1,033 |
|
|
Securities
available-for-sale
|
|
|
205 |
|
|
|
2,467 |
|
|
|
155 |
|
|
|
2,827 |
|
|
Equity
securities
|
|
|
374 |
|
|
|
– |
|
|
|
– |
|
|
|
374 |
|
|
Derivative
financial instruments
|
|
|
18 |
|
|
|
10 |
|
|
|
– |
|
|
|
28 |
|
|
Total
|
|
$ |
2,620 |
|
|
$ |
4,376 |
|
|
$ |
157 |
|
|
$ |
7,153 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
financial instruments
|
|
$ |
– |
|
|
$ |
82 |
|
|
$ |
– |
|
|
$ |
82 |
|
Our
Level 1 assets include cash, money market instruments, U.S. Treasury securities,
marketable equity securities and equity forwards. Level 2 assets include other
government and agency securities, commercial paper, corporate bonds,
asset-backed securities, municipal bonds, preferred securities, and other
derivatives. Our Level 3 assets include student loan auction-rate securities and
structured investment vehicle securities. As of June 30, 2008, we held $157
million of investments which were measured using unobservable (Level
3) inputs, representing approximately 2% of our total fair value investment
portfolio. Student loan auction-rate securities of $155 million and structured
investment vehicle securities of $2 million were valued based on broker-provided
valuations, which approximate fair value. In February 2008, the auction-rate
securities market experienced a number of failed auctions for student
loan-backed securities, including those that we held and continue to hold, which
severely limited the liquidity of these securities. Due to market liquidity
constraints related to the failed auctions, we classified the auction-rate
securities as non-current assets consistent with the long-term maturity dates of
the underlying student loans. As of June 30, 2008, we believed that the
unrealized losses in the auction-rate securities were temporary
and
that
we had the ability to hold the assets to maturity. All of our auction-rate
securities are AAA/Aaa-rated and are collateralized by student loans that are
guaranteed by the U.S. government to be repaid at no less than 95% of par
value.
The
following table sets forth a summary of the changes in the fair value of our
Level 3 financial assets, which were measured at fair value on a recurring
basis for the second quarter and first six months of 2008 (in millions).
|
|
|
Three
Months
Ended
June 30, 2008
|
|
|
Six
Months
Ended
June 30, 2008
|
|
|
|
|
Structured
Investment Vehicle Securities
|
|
|
|
|
|
Structured
Investment Vehicle Securities
|
|
|
|
|
|
Beginning
balance
|
|
$ |
2 |
|
|
$ |
161 |
|
|
$ |
7 |
|
|
$ |
– |
|
|
Transfer
into Level 3(1)
|
|
|
– |
|
|
|
– |
|
|
|
– |
|
|
|
174 |
|
|
Total
unrealized losses(2)
|
|
|
– |
|
|
|
(3 |
) |
|
|
(1 |
) |
|
|
(16 |
) |
|
Purchases,
issuances, settlement
|
|
|
– |
|
|
|
(3 |
) |
|
|
(4 |
) |
|
|
(3 |
) |
|
Ending
balance
|
|
$ |
2 |
|
|
$ |
155 |
|
|
$ |
2 |
|
|
$ |
155 |
|
___________
|
(1)
|
During
the first quarter of 2008, we held $174 million of auction-rate securities
that were transferred to Level 3 assets.
|
|
(2)
|
The
unrealized loss of $3 million in the second quarter and $16 million in the
first six months of 2008 was included in OCI as of June 30,
2008.
|
We
are a party to various legal proceedings, including 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. We are cooperating with the
associated investigation. Through counsel we are having discussions with
government representatives about the status of their investigation and
Genentech’s views on this matter, including potential resolution. Previously the
investigation had been both criminal and civil in nature. We have been informed
by the prosecutor handling this matter that the government has declined to
prosecute the company criminally in connection with this investigation. The
civil matter is still ongoing. The outcome of this matter cannot be
determined at this time.
We
and the City of Hope National Medical Center (COH) are parties to a 1976
agreement related 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 manufacture, use, and sell the products
covered by the Riggs/Itakura Patents. On August 13, 1999, COH filed a complaint
against us in the Superior Court in Los Angeles County, California, alleging
that we owe royalties to 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 COH approximately
$300 million in compensatory damages. On June 24, 2002, a jury voted to award
COH an additional $200 million in punitive damages. Such amounts were accrued as
an expense in the second quarter of 2002. Included within current liabilities in
“Accrued litigation” in the accompanying Condensed Consolidated Balance Sheet at
December 31, 2007 was $776 million, which represented our estimate of
the costs for the resolution of the COH matter as of that reporting
date. 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 California Supreme
Court heard our appeal on this matter on February 5, 2008, and on April 24, 2008
overturned the award of $200 million in punitive damages to COH but upheld the
award of $300 million in compensatory damages. We paid $476 million to COH
in the second quarter of 2008, reflecting the amount of compensatory damages
awarded plus interest thereon from the date of the original decision, June 10,
2002.
As
a result of the April 24, 2008 California Supreme Court decision, we reversed a
$300 million net litigation accrual related to the punitive damages and accrued
interest, which we recorded as “Special items: litigation-related” in our
Condensed Consolidated Statements of Income for the first quarter and first six
months of 2008. In the second quarter and first six months of 2007, we recorded
accrued interest and bond costs on both the compensatory and punitive damages,
totaling $13 million and $26 million, respectively. In conjunction with the COH
judgment in 2002, we posted a surety bond and were required to pledge cash and
investments of $788 million to secure the bond, and this balance was reflected
in “Restricted cash and investments” in the accompanying Condensed Consolidated
Balance Sheets. Subsequent to June 30, 2008, the court completed certain
administrative procedures to dismiss the case. As a result, the restrictions
were lifted from the restricted cash and investments accounts, and the funds
became available for use in our operations.
On
April 11, 2003, MedImmune, Inc. 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 related to U.S. Patent No. 6,331,415 (the
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
included claims for violation of anti-trust, patent, and unfair competition
laws. MedImmune sought a ruling that the Cabilly patent was invalid and/or
unenforceable, a determination that MedImmune did not owe royalties under the
Cabilly patent on sales of its Synagis® antibody
product, an injunction to prevent us from enforcing the Cabilly patent, an award
of actual and exemplary damages, and other relief. On June 11, 2008, we
announced that we settled this litigation with MedImmune. Pursuant to the
settlement agreement, the U.S. District Court dismissed all the claims against
us in the lawsuit. The litigation has been fully resolved and dismissed and the
settlement did not have a material effect on our operating results for the
second quarter and first six months of 2008.
On
May 13, 2005, a request was filed by a third party for reexamination of the
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 and Trademark Office (Patent Office) ordered reexamination of the Cabilly
patent. On September 13, 2005, the Patent Office mailed an initial non-final
Patent Office action rejecting all 36 claims of the Cabilly patent. We filed our
response to the Patent Office action on November 25, 2005. On December 23, 2005,
a second request for reexamination of the Cabilly 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 Patent Office action in the
merged proceeding, rejecting all the claims of the Cabilly patent based on
issues raised in the two reexamination requests. We filed our response to the
Patent Office action on October 30, 2006. On February 16, 2007, the Patent
Office mailed a final Patent Office action rejecting all the claims of the
Cabilly patent. We responded to the final Patent Office action on May 21, 2007
and requested continued reexamination. On May 31, 2007, the Patent Office
granted the request for continued reexamination, and in doing so withdrew the
finality of the February 2007 Patent Office action and agreed to treat our May
21, 2007 filing as a response to a first Patent Office action. On February 25,
2008, the Patent Office mailed a final Patent Office action rejecting all the
claims of the Cabilly patent. We filed our response to that final Patent Office
action on June 6, 2008. On July 19, 2008, the Patent Office mailed an advisory
action replying to our response and confirming the rejection of all claims of
the Cabilly patent. We intend to file a notice of appeal challenging the
rejection. The Cabilly patent, which expires in 2018, relates to methods that we
and others use to make certain antibodies or antibody fragments, as well as
cells and deoxyribonucleic acid (DNA) used in these methods. We have licensed
the Cabilly patent to other companies and derive significant royalties from
those licenses. The Cabilly patent licenses contributed royalty revenue of $75
million and $159 million in the second quarter and first six months of 2008,
respectively. The claims of the Cabilly patent remain valid and enforceable
throughout the reexamination and appeals processes. The outcome of this matter
cannot be determined at this time.
In
2006, we made development decisions involving our humanized anti-CD20 program,
and our collaborator, Biogen Idec Inc., disagreed with certain of our
development decisions related to humanized anti-CD20 products. Under our 2003
collaboration agreement with Biogen Idec, we believe that we are permitted to
proceed with further trials of certain humanized anti-CD20 antibodies, and
Biogen Idec disagreed with our position. The disputed issues have been submitted
to arbitration. In the arbitration, Biogen Idec filed motions for a preliminary
injunction and summary judgment seeking to stop us from proceeding with certain
development activities, including planned clinical trials. On April 20, 2007,
the arbitration panel denied Biogen Idec’s motion for a preliminary injunction
and Biogen Idec’s motion for summary judgment. Resolution of the arbitration
could require that both parties agree to certain development decisions before
moving forward with humanized anti-CD20 antibody clinical trials
(and
possibly
clinical trials of other collaboration products, including Rituxan), in which
case we may have to alter or cancel planned clinical trials in order to obtain
Biogen Idec’s approval. The hearing of this matter is scheduled to begin in
September 2008. We expect a final decision within six months of the conclusion
of the hearing, unless the parties are able to resolve the matter earlier
through settlement discussions or otherwise. The outcome of this matter cannot
be determined at this time.
On
June 28, 2003, Mr. Ubaldo Bao Martinez filed a lawsuit against Porriño Town
Council and Genentech España S.L. in the Contentious Administrative Court
Number One of Pontevedra, Spain. The lawsuit challenges the Town
Council’s decision to grant licenses to Genentech España S.L. for the
construction and operation of a warehouse and biopharmaceutical
manufacturing facility in Porriño, Spain. On January 16, 2008, the
Administrative Court ruled in favor of Mr. Bao on one of the claims in the
lawsuit and ordered the closing and demolition of the facility, subject to
certain further legal proceedings. On February 12, 2008, we and the Town Council
filed appeals of the Administrative Court decision at the High Court in Galicia,
Spain. In addition, we are evaluating with legal counsel in Spain whether there
may be other administrative remedies available to overcome the Administrative
Court’s ruling. We sold the assets of Genentech España S.L., including the
Porriño facility, to Lonza Group Ltd. in December 2006, and Lonza has operated
the facility since that time. Under the terms of that sale, we retained
control of the defense of this lawsuit and agreed to indemnify Lonza against
certain contractually defined liabilities up to a specified limit, which is
currently estimated to be approximately $100 million. The outcome of this
matter, and our indemnification obligation to Lonza, if any, cannot be
determined at this time.
On
May 30, 2008, Centocor, Inc. filed a patent lawsuit against Genentech and COH in
the U.S. District Court for the Central District of California. The lawsuit
relates to the Cabilly patent that we co-own with COH and under which Centocor
and other companies have been licensed and are paying royalties to us. The
lawsuit seeks a declaratory judgment of patent invalidity and unenforceability
with regard to the Cabilly patent and of patent non-infringement with regard to
Centocor’s marketed product ReoPro®
(Abciximab) and its unapproved product CNTO 1275 (Ustekinumab). Centocor also
seeks to recover the royalties it has paid to Genentech for ReoPro® and the
monies it alleges that Celltech has paid to Genentech for Remicade®
(infliximab), a product marketed by Centocor under an agreement between Centocor
and Celltech. Genentech is scheduled to respond to the complaint on August 7,
2008. The outcome of this matter cannot be determined at this time.
On
May 8, 2008 and June 11, 2008, Genentech was named as a defendant, along with
InterMune, Inc. and its former chief executive officer, W. Scott Harkonen, in
two separate class-action complaints in the U.S. District Court for the Northern
District of California. Both complaints seek relief for a specific class of
plaintiffs who allegedly received Actimmune® for the
treatment of idiopathic pulmonary fibrosis and they allege violations of federal
racketeering laws, unfair competition laws, and consumer protection laws, and
also seek damages for unjust enrichment. Actimmune® is an
interferon-gamma product that was licensed by Genentech to Connectics
Corporation and was subsequently assigned to InterMune. InterMune currently
sells Actimmune® in the
U.S. The complaints are related in part to royalties that we received in
connection with the Actimmune® product.
The outcome of this matter cannot be determined at this time.
On
July 21, 2008, we announced that we received an unsolicited proposal from Roche
to acquire all of the outstanding shares of our stock not owned by Roche at a
price of $89.00 in cash per share. See also Note 9, “Subsequent Event,” for more
information regarding the proposal. Subsequently, twenty-six shareholder
lawsuits have been filed against Genentech and/or the members of its Board of
Directors, and various Roche entities, including Roche Holdings, Inc., Roche
Holding AG and Roche Holding Ltd. The lawsuits are currently pending in various
state courts, including the Delaware Court of Chancery, San Francisco County
Superior Court, and San Mateo County Superior Court, as well as one lawsuit in
the United States District Court for the Northern District of California. The
lawsuits generally assert class action claims for breach of fiduciary duty and
aiding and abetting breaches of fiduciary duty based in part on allegations
that, in connection with Roche’s offer to purchase the remaining shares, some or
all of the defendants have failed to properly value Genentech, have failed to
solicit other potential acquirers and are engaged in improper self-dealing. Two
of the lawsuits allege derivative claims alleging breaches of fiduciary duty by
defendants in connection with adoption of the July 1999 Affiliation Agreement
with RHI (Affiliation Agreement), and those two and one other of the lawsuits
seek the invalidation, in whole or in part, of the Affiliation Agreement. One of
the lawsuits seeks an order deeming Articles 8 and 9 of the Company’s Amended
and Restated Certificate of Incorporation inapplicable or invalid to a
potential transaction with Roche. The outcome of these matters cannot be
determined at this time.
|
Note
6.
|
Relationship
with Roche Holdings, Inc. and Related Party
Transactions
|
Roche Holdings, Inc.’s Ability to Maintain Percentage
Ownership Interest in Our Stock
We
issue shares of Common Stock in connection with our stock option and stock
purchase plans, and we may issue additional shares for other purposes. Our
Affiliation Agreement with RHI provides, among other things, that with respect
to any issuance of our Common Stock in the future, we will repurchase a
sufficient number of shares so that immediately after such issuance, the
percentage of our Common Stock owned by RHI will be no lower than 2% below the
“Minimum Percentage” (subject to certain conditions). The Minimum Percentage
equals the lowest number of shares of Genentech Common Stock owned by RHI since
its July 1999 offering of our Common Stock (to be adjusted in the future for
dispositions of shares of Genentech Common Stock by RHI as well as for stock
splits or stock combinations) divided by 1,018,388,704 (to be adjusted in the
future for stock splits or stock combinations), which is the number of shares of
Genentech Common Stock outstanding at the time of the July 1999 offering, as
adjusted for stock splits. We have repurchased shares of our Common Stock since
2001. The Affiliation Agreement also provides that, upon RHI’s request, we will
repurchase shares of our Common Stock to increase RHI’s ownership to the Minimum
Percentage. In addition, RHI will have a continuing option to buy stock from us
at prevailing market prices to maintain its percentage ownership interest. Under
the terms of the Affiliation Agreement, RHI’s Minimum Percentage is 57.7%, and
RHI’s ownership percentage is to be no lower than 55.7%. RHI’s ownership
percentage of our outstanding shares was 55.9% as of June 30, 2008 and
55.6% as of July 31, 2008. Future share repurchases under our share repurchase
program, including the May 2008 prepaid share repurchase arrangement (see also
Note 8, “Capital Stock”), may increase Roche’s ownership percentage. However,
significant option exercises and stock purchases by employees could result in
further dilution, and limitations in the number of shares we receive under, or
modification or cancellation of, our existing prepaid share repurchase
arrangement could negatively affect our ability to offset dilution.
See
also Note 8, “Capital Stock,” and Note 9, “Subsequent Event,” regarding our
prepaid share repurchase arrangement and Roche’s proposal to acquire all
outstanding shares of our stock not owned by Roche.
Related
Party Transactions
We
enter into transactions with related parties, Roche Holding AG and affiliates
(Roche) and Novartis AG and affiliates (Novartis). The accounting policies that
we apply to our transactions with our related parties are consistent with those
applied in transactions with independent third parties, and all related
party agreements are negotiated on an arm’s-length basis.
In
our royalty and supply arrangements with related parties, we are the principal,
as defined under Emerging Issues Task Force (EITF) Issue No. 99-19, “Reporting Revenue Gross as a
Principal versus Net as an Agent” (EITF 99-19), because we
bear the manufacturing risk, general inventory risk, and the risk to defend our
intellectual property. For circumstances in which we are the principal in the
transaction, we record the transaction on a gross basis in accordance with EITF
99-19; otherwise, our transactions are recorded on a net
basis.
Roche
We
signed two product supply agreements with Roche in July 2006, each of which was
amended in November 2007. The Umbrella Manufacturing Supply Agreement (Umbrella
Agreement) supersedes our previous product supply agreements with Roche. The
Short-Term Supply Agreement (Short-Term Agreement) supplements the terms of the
Umbrella Agreement. Under the Short-Term Agreement, Roche has agreed to purchase
specified amounts of Herceptin, Avastin, and Rituxan through 2008. Under the
Umbrella Agreement, Roche has agreed to purchase specified amounts of Herceptin
and Avastin through 2012, and on a perpetual basis, either party may order other
collaboration products from the other party, including Herceptin and Avastin
after 2012, pursuant to certain forecast terms. The Umbrella Agreement also
provides that either party may terminate its obligation to purchase and/or
supply Avastin and/or Herceptin with six years notice on or after December 31,
2007. To date, we have not received such notice of termination from
Roche.
Under
the July 1999 amended and restated licensing and marketing agreement and the
July 1998 licensing and marketing agreement related to anti-HER2 antibodies
(including Herceptin and pertuzumab), Roche has the right to opt in to
development programs we undertake on our products at certain pre-defined stages
of development. When Roche opts in to a program, we record the opt-in payments
received as deferred revenue, which we recognize over the expected development
periods or product life, as appropriate. As of June 30, 2008, the amounts
in short-term and long-term deferred revenue related to opt-in payments received
from Roche were $48 million and $193 million, respectively. For the second
quarter and first six months of 2008, we recognized $13 million and $24 million,
respectively, as contract revenue related to opt-in payments previously received
from Roche. For the second quarter and first six months of 2007, we recognized
$11 million and $23 million, respectively, as contract revenue related to opt-in
payments previously received from Roche.
In
February 2008, Roche acquired Ventana Medical Systems, Inc., and as a result of
the acquisition, Ventana is considered a related party. We have engaged in
transactions with Ventana prior to and since the acquisition, but these
transactions have not been material to our results of operations.
In
May 2008, Roche acquired Piramed Limited, a privately held entity based in the
United Kingdom, and as a result of the transaction, Piramed is considered a
related party. We have a previously existing licensing agreement with Piramed
related to a molecule in our development pipeline.
In
June 2008, we entered into a licensing agreement with Roche, under which we
obtained rights to a preclinical small molecule drug development program. We
recorded $35 million in research and development (R&D) expense in the second
quarter of 2008 related to this agreement. The future R&D costs incurred
under the agreement and any profit and loss from global commercialization will
be shared equally with Roche.
In
July 2008, we signed an agreement with Chugai-Pharmaceuticals Co., Ltd., a
Japan-based entity and a member of Roche, under which we agreed to manufacture
Actemra, a product of Chugai, at our Vacaville, California facility. After an
initial term of five years, the agreement may be terminated subject to certain
terms and conditions under the contract.
We
currently have no commercialized products subject to profit sharing arrangements
with Roche.
Under
our existing arrangements with Roche, including our licensing and marketing
agreements, we recognized the following amounts (in millions):
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales to Roche
|
|
$ |
144 |
|
|
$ |
253 |
|
|
$ |
281 |
|
|
$ |
516 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties
earned from Roche
|
|
$ |
391 |
|
|
$ |
283 |
|
|
$ |
762 |
|
|
$ |
538 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Roche
|
|
$ |
20 |
|
|
$ |
30 |
|
|
$ |
40 |
|
|
$ |
60 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales on product sales to Roche
|
|
$ |
89 |
|
|
$ |
137 |
|
|
$ |
152 |
|
|
$ |
258 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development expenses incurred on joint development projects with
Roche
|
|
$ |
77 |
|
|
$ |
70 |
|
|
$ |
148 |
|
|
$ |
128 |
|
Certain
R&D
expenses are partially reimbursable to us by Roche. Amounts that Roche owes us,
net of amounts reimbursable to Roche by us on these projects, are recorded as
contract revenue. Conversely, R&D expenses may include the net settlement of
amounts we owe Roche on R&D expenses that Roche incurred on joint
development projects, less amounts reimbursable to us by Roche on these
projects.
Novartis
Based
on information available to us at the time of filing this Quarterly Report on
Form 10-Q, we believe that the Novartis Group holds approximately 33.3% of the
outstanding voting shares of Roche. As a result of this ownership, the Novartis
Group is deemed to have an indirect beneficial ownership interest under FAS No.
57, “Related Party
Disclosures” (FAS 57), of more than
10% of our voting stock.
We
have an agreement with Novartis Pharma AG (a wholly owned subsidiary of Novartis
AG; Novartis Pharma AG and affiliates are collectively referred to
hereafter as Novartis) under which it has the exclusive right to develop and
market Lucentis outside the U.S. for indications related to diseases or
disorders of the eye. As part of this agreement, the parties will share the cost
of certain of our ongoing development expenses for Lucentis.
We
and Novartis are co-developing and co-promoting Xolair in the U.S. We record all
sales, COS, and marketing and sales expenses in the U.S.; Novartis markets
the product in and records all sales, COS, and marketing and sales expenses
in Europe. We and Novartis share the resulting U.S. and European operating
profits according to prescribed profit sharing percentages. Generally, we
evaluate whether we are a net recipient or payor of funds on an annual basis in
our cost and profit sharing arrangements. Net amounts received on an annual
basis under such arrangements are classified as contract revenue, and net
amounts paid on an annual basis are classified as profit sharing expense. With
respect to the U.S. operating results, for the full year in 2007 we were a net
payor to Novartis, and for the full year in 2008 we similarly anticipate being a
net payor to Novartis. As a result, for the second quarters and first six months
of 2008 and 2007, the portion of the U.S. operating results that we owed to
Novartis was recorded as collaboration profit sharing expense. With respect to
the European operating results, for the full year in 2007 we were a net payor to
Novartis, and for the full year in 2008 we anticipate being a net recipient from
Novartis. As a result, for the second quarter and first six months of 2008, the
portion of the European operating results that Novartis owed us was recorded as
contract revenue. For the same periods in 2007, however, our portion of the
European operating results was recorded as collaboration profit sharing expense.
Effective with our acquisition of Tanox, Inc. on August 2, 2007, Novartis also
makes: (1) additional profit sharing payments to us on U.S. sales of
Xolair, which reduces our profit sharing expense; (2) royalty payments to us on
sales of Xolair worldwide, which we record as royalty revenue; and (3)
manufacturing service payments related to Xolair, which we record as contract
revenue.
Under
our existing arrangements with Novartis, we recognized the following amounts
(in
millions):
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales to Novartis
|
|
$ |
2 |
|
|
$ |
3 |
|
|
$ |
5 |
|
|
$ |
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalties
earned from Novartis
|
|
$ |
60 |
|
|
$ |
13 |
|
|
$ |
112 |
|
|
$ |
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contract
revenue from Novartis
|
|
$ |
15 |
|
|
$ |
4 |
|
|
$ |
26 |
|
|
$ |
44 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales on product sales to Novartis
|
|
$ |
1 |
|
|
$ |
3 |
|
|
$ |
4 |
|
|
$ |
7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development expenses incurred on joint development projects with
Novartis
|
|
$ |
12 |
|
|
$ |
9 |
|
|
$ |
20 |
|
|
$ |
19 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collaboration
profit sharing expense to Novartis
|
|
$ |
48 |
|
|
$ |
49 |
|
|
$ |
89 |
|
|
$ |
96 |
|
Contract
revenue in the first six months of 2007 included a $30 million milestone payment
from Novartis for European Union approval of Lucentis for the treatment of
neovascular (wet) age-related macular degeneration (AMD).
Certain
R&D
expenses are partially reimbursable to us by Novartis. The amounts that Novartis
owes us, net of amounts reimbursable to Novartis by us on those projects, are
recorded as contract revenue. Conversely, R&D
expenses may
include the net settlement of amounts we owe Novartis on R&D expenses that
Novartis incurred on joint development projects, less amounts reimbursable to us by Novartis on
those projects.
Our
effective income tax rate was 40% in the second quarter of 2008 compared to 37%
in the second quarter of 2007, mainly due to a $33 million settlement with the
Internal Revenue Service (IRS) for an item related to prior years. Our effective
income tax rate was 39% in the first six months of 2008 compared to 37% in the
first six months of 2007, mainly due to the IRS settlement.
In
May 2008, we entered into a prepaid share repurchase arrangement with an
investment bank pursuant to which we delivered $500 million to the investment
bank. The investment bank is obligated to deliver to us, by September 30, 2008,
not fewer than five million shares of our Common Stock based on a pre-determined
formula, subject to a possible reduction in the number of shares received, an
extension of the date on which shares are to be delivered, or other
modifications or cancellation of the plan in certain circumstances. The prepaid
amount has been reflected as a reduction of our stockholders’ equity as of June
30, 2008. There was no effect on EPS for the three or six months ended June 30,
2008 as a result of entering into this agreement.
On
July 21, 2008, we announced that we received an unsolicited proposal from
Roche to acquire all of the outstanding shares of our stock not owned by Roche
at a price of $89.00 in cash per share. Roche’s ownership percentage of our
outstanding shares was 55.9% as of June 30, 2008 and 55.6% as of July 31,
2008. A special committee of our Board of Directors, composed of the
independent directors, has been formed to review, evaluate, and, in the special
committee’s discretion, negotiate and recommend or not recommend the proposal.
The Board of Directors has resolved that it will not recommend any possible
transaction with Roche without the prior favorable recommendation of such
transaction by the special committee. The outcome of the process has not been
pre-determined, and there can be no assurance that the special committee will
approve any transaction with Roche.
The
Board of Directors and Stockholders of Genentech, Inc.
We
have reviewed the condensed consolidated balance sheet of Genentech, Inc. as of
June 30, 2008, and the related condensed consolidated statements of income for
the three-month and six-month periods ended June 30, 2008 and 2007 and cash
flows for the six-month periods ended June 30, 2008 and 2007. These financial
statements are the responsibility of the Company’s management.
We
conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based
on our review, we are not aware of any material modifications that should be
made to the condensed consolidated financial statements referred to above for
them to be in conformity with U.S. generally accepted accounting
principles.
We
have previously audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
Genentech, Inc. as of December 31, 2007, and the related consolidated statements
of income, stockholders’ equity, and cash flows for the year then ended, not
presented herein, and in our report dated February 5, 2008, we expressed an
unqualified opinion on those consolidated financial statements and included an
explanatory paragraph relating to the change in method of accounting for
stock-based compensation in accordance with guidance provided in Statement of
Financial Accounting Standards No. 123(R), “Share-based Payment.” In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 2007, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
Palo
Alto, California
July
30, 2008
GENENTECH,
INC.
FINANCIAL
REVIEW
Overview
The
information included in this Quarterly Report on Form 10-Q should be read in
conjunction with the Consolidated Financial Statements and accompanying notes
included in our Annual Report on Form 10-K for the year ended December 31,
2007.
The
Company
Genentech
is a leading biotechnology company that discovers, develops, manufactures, and
commercializes medicines for patients with 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 During the Second Quarter of 2008
We
primarily earn revenue and income and generate cash from product sales and
royalty revenue. In the second quarter of 2008, our total operating revenue was
$3,236 million, an increase of 8% from $3,004 million in the second quarter of
2007. Our net income for the second quarter of 2008 was $782 million, an
increase of 5% from $747 million in the second quarter of 2007. In the
first six months of 2008, our total operating revenue was $6,299 million, an
increase of 8% from $5,847 million in the first six months of 2007. Our net
income for the first six months of 2008 was $1,764 million, an increase of 21%
from $1,453 million in the first six months of 2007.
On
April 14, 2008, we and Biogen Idec announced that OLYMPUS, a Phase II/III study
of Rituxan for primary-progressive multiple sclerosis (PPMS), did not meet its
primary endpoint as measured by the time to confirmed disease progression during
the 96-week treatment period. However, we did observe evidence of biologic
activity in a subset of patients. We will continue to analyze the results of the
study with Biogen Idec and expect to submit the data for presentation at an
upcoming medical meeting.
On
April 20, 2008, we announced an update to the previously reported results from
B017704, the Roche-sponsored international Phase III clinical study of Avastin
in combination with gemcitabine and cisplatin chemotherapy in patients with
advanced, non-squamous, non-small cell lung cancer (NSCLC). The update confirmed
the clinically and statistically significant improvement in the primary endpoint
of progression-free survival (PFS) for the two different doses of Avastin
studied in the trial (15 mg/kg/every-three-weeks and 7.5
mg/kg/every-three-weeks) compared to chemotherapy alone. The study did not
demonstrate a statistically significant prolongation of overall survival, a
secondary endpoint, for either dose in combination with gemcitabine and
cisplatin chemotherapy compared to chemotherapy alone. Median survival of
patients in all arms of the study exceeded one year, which is longer than
previously reported survival times in this indication.
On
April 24, 2008, we announced that the California Supreme Court overturned the
award of $200 million in punitive damages to COH but upheld the award of $300
million in compensatory damages resulting from a contract dispute brought by
COH. The punitive damages were part of a 2004 decision of the California
Court of Appeal, which upheld a 2002 Los Angeles County Superior Court jury
verdict awarding these amounts. As a result of the California Supreme Court
decision, we reversed a $300 million net litigation accrual related to the
punitive damages and accrued interest, which was recorded as “Special items:
litigation-related” in our Condensed Consolidated Statements of Income for the
first quarter and first six months of 2008. We paid $476 million to COH in the
second quarter of 2008, reflecting the amount of compensatory damages awarded,
plus interest thereon from the date of the original decision in
2002.
On
April 29, 2008, we announced that EXPLORER, the Phase II/III study of Rituxan
for systemic lupus erythematosus (SLE, commonly called lupus), did not meet its
primary endpoint, defined as the proportion of Rituxan treated patients who
achieved a major clinical response (MCR) or partial clinical response (PCR),
measured
by
the British Isles Lupus Assessment Group (BILAG), a lupus activity response
index, compared to placebo at 52 weeks. The study also did not meet any of the
six secondary endpoints.
On
June 11, 2008, we announced that we settled the patent litigation with MedImmune
involving the Cabilly patent. The settlement resolves disputed issues with
respect to MedImmune’s marketed product Synagis® as well
as a related product for which MedImmune is seeking regulatory approval. The
settlement also permits MedImmune to obtain licenses for certain additional
pipeline products under the Cabilly patent family.
On
July 21, 2008, we announced that we received an unsolicited proposal from
Roche to acquire all of the outstanding shares of our stock not owned by Roche
at a price of $89.00 in cash per share. Roche’s ownership percentage of our
outstanding shares was 55.9% as of June 30, 2008 and 55.6% as of July 31,
2008. A special committee of our Board of Directors, composed of the
independent directors, has been formed to review, evaluate, and, in the special
committee’s discretion, negotiate and recommend or not recommend the proposal.
The Board of Directors has resolved that it will not recommend any possible
transaction with Roche without the prior favorable recommendation of such
transaction by the special committee. The outcome of the process has not been
pre-determined, and there can be no assurance that the special committee will
approve any transaction with Roche.
Our
Strategy and Goals
As
announced in 2006, our business objectives for the years 2006 through 2010
include bringing at least 20 new molecules into clinical development, bringing
at least 15 major new products or indications onto the market, becoming the
number one U.S. oncology company in sales, and achieving certain financial
growth measures. These objectives are reflected in our revised Horizon 2010
strategy and goals summarized on our website at www.gene.com/gene/about/corporate/growthstrategy.
In 2007, we announced an internal stretch goal to add a total of 30 molecules
into development during the five-year period from the beginning of 2006 through
the end of 2010.
Economic
and Industry-wide Factors
Our
strategy and goals are challenged by economic and industry-wide factors that
affect our business. Key factors that affect our future growth are discussed
below.
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We
face significant competition in the diseases of interest to us from
pharmaceutical and biotechnology companies. The introduction of new
competitive products or follow-on biologics, new information about
existing products, and pricing and distribution decisions by us or our
competitors may result in lost market share for us, reduced utilization of
our products, lower prices, and/or reduced product sales, even for
products protected by patents. We monitor the competitive landscape and
develop strategies in response to new
information.
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Our
long-term business growth depends upon our ability to continue to
successfully develop and commercialize important novel therapeutics to
treat unmet medical needs. We recognize that the successful development of
pharmaceutical products 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 product recalls or
withdrawals.
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Our
business model requires appropriate pricing and reimbursement for our
products to offset the costs and risks of drug development. Some of the
pricing and distribution of our products have received negative press
coverage and public and governmental scrutiny. We will continue to meet
with patient groups, payers, and other stakeholders in the healthcare
system to understand their issues and concerns. The pricing and
reimbursement environment for our products may change in the future and
become more challenging due to, among other reasons, new policies of the
next presidential administration or new healthcare legislation passed by
congress.
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As
the Medicare and Medicaid programs are the largest payers for our
products, rules related to the programs’ coverage and reimbursement
continue to represent an important issue for our business. New regulations
related to hospital and physician payment continue to be implemented
annually. As a result of the Deficit Reduction Act of 2005, new
regulations became effective in the fourth quarter of 2007 that will
affect the discounted price for our products paid by Medicaid and
government-affiliated customers. We consider these rules as we plan our
business and work to represent our point of view to the legislators and
payers.
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Intellectual
property protection of our products is crucial to our business. Loss of
effective intellectual property protection could result in lost sales to
competing products and loss of royalty payments (for example, royalty
income associated with the Cabilly patent) from licensees, and may
negatively affect our sales, royalty revenue, 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.
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Manufacturing
pharmaceutical products is difficult and complex, and requires facilities
specifically designed and validated to run biotechnology production
processes. Difficulties or delays in product manufacturing or in obtaining
materials from our suppliers, or difficulties in accurately forecasting
manufacturing capacity needs or complying with regulatory requirements,
could negatively affect our business. Additionally, we have had, and may
continue to have, an excess of available capacity, which could lead to
idling of a portion of our manufacturing facilities, during which
time we would incur unabsorbed or idle plant charges or other excess
capacity charges, resulting in an increase in our COS. We use integrated
demand management and manufacturing processes to optimize our production
processes.
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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.
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Marketed
Products
We
commercialize the pharmaceutical products listed below in the
U.S.:
Avastin (bevacizumab) is an
anti-VEGF (vascular endothelial growth factor) 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 NSCLC. On February 22, 2008,
we received accelerated approval from the FDA to market Avastin in combination
with paclitaxel chemotherapy for the treatment of patients who have not received
prior chemotherapy for metastatic HER2-negative breast cancer (BC).
Rituxan (rituximab) is an
anti-CD20 antibody that we commercialize with Biogen Idec. It is approved for
first-line treatment of patients with follicular, CD20-positive, B-cell
non-Hodgkin’s lymphoma (NHL) in combination with cyclophosphamide, vincristine,
and prednisone (CVP) chemotherapy regimens or following CVP chemotherapy in
patients with stable disease or who achieve a partial or complete response
following first-line treatment with CVP chemotherapy. Rituxan is also approved
for treatment of patients with relapsed or refractory, low-grade or follicular,
CD20-positive, B-cell NHL, including retreatment and bulky diseases. Rituxan is
indicated for first-line treatment of patients with diffuse large B-cell,
CD20-positive NHL in combination with cyclophosphamide, doxorubicin,
vincristine, and prednisone (CHOP) or other anthracycline-based chemotherapy.
Rituxan is also indicated for use in combination with methotrexate to reduce
signs and symptoms and slow the progression of structural damage in adult
patients with moderate-to-severe rheumatoid arthritis (RA) who have had an
inadequate response to one or more tumor necrosis factor (TNF) antagonist
therapies.
Herceptin (trastuzumab) is a
humanized anti-HER2 antibody approved for treatment of patients (who have
tumors
that
overexpress the HER2 protein) with node-positive or node-negative (Estrogen
Receptor/Progesterone Receptor negative or with one high-risk feature) BC as
part of an adjuvant treatment regimen containing 1) doxorubicin,
cyclophosphamide, and either paclitaxel or docetaxel; 2) docetaxel and
carboplatin and as a single agent following multi-modality anthracycline-based
therapy. It is also approved for use as a first-line therapy in combination with
paclitaxel and as a single agent in patients who have received one or more
chemotherapy regimens for metastatic disease.
Lucentis (ranibizumab) is an
anti-VEGF antibody fragment approved for the treatment of neovascular (wet)
AMD.
Xolair (omalizumab) is a
humanized anti-IgE (immunoglobulin E) antibody that we commercialize with
Novartis Pharma AG. Xolair is approved for adults and adolescents (age 12 or
older) 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 signaling pathway.
Tarceva is approved for the treatment of patients with locally advanced or
metastatic 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) is a
tissue-plasminogen activator (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 I, approved for the
treatment of cystic fibrosis.
Raptiva (efalizumab) is a
humanized anti-CD11a antibody approved for the treatment of chronic
moderate-to-severe plaque psoriasis in adults age 18 or older who are candidates
for systemic therapy or phototherapy.
Licensed
Products
We
receive royalty revenue from various licensees, including significant royalty
revenue from Roche on sales of:
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Herceptin,
Pulmozyme, and Avastin outside the
U.S.;
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Rituxan
outside the U.S., excluding Japan;
and
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Nutropin
products, Activase, and TNKase in
Canada.
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See
Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for
information regarding certain patent-related legal proceedings.
Available
Information
The
following information can be found on our website at www.gene.com, or can be
obtained free of charge by contacting our Investor Relations Department at (650)
225-4150 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 is
reasonably practicable after such material is electronically filed with
the U.S. Securities and Exchange
Commission;
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Our
policies related to corporate governance, including our Principles of
Corporate Governance, Good Operating Principles, and Code of Ethics, which
apply to our Chief Executive Officer, Chief Financial Officer, 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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Critical
Accounting Policies and the Use of Estimates
The
accompanying discussion and analysis of our financial condition and results of
operations are based on our Condensed Consolidated Financial Statements and the
related disclosures, which have been prepared in accordance with U.S. GAAP. The
preparation of these Condensed Consolidated Financial Statements requires
management to make estimates, assumptions, and judgments that affect the
reported amounts in our Condensed Consolidated Financial Statements and
accompanying notes. These estimates form the basis for 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 expectations for 2008, because these
policies require management to make significant estimates, assumptions, and
judgments about matters that are inherently uncertain.
Loss
Contingencies
We
are currently, and have been, involved in certain legal proceedings, including
licensing and contract disputes, shareholder lawsuits, and other matters. See
Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more
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. 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 that differs from our current estimates could have a material effect on
our financial position or our results of operations in any one
quarter.
Revenue
Recognition–Avastin U.S. Product Sales and Patient Assistance
Program
In
February 2007, we launched the Avastin Patient Assistance Program, which is a
voluntary program that enables eligible patients who have received 10,000 mg of
Avastin in a 12-month period to receive free Avastin in excess of the 10,000 mg
during the remainder of the 12-month period. Based on the current wholesale
acquisition cost, the 10,000 mg 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 financial eligibility requirements for this program. The program is
available for eligible patients who enroll, regardless of whether they are
insured. We defer a portion of our gross Avastin product sales revenue to
reflect our estimate of the commitment to supply free Avastin to eligible
patients who elect to enroll in the program.
In
order to estimate the amount of free Avastin to be provided to patients under
the Avastin Patient Assistance 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 patients may elect to enroll in the program, the number of
patients who will meet the financial eligibility requirements of the program,
and the duration and extent of treatment for the FDA-approved indications, among
other factors. We have based our enrollment assumptions on physician surveys and
other information that we consider relevant. We will continue to update our
estimates in each reporting period as new information becomes available. If the
actual results underlying this deferred revenue accounting vary significantly
from our estimates, we will need to adjust these estimates. Based on these
estimates, we defer a portion of Avastin revenue on product vials sold through
normal commercial channels. The deferred revenue will be recognized when free
Avastin vials are delivered. In the second quarter and first six months of 2008,
we deferred $1 million and $2 million, respectively, of Avastin product sales,
resulting in a total deferred revenue liability in connection with the Avastin
Patient Assistance Program of $4 million in our Condensed Consolidated Balance
Sheet as of June 30, 2008. In the first six months of 2007, we
deferred $3 million of Avastin product sales in connection with the Avastin
Patient Assistance Program. Usage of the Avastin Patient Assistance Program may
increase with the approval of Avastin for the treatment of metastatic
HER2-negative BC. As we continue to evaluate the amount of revenue to defer
related to the Avastin Patient Assistance Program, we may recognize previously
deferred revenue in Avastin U.S. product sales in future periods or increase the
amount of revenue deferred.
Product
Sales Allowances
Revenue
from U.S. product sales is recorded net of allowances and accruals for rebates,
healthcare provider contractual chargebacks, prompt-pay sales discounts, product
returns, and wholesaler inventory management allowances, all of which are
established at the time of sale. Sales allowances and accruals are based
on estimates of the amounts earned or to be claimed on the related sales.
The amounts reflected in our Condensed Consolidated Statements of Income as
product sales allowances have been relatively consistent at approximately seven
to eight percent of gross sales. In order to prepare our Condensed Consolidated
Financial Statements, we are required to make estimates regarding the amounts
earned or to be claimed on the related product sales.
Definitions
for the product sales allowance types are as follows:
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Rebate
allowances and accruals include 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.
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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.
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Prompt-pay
sales discounts are credits granted to wholesalers for remitting payment
on their purchases within established cash payment incentive
periods.
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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.
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Healthcare
provider contractual chargebacks are the result of our contractual
commitments to provide products to healthcare providers at specified
prices or discounts.
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We
believe that our estimates related to wholesaler inventory management payments
are not material amounts, based on the historical levels of credits and
allowances as a percentage of product sales. We believe that 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 and product returns allowances to be the only
estimations that involve material amounts and require a higher degree of
subjectivity and judgment to account for the obligations. As a result of the
uncertainties involved in estimating rebate allowances and accruals and
product returns allowances, there is a possibility that materially different
amounts could be reported under different conditions or using different
assumptions.
Our
rebates are based on 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 rebates (including Medicaid) 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
and 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 that our rebate allowances and accruals estimation process
provides a high degree of confidence in the annual allowance amounts
established. Based on our estimation, the changes in rebate allowances and
accruals estimates related to prior years have not exceeded 3%. To further
illustrate our sensitivity to changes in the rebate allowances and accruals
process, a 10% change in our annualized rebate allowances and accruals provision
experienced to date in 2008 (which is in excess of three times the level of
variability that we reasonably expect to observe for rebates) would have an
approximate $20 million unfavorable effect on our results (or approximately
$0.01 per share). The total rebate allowances and accruals recorded in our
Condensed Consolidated Balance Sheets were $78 million as of June 30, 2008 and
$70 million as of December 31, 2007.
At
the time of sale, we record product returns allowances based on our best
estimate of the portion of sales that will be returned by our customers in the
future. Product returns allowances are established in accordance with our
returns policy, which allows buyers to return our products with two months or
less remaining prior to product expiration and up to six months following
product expiration. As part of the estimating process, we compare historical
return data to the related sales on a production lot basis. Historical rates of
return are then determined by product and may be adjusted for known or expected
changes in the marketplace. Actual annual product returns processed were less
than 0.5% of gross product sales in all periods between 2005 and 2007, while
annual provisions for expected future product returns were less than 1% of gross
product sales in all such periods. Although product returns allowances are
recorded at the time of sale, the majority of the returns are expected to occur
within two years of sale. Therefore, our provisions for product returns
allowances may include changes in the estimate for a prior period due to the lag
time. However, to date such changes have not been material. For example, in
2007, changes in estimates related to prior years were approximately 0.3% of
2007 gross product sales. To illustrate our sensitivity to changes in the
product returns allowances, if we were to experience an adjustment rate of 0.5%
of 2007 gross product sales, which is nearly twice the level of annual
variability that we have historically observed for product returns, that change
in estimate would likely have an unfavorable effect of approximately $50 million
(or approximately $0.03 per share) on our results of operations. Product returns
allowances recorded in our Condensed Consolidated Balance Sheets were $87
million as of June 30, 2008 and $60 million as of December 31,
2007.
All
of the aforementioned categories of allowances and accruals are evaluated
quarterly and adjusted when trends or significant events indicate that a change
in estimate is appropriate. Such changes in estimate could materially affect our
results of operations or financial position; however, to date they have not been
material. It is possible that we may need to adjust our estimates in future
periods. Our Condensed Consolidated Balance Sheets reflected estimated product
sales allowance reserves and accruals totaling $214 million as of June 30, 2008
and $176 million as of December 31, 2007.
Royalties
For
substantially all of our agreements with licensees, we estimate royalty revenue
and royalty receivables in the period the royalties are earned, which is in
advance of collection. Royalties from Roche, which are approximately 60% of our
total royalty revenue, are reported based on actual sales reports from Roche.
Our estimates of royalty revenue and receivables from non-Roche licensees are
primarily based on communication with some licensees, historical information,
forecasted sales trends, and our assessment of collectibility. Differences
between actual royalty revenue and estimated royalty revenue are adjusted for in
the period in which they become known, typically
the
following quarter. Since 2005, the adjustment to our royalty revenue related to
prior periods has not exceeded 1% of total annual royalty revenue. However, on a
quarterly basis, adjustments related to prior quarters have been higher than 1%
of total royalty revenue for the respective quarter. To further illustrate our
sensitivity to the royalty estimation process, a 1% adjustment to total annual
royalty revenue, which is at the upper end of the range of our historic
experience, would result in an adjustment to total 2007 annual royalty revenue
of approximately $25 million (or approximately $0.01 to $0.02 per
share, net of any related royalty expenses).
For
cases in which the collectibility of a royalty amount is doubtful, royalty
revenue is not recorded in advance of payment, but is recognized as cash is
received. In the case of a receivable related to previously recognized royalty
revenue that is subsequently determined to be uncollectible, the receivable is
reserved for by reversing the previously recorded royalty revenue in the period
in which the circumstances that make collectibility doubtful are determined, and
future royalties from the licensee are recognized on a cash basis until it is
determined that collectibility is reasonably assured.
We
have confidential licensing agreements with a number of companies under which we
receive royalty revenue on sales of products that are covered by the Cabilly
patent. The Cabilly patent, which expires in 2018, relates to methods that we
and others use to make certain antibodies or antibody fragments, as well as
cells and DNA used in those methods. The Patent Office is performing a
reexamination of the patent, and on February 25, 2008 issued a final Patent
Office action rejecting all the claims of the Cabilly patent. We filed our
response to that final Patent Office action on June 6, 2008. On July 19, 2008,
the Patent Office mailed an advisory action replying to our response and
confirming the rejection of all claims of the Cabilly patent. We intend to file
a notice of appeal challenging the rejection. The claims of the patent remain
valid and enforceable throughout the reexamination and appeals processes. In
addition, in May 2008, Centocor, Inc. filed a lawsuit against us challenging the
Cabilly patent. See also Note 5, “Contingencies,” in the Notes to Condensed
Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on
Form 10-Q for more information on our Cabilly patent litigation and
reexamination.
Cabilly
patent royalties are generally due 60 days after the end of the quarter in which
they are earned and recorded by us as royalty revenue. Additionally, we pay COH
a percentage of our Cabilly patent royalty revenue 60 days after the quarter in
which we receive payments from our licensees. As of June 30, 2008, our Condensed
Consolidated Balance Sheet included Cabilly patent receivables totaling
approximately $69 million and related COH payables totaling approximately $30
million.
Income
Taxes
Our
income tax provision is based on income before taxes and is computed using the
liability method in accordance with FAS No. 109, “Accounting for Income
Taxes.” 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, or the findings or expected results from any tax
examinations. 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;
the results of any tax examinations; changing interpretations of existing tax
laws or regulations; changes in estimates of prior years’ items; past and future
levels of R&D spending; acquisitions; changes in our corporate
structure; and changes in overall levels of income before taxes all of which may
result in periodic revisions to our effective income tax rate. For example,
the effective income tax rates in the second quarter and first six months of
2008 were unfavorably affected by a $33 million settlement with the IRS for an
item related to prior years. Uncertain tax positions are accounted for in
accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes.” We accrue tax-related interest and penalties related to
uncertain tax positions, and include these items with income tax expense in the
Condensed Consolidated Statements of Income.
Inventories
Inventories
may include currently marketed products manufactured under a new process or at
facilities awaiting regulatory licensure. These inventories are capitalized
based on our judgment of probable near-term regulatory licensure. Excess or idle
capacity costs, resulting from utilization below a plant’s normal capacity, are
expensed in
the
period in which they are incurred. The valuation of inventory requires us to
estimate the value of inventory that may expire prior to use or that may fail to
be released for commercial sale. For example, in the second quarter of 2008, we
recognized a $50 million charge related to failed lots from a manufacturing
start-up campaign. The determination of obsolete inventory requires us to
estimate the future demands for our products, and in the case of pre-approval
inventories, to estimate the regulatory approval date for the product or for the
licensure of either the manufacturing facility or the new manufacturing process.
We may be required to expense previously capitalized inventory costs upon a
change in our estimate, due to, among other potential factors, the 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
salable.
Valuation
of Acquired Intangible Assets
We
have acquired intangible assets in connection with our acquisition of Tanox.
These intangible assets consist of developed product technology and core
technologies associated with intellectual property and rights thereon, primarily
related to the Xolair molecule, and assets related to the fair value write-up of
Tanox’s royalty contracts, as well as goodwill. When significant identifiable
intangible assets are acquired, we determine the fair value of these assets as
of the acquisition date, using valuation techniques such as discounted cash flow
models. These models require the use of significant estimates and assumptions
including, but not limited to, determining the timing and expected costs to
complete the in-process projects, projecting regulatory approvals, estimating
future cash flows from product sales resulting from completed products and
in-process projects, and developing appropriate discount rates and probability
rates by project.
We
believe that the fair value assigned to the intangible assets acquired is based
on reasonable estimates and assumptions, given the available facts and
circumstances as of the acquisition date. However, we may record adjustments to
goodwill resulting from our acquisition of Tanox for the resolution of
pre-acquisition contingencies, our restructuring activities, tax matters, and
other estimates related to the acquisition for a period of up to one year after
the acquisition date. Further, we will have to continually evaluate whether the
fair value of any or all intangible assets has been impaired.
Employee
Stock-Based Compensation
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 (Redemption) by RHI, 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
GAAP, we review our valuation assumptions at each grant date, and, as a result,
our valuation assumptions used to value employee stock-based awards granted in
future periods may change. See Note 2, “Employee Stock-Based Compensation,” in
the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of
this Quarterly Report on Form 10-Q for more information.
Results
of Operations
(In
millions, except per share amounts)
|
|
|
Three
Months
Ended
June 30,
|
|
|
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product
sales
|
|
$ |
2,536 |
|
|
$ |
2,443 |
|
|
|
4
|
% |
|
$ |
4,915 |
|
|
$ |
4,773 |
|
|
|
3
|
% |
|
Royalties
|
|
|
629 |
|
|
|
484 |
|
|
|
30 |
|
|
|
1,244 |
|
|
|
903 |
|
|
|
38 |
|
|
Contract
revenue
|
|
|
71 |
|
|
|
77 |
|
|
|
(8 |
) |
|
|
140 |
|
|
|
171 |
|
|
|
(18 |
) |
|
Total
operating revenue
|
|
|
3,236 |
|
|
|
3,004 |
|
|
|
8 |
|
|
|
6,299 |
|
|
|
5,847 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales
|
|
|
441 |
|
|
|
429 |
|
|
|
3 |
|
|
|
831 |
|
|
|
821 |
|
|
|
1 |
|
|
Research
and development
|
|
|
649 |
|
|
|
603 |
|
|
|
8 |
|
|
|
1,266 |
|
|
|
1,213 |
|
|
|
4 |
|
|
Marketing,
general and administrative
|
|
|
559 |
|
|
|
532 |
|
|
|
5 |
|
|
|
1,076 |
|
|
|
1,023 |
|
|
|
5 |
|
|
Collaboration
profit sharing
|
|
|
313 |
|
|
|
277 |
|
|
|
13 |
|
|
|
592 |
|
|
|
529 |
|
|
|
12 |
|
|
Recurring
amortization charges related to redemption and acquisition
|
|
|
43 |
|
|
|
26 |
|
|
|
65 |
|
|
|
86 |
|
|
|
52 |
|
|
|
65 |
|
|
Special
items: litigation-related
|
|
|
2 |
|
|
|
13 |
|
|
|
(85 |
) |
|
|
(300 |
) |
|
|
26 |
|
|
|
* |
|
|
Total
costs and expenses
|
|
|
2,007 |
|
|
|
1,880 |
|
|
|
7 |
|
|
|
3,551 |
|
|
|
3,664 |
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income
|
|
|
1,229 |
|
|
|
1,124 |
|
|
|
9 |
|
|
|
2,748 |
|
|
|
2,183 |
|
|
|
26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
and other income, net
|
|
|
93 |
|
|
|
75 |
|
|
|
24 |
|
|
|
166 |
|
|
|
149 |
|
|
|
11 |
|
|
Interest
expense
|
|
|
(15 |
) |
|
|
(17 |
) |
|
|
(12 |
) |
|
|
(32 |
) |
|
|
(35 |
) |
|
|
(9 |
) |
|
Total
other income, net
|
|
|
78 |
|
|
|
58 |
|
|
|
34 |
|
|
|
134 |
|
|
|
114 |
|
|
|
18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before taxes
|
|
|
1,307 |
|
|
|
1,182 |
|
|
|
11 |
|
|
|
2,882 |
|
|
|
2,297 |
|
|
|
25 |
|
|
Income
tax provision
|
|
|
525 |
|
|
|
435 |
|
|
|
21 |
|
|
|
1,118 |
|
|
|
844 |
|
|
|
32 |
|
|
Net
income
|
|
$ |
782 |
|
|
$ |
747 |
|
|
|
5 |
|
|
$ |
1,764 |
|
|
$ |
1,453 |
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.74 |
|
|
$ |
0.71 |
|
|
|
4
|
% |
|
$ |
1.68 |
|
|
$ |
1.38 |
|
|
|
22
|
% |
|
Diluted
|
|
$ |
0.73 |
|
|
$ |
0.70 |
|
|
|
4 |
|
|
$ |
1.65 |
|
|
$ |
1.36 |
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of sales as a % of product sales
|
|
|
17
|
% |
|
|
18
|
% |
|
|
|
|
|
|
17
|
% |
|
|
17
|
% |
|
|
|
|
|
Research
and development as a % of operating revenue
|
|
|
20 |
|
|
|
20 |
|
|
|
|
|
|
|
20 |
|
|
|
21 |
|
|
|
|
|
|
Marketing,
general and administrative as a % of operating revenue
|
|
|
17 |
|
|
|
18 |
|
|
|
|
|
|
|
17 |
|
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pretax
operating margin
|
|
|
38
|
% |
|
|
37
|
% |
|
|
|
|
|
|
44
|
% |
|
|
37
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective
income tax rate
|
|
|
40
|
% |
|
|
37
|
% |
|
|
|
|
|
|
39
|
% |
|
|
37
|
% |
|
|
|
|
________________________
|
*
|
Calculation
not meaningful.
|
|
|
Percentages
in this table and throughout the discussion and analysis of our financial
condition and results of operations may reflect rounding
adjustments.
|
Total
Operating Revenue
Total
operating revenue increased 8% in the second quarter and first six months of
2008 from the comparable periods in 2007. These increases were primarily
due to higher product sales and royalty revenue, and are discussed
below.
Total
Product Sales
(In
millions)
|
|
|
Three
Months
|
|
|
|
|
|
Six
Months
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
U.S. product sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Avastin
|
|
$ |
650 |
|
|
$ |
564 |
|
|
|
15
|
% |
|
$ |
1,250 |
|
|
$ |
1,097 |
|
|
|
14
|
% |
|
Rituxan
|
|
|
651 |
|
|
|
582 |
|
|
|
12 |
|
|
|
1,255 |
|
|
|
1,117 |
|
|
|
12 |
|
|
Herceptin
|
|
|
338 |
|
|
|
329 |
|
|
|
3 |
|
|
|
678 |
|
|
|
640 |
|
|
|
6 |
|
|
Lucentis
|
|
|
216 |
|
|
|
209 |
|
|
|
3 |
|
|
|
414 |
|
|
|
420 |
|
|
|
(1 |
) |
|
Xolair
|
|
|
129 |
|
|
|
120 |
|
|
|
8 |
|
|
|
246 |
|
|
|
231 |
|
|
|
6 |
|
|
Tarceva
|
|
|
119 |
|
|
|
102 |
|
|
|
17 |
|
|
|
230 |
|
|
|
203 |
|
|
|
13 |
|
|
Nutropin
products
|
|
|
89 |
|
|
|
94 |
|
|
|
(5 |
) |
|
|
173 |
|
|
|
185 |
|
|
|
(6 |
) |
|
Thrombolytics
|
|
|
68 |
|
|
|
67 |
|
|
|
1 |
|
|
|
135 |
|
|
|
135 |
|
|
|
0 |
|
|
Pulmozyme
|
|
|
63 |
|
|
|
55 |
|
|
|
15 |
|
|
|
120 |
|
|
|
107 |
|
|
|
12 |
|
|
Raptiva
|
|
|
28 |
|
|
|
27 |
|
|
|
4 |
|
|
|
54 |
|
|
|
51 |
|
|
|
6 |
|
|
Total
U.S. product sales(1)
|
|
|
2,351 |
|
|
|
2,149 |
|
|
|
9 |
|
|
|
4,556 |
|
|
|
4,186 |
|
|
|
9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
product sales to collaborators
|
|
|
185 |
|
|
|
294 |
|
|
|
(37 |
) |
|
|
359 |
|
|
|
587 |
|
|
|
(39 |
) |
|
Total
product sales
|
|
$ |
2,536 |
|
|
$ |
2,443 |
|
|
|
4 |
|
|
$ |
4,915 |
|
|
$ |
4,773 |
|
|
|
3 |
|
______________________
|
(1)
|
The
totals may not appear to equal the sum of the individual line items due to
rounding.
|
Total
product sales increased 4% in the second quarter and 3% in the first six months
of 2008 from the comparable periods in 2007. Total U.S. product sales
increased 9% to $2,351 million in the second quarter and 9% to $4,556 million in
the first six months of 2008 from the comparable periods in 2007. The increases
in U.S. sales were due to higher sales across most products, in particular
higher sales of our oncology products. Increased U.S. sales volume accounted for
65%, or $131 million, of the increase in U.S. net product sales in the second
quarter of 2008, and 67%, or $247 million, of the increase in the first six
months of 2008. Changes in net U.S. sales prices across the majority of products
in the portfolio accounted for most of the remainder of the increases in
U.S. net product sales in the second quarter and first six months of
2008.
Our
references below to market adoption and penetration, as well as patient share,
are derived from our analyses of market tracking studies and surveys that we
undertake with physicians. We consider these tracking studies and surveys
indicative of trends and information with respect to our end users’ buying
patterns. We use statistical analyses and management judgment to interpret the
data that we obtain, and as such, the adoption, penetration, and patient share
data presented herein represent estimates. Limitations in sample size and the
timeliness in receiving and analyzing this data result in inherent margins of
error; thus, where presented, we have rounded our percentage estimates to the
nearest 5%.
Avastin
Net
U.S. sales of Avastin increased 15% to $650 million in the second quarter and
14% to $1,250 million in the first six months of 2008 from the comparable
periods in 2007. Net U.S. sales in the second quarter and first six months of
2008 excluded net revenue of $1 million and $2 million, respectively that
was deferred in connection with our Avastin Patient Assistance Program. The
increases in sales were primarily due to increased use of Avastin for first-line
treatment of metastatic BC, which received accelerated approval from the FDA in
the first quarter of 2008, and for first-line treatment of metastatic
NSCLC.
Avastin
received accelerated approval on February 22, 2008 for use in combination with
paclitaxel chemotherapy for patients who have not received prior chemotherapy
for metastatic HER2-negative BC. For first-line treatment of metastatic
HER2-negative BC patients, we estimate that Avastin penetration in the second
quarter of 2008 was approximately 35%, an increase from the rate of adoption in
the second quarter of 2007 and the first quarter of 2008. With respect to
dose, the percentage of metastatic BC patients receiving the high dose of
Avastin, defined as 5 mg/kg/weekly-equivalent, remained approximately 75%
in the second quarter of 2008, in-line with the first quarter
of
2008. The U.S. labeled dose of Avastin in metastatic BC is 10 mg/kg,
administered intravenously every two weeks. Data from AVADO, the
Roche-sponsored, placebo-controlled Phase III trial, was presented at the
American Society of Clinical Oncology (ASCO) annual meeting in June 2008.
In the AVADO study, two dose levels of Avastin, a
7.5 mg/kg/every-three-weeks dose and a 15 mg/kg/every-three-week dose,
in combination with docetaxel chemotherapy, showed a statistically
significant improvement in PFS and response rate compared to docetaxel
chemotherapy alone. While the study was not designed to detect a difference
between the Avastin doses, positive trends towards the higher dose were seen
across the primary and secondary end points. The overall survival data for AVADO
is anticipated in the first half of 2009. No new safety signals were detected in
this study. We are required to submit the results of the AVADO study and RIBBON
I, a Phase III study in first-line metastatic BC, to the FDA by mid-2009 for the
FDA to consider converting the accelerated approval into a full approval. The
RIBBON I study results are expected later this year, with a primary endpoint of
PFS.
For
first-line treatment of metastatic NSCLC patients, among the approximately 50%
to 60% of patients with first-line metastatic lung cancer who are eligible for
Avastin therapy, we estimate that penetration in the second quarter of 2008 was
approximately 65%, an increase from approximately 60% reported in previous
quarters. With respect to dose, the percentage of lung cancer patients receiving
the high dose of Avastin, defined as at least 5 mg/kg/weekly-equivalent,
was approximately 70% in the second quarter of 2008, in-line with the
second quarter of 2007 and the first quarter of 2008. The labeled dose of
Avastin in lung cancer is 15 mg/kg, administered intravenously every three
weeks. However, we expect dose in metastatic NSCLC to continue to be a source of
uncertainty for Avastin. The Roche-sponsored BO17704 study, which was presented
at the ASCO annual meeting in June 2007, evaluated a
15 mg/kg/every-three-weeks dose of Avastin (the dose approved in the U.S.
for use in combination with carboplatin and paclitaxel) and a
7.5 mg/kg/every-three-weeks dose of Avastin (a dose not approved for use in
the U.S.) in combination with gemcitabine and cisplatin chemotherapy
compared to chemotherapy alone in patients with previously untreated, advanced
NSCLC. Both doses met the primary endpoint of prolonging PFS compared to
chemotherapy alone. Although the study was not designed to compare the Avastin
doses, a similar treatment effect in PFS was observed between the two arms. On
April 20, 2008, we announced that the study did not demonstrate a statistically
significant prolongation of overall survival, a secondary endpoint, for either
dose in combination with gemcitabine and cisplatin chemotherapy compared to
chemotherapy alone. Median survival of patients in all arms of the study
exceeded one year, which is longer than previously reported survival times in
this indication. Based on these results, additional physicians may adopt
Avastin at the lower dose of 7.5 mg/kg/every-three-weeks or choose not to
prescribe Avastin.
In
both first- and second-line treatment of metastatic colorectal cancer (CRC),
penetration in the second quarter of 2008 increased from the second quarter of
2007, but was in-line compared to the first quarter of 2008.
At
the ASCO meeting in June 2008, we also presented data on our adjuvant colon
cancer study, C-08, sponsored by the National Cancer Institute and conducted by
the National Surgical Adjuvant Breast and Bowel Project (NSABP). The preliminary
safety analysis showed no new or unexpected safety events in the Avastin arm and
supports the decision by the NSABP to continue the study as planned. We expect
the NSABP to conduct an interim analysis of the study in the fourth quarter of
2008, and if the study continues past the interim analysis, we expect the final
analysis in 2009.
In
the second quarter of 2008, we and Roche distributed a Dear Healthcare Provider
Letter describing the previously reported findings of microangiopathic hemolytic
anemia (MAHA) in patients treated with Avastin and Sutent® in
two metastatic renal cell cancer trials, an investigator sponsored trial and the
SABRE-R clinical trial. The events were reversible upon discontinuation of
Avastin and Sutent®, and to
date, MAHA has been observed in Avastin treatment only when it is combined with
Sutent®. All of
our SABRE studies evaluating this combination have been
discontinued.
Rituxan
Net
U.S. sales of Rituxan increased 12% to $651 million in the second quarter and
12% to $1,255 million in the first six months of 2008 from the comparable
periods in 2007. In the oncology setting, sales growth continues to be driven
primarily by use of Rituxan following first-line therapy in indolent NHL.
Overall adoption of Rituxan in other areas of NHL and chronic lymphocytic
leukemia, an unapproved indication, remained stable compared to the second
quarter of 2007.
In
the RA setting, the primary driver of growth was an increased share of patients
who have failed anti-TNF therapies. 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. In June 2008, we received a
report of a fatal progressive multifocal leukoencephalopathy (PML) case in a
patient who received Rituxan in the REFLEX trial and extension study for Rituxan
in RA. The final course of Rituxan was completed 18 months prior to the
development of PML and the patient had multiple confounding factors associated
with immunosuppression. Immunology investigators have been informed, and we will
continue to work with the FDA to discuss what additional steps need to be
taken.
On
April 14, 2008, we and Biogen Idec announced that OLYMPUS, a Phase II/III study
of Rituxan for PPMS, did not meet its primary endpoint as measured by the time
to confirmed disease progression during the 96-week treatment period. We
observed biologic activity in a subset of patients, and will continue to
analyze the results of the study with Biogen Idec and will submit the data for
presentation at an upcoming medical meeting.
On
April 29, 2008, we announced that EXPLORER, the Phase II/III study of Rituxan
for SLE, did not meet its primary endpoint defined as the proportion of Rituxan
treated patients who achieved a MCR or PCR measured by BILAG, a lupus activity
response index, compared to placebo at 52 weeks. The study also did not meet any
of the six secondary endpoints. Our market research indicates that approximately
one percent of U.S. Rituxan sales are attributable to Rituxan use in the lupus
setting (an unapproved use).
Herceptin
Net
U.S. sales of Herceptin increased 3% to $338 million in the second quarter and
6% to $678 million in the first six months of 2008 from the comparable periods
in 2007. The sales growth was primarily due to price increases in 2008 and 2007
and increased use of Herceptin in the treatment of early-stage HER2-positive
BC. We estimate that Herceptin penetration in the adjuvant setting was
approximately 85% in the second quarter of 2008, an increase from the second
quarter of 2007. In first-line treatment of metastatic HER2-positive BC
patients, Herceptin penetration was approximately 75% for the second quarter of
2008, an increase from the second quarter of 2007.
On
May 22, 2008, the FDA approved two additional label expansions for Herceptin in
HER2-positive, adjuvant BC. One of the label expansions added the use of a new
treatment option with Herceptin in combination with docetaxel and carboplatin
chemotherapies, which provides a shorter, less cardiotoxic regimen as an
alternative for some patients. The other label expansion added the use of a new
treatment option with Herceptin in combination with anthracycline,
cyclophosphamide, and docetaxel chemotherapies.
Lucentis
Net
U.S. sales of Lucentis increased 3% to $216 million in the second quarter and
decreased 1% to $414 million in the first six months of 2008 from the comparable
periods in 2007. The launch of improved patient access programs in March
2008, a revised promotional campaign, and enhanced distribution options for
Lucentis that began in May 2008, along with a more stable market environment,
contributed to the sales growth in the second quarter of 2008. We believe that
the percentage of newly diagnosed patients who were treated with Lucentis during
the second quarter of 2008 was approximately 45% compared to approximately 40%
during the first quarter of 2008 and 55% during the second quarter of 2007.
Although sales increased in the second quarter of 2008, it is difficult to
interpret a sales trend during a period that has a change in distribution, and
while the continued unapproved use of Avastin and reimbursement concerns from
retinal specialists remain challenges.
Xolair
Net
U.S. sales of Xolair increased 8% to $129 million in the second quarter and 6%
to $246 million in the first six months of 2008 from the comparable periods in
2007.
On
April 10, 2008, we and Novartis announced that a Phase III study evaluating
Xolair in patients 6 to 11 years of age with moderate-to-severe, persistent,
inadequately controlled allergic asthma met its primary endpoint, demonstrating
a statistically significant reduction in exacerbations in Xolair-treated
patients compared to placebo
treated
patients, with no new safety signals reported. We will work with Novartis to
evaluate the complete study results, including feedback from the FDA, to
determine the next steps.
Tarceva
Net
U.S. sales of Tarceva increased 17% to $119 million in the second quarter and
13% to $230 million in the first six months of 2008 from the comparable periods
in 2007. The sales growth was primarily due to price increases in 2008 and 2007
and lower return reserve requirements in the second quarter and first six months
of 2008. We estimate that Tarceva penetration in second-line treatment of NSCLC
in the second quarter of 2008 remained stable at approximately 30% compared to
the same period in 2007. In the first-line pancreatic cancer setting, we
estimate that Tarceva penetration in the second quarter of 2008 was
approximately 40%, an increase from the second quarter of 2007.
Nutropin
Products
Combined
net U.S. sales of our Nutropin products decreased 5% to $89 million in the
second quarter and 6% to $173 million in the first six months of 2008 from the
comparable periods in 2007.
Thrombolytics
Combined
net U.S. sales of our three thrombolytics products—Activase, Cathflo Activase,
and TNKase—increased 1% to $68 million in the second quarter and remained flat
in the first six months of 2008 from the comparable periods in 2007. Sales in
the second quarter and first six months of 2008 were favorably affected by price
increases in 2008 and 2007 and increases in sales volume. However, these
increases were offset by increased product return reserve
requirements.
Pulmozyme
Net
U.S. sales of Pulmozyme increased 15% to $63 million in the second quarter and
12% to $120 million in the first six months of 2008 from the comparable periods
in 2007.
Raptiva
Net
U.S. sales of Raptiva increased 4% to $28 million in the second quarter and 6%
to $54 million in the first six months of 2008 from the comparable periods in
2007.
Sales
to Collaborators
Product
sales to collaborators, which were for non-U.S. markets, decreased 37% to $185
million in the second quarter and 39% to $359 million in the first six months of
2008 from the comparable periods in 2007. The decreases were primarily due to
the quarterly timing of Herceptin and Avastin sales to Roche. For 2008, we
forecast sales to collaborators to increase by approximately 10% to 15% over
2007 with quarterly fluctuations due to the timing of the production and order
plan.
Herceptin
sales to Roche since the third quarter of 2006 reflect more favorable pricing
terms that were part of the supply agreement with Roche signed at that time.
These favorable pricing terms will continue through the end of
2008.
Royalties
Royalty
revenue increased 30% to $629 million in the second quarter and 37% to $1,244
million in the first six months of 2008 from the comparable periods in
2007. Excluding the effect of a collaboration agreement in the second quarter of
2007, which resulted in one-time royalty revenue of approximately $65 million in
that quarter, royalty revenue increased 50% in the second quarter and 48% in the
first six months of 2008 from the comparable periods in 2007. The majority of
the increases were due to higher sales by Roche of our Avastin, Herceptin,
and Rituxan products, and higher sales by Novartis of our Lucentis product. In
addition, approximately $40 million of
the
increase in the second quarter of 2008 and approximately $85 million of the
increase in the first six months of 2008 was due to net foreign-exchange-related
benefits from the weaker U.S. dollar during these periods compared to the same
periods of 2007. Royalty revenue for the first six months of 2008 also included
approximately $20 million of net adjustments increasing royalty revenue due to
changes in estimates for amounts reported in 2007, compared to immaterial
amounts of such net adjustments recorded in the first six months of
2007.
Cash
flows from royalty income include revenue denominated in foreign currencies. We
currently enter into foreign currency option contracts (options) and forwards to
hedge a portion of these foreign currency cash flows. These existing options and
forwards are due to expire between 2008 and 2010, and we expect to continue
to enter into similar contracts in accordance with our hedging
policy.
Of
the overall royalties received, royalties from Roche represented approximately
62% in the second quarter and 61% in the first six months of 2008 compared to
approximately 58% in the second quarter and 60% in the first six months of 2007.
Royalties from other licensees included royalty revenue on our patent licenses,
including our Cabilly patent, as discussed below.
We
have confidential licensing agreements with a number of companies under which we
receive royalty revenue on sales of products covered by the Cabilly patent. The
Cabilly patent expires in December 2018, but is the subject of litigation and an
ongoing reexamination, and an appeals process. The net pretax contributions
related to the Cabilly patent were as follows (in millions, except per share
amounts):
|
|
|
Three
Months
Ended
June 30,
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty
revenue
|
|
$ |
75 |
|
|
$ |
46 |
|
|
$ |
159 |
|
|
$ |
108 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
expenses(1)
|
|
$ |
35 |
|
|
$ |
27 |
|
|
$ |
71 |
|
|
$ |
57 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
of tax effect of Cabilly patent on diluted EPS
|
|
$ |
0.02 |
|
|
$ |
0.01 |
|
|
$ |
0.05 |
|
|
$ |
0.03 |
|
______________________
|
(1)
|
Gross
expenses include COH’s share of royalty revenue and royalty COS on our
U.S. product sales.
|
See
also Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial
Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more
information on our Cabilly patent litigation and reexamination.
Royalties
are difficult to forecast because of the number of products involved, the
availability of licensee sales data, potential contractual and intellectual
property disputes, and the volatility of foreign currency exchange rates. For
2008, we forecast royalty revenue to grow approximately 20% to 30% relative to
2007, but a number of factors could affect these results. Higher than forecasted
licensed product sales could positively affect royalty revenue. However, royalty
revenue growth could be negatively affected by a number of factors, including
the strengthening of the U.S. dollar, lower than expected sales of licensees’
products, the termination of licenses, changes to the terms of contracts under
which licenses have been granted, or the failure of licensees to meet their
contractual payment obligations for any reason, including an adverse decision or
ruling in litigation involving the Cabilly patent, the Cabilly patent
reexamination or related proceedings.
Contract
Revenue
Contract
revenue decreased 8% to $71 million in the second quarter and 18% to $140
million in the first six months of 2008 from the comparable periods in 2007. The
decreases were mainly due to lower reimbursements from Roche related to
R&D efforts on Avastin. The decrease in the first six months of 2008
was also due to the receipt of a milestone payment from Novartis Pharma AG in
the first quarter of 2007 related to European Union approval of Lucentis.
Contract revenue in the second quarter and first six months of 2008 included
manufacturing service payments related to Xolair, which Novartis pays us as a
result of our acquisition of Tanox, and our share of European profits related to
Xolair. See “Related Party Transactions” below for more information on
contract revenue from Roche and Novartis.
For
2008, we forecast contract revenue to remain relatively flat compared to 2007.
However, contract revenue varies each quarter and is dependent on a number of
factors, including the timing and level of reimbursements from ongoing
development efforts, milestones, opt-in payments received, new contract
arrangements, and foreign currency exchange rates.
Cost
of Sales
Cost
of sales (COS) as a percentage of product sales was 17% in the second quarter
and first six months of 2008 compared to 18% in the second quarter and 17% in
the first six months of 2007. COS as a percentage of product sales during
the second quarter and first six months of 2008 was favorably affected by a
decreased volume of lower margin sales to collaborators. However, COS for these
periods included a $50 million charge related to failed lots from a
manufacturing start-up campaign at one of our facilities, as well as smaller
charges related to the ongoing effect of our Voluntary Severance Program (VSP)
and excess manufacturing capacity in our manufacturing network. The VSP gave
certain manufacturing employees the opportunity to voluntarily resign from the
company in exchange for a severance package. For the first six months of 2008,
compensation charges related to the VSP included in COS were $27 million. Since
a substantial majority of the employees enrolled under the VSP departed during
the first six months of 2008, the remaining charges that will be recorded in the
second half of 2008 are not expected to have a material effect on our results of
operations.
Research
and Development
Research
and development (R&D) expenses increased 8% to $649 million in the second
quarter and 4% to $1,266 million in the first six months of 2008 from the
comparable periods in 2007. The higher levels of expenses in the second quarter
and first six months of 2008 reflected increased development activity mainly as
a result of collaboration arrangements entered into in 2007, increased clinical
manufacturing expenses, and higher research expenses. The increases in R&D
expenses were offset by a reduction of in-licensing expenses of approximately
$140 million in the first six months of 2008 compared to the first six
months of 2007, due to significant new collaborations entered into during
the first six months of 2007. R&D as a percentage of operating revenue was
20% in the second
quarter and first six months of 2008 compared to 20% in the second quarter and
21% in the first six months of 2007.
Marketing,
General and Administrative
Marketing,
general and administrative (MG&A) expenses increased 5% to $559 million in the second
quarter and 5% to $1,076 million in the first six months of 2008 from the
comparable periods in 2007. These increases were primarily due to an increase in
royalty expense, primarily to Biogen Idec, resulting from higher Roche sales of
Rituxan. MG&A as a percentage of operating revenue was 17% in the second quarter
and in the first six months of 2008 compared to 18% in the second quarter and
17% in the first six months 2007.
Collaboration
Profit Sharing
Collaboration
profit sharing expenses increased 13% to $313 million in the second
quarter and 12% to $592 million in the first six months of 2008 from the
comparable periods in 2007, primarily due to higher sales of Rituxan and
Tarceva.
The
following table summarizes the amounts resulting from the respective profit
sharing collaborations for the periods presented (in millions):
|
|
|
Three
Months
Ended
June 30,
|
|
|
|
|
|
Six
Months
Ended
June 30,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Rituxan profit sharing expense
|
|
$ |
213 |
|
|
$ |
188 |
|
|
|
13
|
% |
|
$ |
404 |
|
|
$ |
354 |
|
|