In 2002, Chugai started a strategic alliance with the Swiss company Roche, one of the world's leading pharmaceutical companies. Under its unique business model, Chugai has realized its continuous growth. Roche is a pharmaceutical company headquartered in Switzerland. Genentech, a leading biotechnology company in the United States, is a wholly owned member of the Roche Group. Chugai owns exclusive rights to develop and market new drugs from the Roche Group in Japan. This stable revenue base enables Chugai to focus its investments in highly innovative proprietary technologies and drug discovery. Products created by Chugai through this process are out-licensed to Roche and expanded to the global market through Roche's infrastructure. The revenue drives Chugai's growth and will be a revenue stream that allows the company to reinvest to create its next products.
In this video, we will present the financial impact that transactions with Roche under the strategic alliance have on Chugai. The explanation will be divided into two parts: out-licensing of in-house products to Roche and in-licensing of products from Roche. Each will be explained along with the development phase of drugs. Proposals for out-licensing Chugai products to Roche are, in principle, made at the time of obtaining early PoC. This realizes rapid development without white space in the development process. Until early PoC is achieved, Chugai will solely be engaged in R&D activities and incur full research and development expenses. Once the out-licensing agreement with Roche is concluded, Chugai will receive lump sum payments at the time of agreement conclusion from Roche, as well as milestone income associated with the achievement of milestones in the development phase.
Regarding the amount of these lump sum payments and the timing of receipt, multiple factors, such as the development status of in-house products at the time of out-licensing, should be taken into consideration. These are determined in the agreement on a product-by-product basis. These lump sum payments received from Roche shall be recognized as other revenue. After out-licensing to Roche, global clinical trials, including Japan, will be led by Roche. Chugai will be in charge of trials in the countries and regions under Chugai territory, including Japan. Therefore, Chugai is supposed to incur only the research and development expenses related to the Chugai territory. In the case where Chugai has the right to manufacture in-house products after regulatory filing in any countries or regions under the Roche territory, Chugai will begin exporting its products with certain margins to prepare for their approval and launch.
The sales will be recognized as export to Roche. At the same time, cost of sales associated with products exported to Roche will be recognized in the income statement. In addition, raw materials and products not yet exported to Roche will be recognized in the balance sheet as inventories. Now, we will explain the export unit price to be used in export to Roche. Calculation methods of the export unit price of each product are specified in documents, such as the agreement at the time of out-licensing to Roche. Although some differences exist among products, one of the factors referenced in the calculation is a weighted average unit price based on Roche's global sales over a certain period of time. The weighted average unit price is calculated by dividing Roche's global sales by the sales volume.
In addition, the export unit price will be reviewed every year based on changes in these factors. The weighted average unit price calculated by Roche's global sales may decline over time. There are cases where launch and market penetration initiate in the U.S., and then sales volume increases in other countries and regions where lower drug prices are set. Due to this impact, Chugai's export unit price to Roche may also decline over time due to the growth of global sales. Once sales are recognized worldwide under the Roche territory, Chugai receives a royalty based on the sales. Royalty income is calculated by multiplying Roche's worldwide sales by the royalty rate. The calculation method is specified in the agreement for each product and varies among products.
Next, we will explain the flow of in-licensing of products from Roche. Chugai has the exclusive right to develop and market Roche products in Japan. Roche incurs full research and development expenses for early clinical trials and non-clinical studies. Chugai can efficiently advance new drug development because it is able to consider and make decisions on drug introduction based on the results of early clinical trials. After conclusion of the in-licensing agreement for Roche products, Chugai will make a lump sum payment to Roche. Also, lump sum payments associated with achievement of milestones in the development phase may be necessary. Lump sum payments are recognized as intangible assets on the balance sheet. Once the product is approved, depreciation will start. If clinical development is discontinued, impairment assessment will be carried out.
After the in-licensing of Roche products, Chugai will conduct R&D activities in collaboration with Roche. Chugai is in charge of clinical trials in Japan and incurs the research and development expenses associated with domestic clinical trials. In the case where products for sale are manufactured by Roche and Chugai purchases them, Chugai imports products from Roche in preparation for approval and launch in Japan. Purchases are recognized as inventories on the balance sheet. Once the product is marketed in Japan, sales in Japan are recognized as domestic sales, and at the same time, cost of sales and selling, general, and administration will be recognized as expenses. Simultaneously, inventories will decrease on the balance sheet as the inventory decreases in accordance with distribution.
Thus, Chugai carries out various transactions with Roche, such as out-licensing of in-house products and in-licensing of Roche products in Japan. Finally, we would like to explain the impact of currency and forex on transactions with Roche. Apart from export to Roche, royalty income, and lump sum payments to be received from Roche, we also conduct business transactions with Roche, such as purchasing and importing raw materials and products and settling certain expenses. In these transactions, the Swiss franc is primarily used as the currency of exchange based on the agreement. Some transactions may use the U.S. dollar as the exchange currency since we outsource drug substance manufacturing to Genentech, a member of the Roche Group in the U.S. For these foreign currency denominated transactions, there is a risk that the yen equivalent amount may increase or decrease due to fluctuations in foreign exchange rates.
Therefore, based on the predetermined policy within the previous year, forward exchange contracts will be made for a certain range of foreign currency transactions to be conducted during the period. In this way, we limit the impact of fluctuations in foreign exchange rates from the assumed levels during the period. In recent years, considering the continuity of transactions and the accuracy of prospects, in the case of export to Roche, foreign exchange contracts will be made by the beginning of the fiscal year at around 80% of the expected transaction volume to hedge the risk of foreign exchange fluctuations. In the same way, we also conduct currency hedging to a certain extent for royalty income and lump sum payments, as well as for purchasing raw materials and products from Roche.
Based on the above, in particular, if the yen depreciates against the Swiss franc during the period, the impact of foreign exchange will be greater than we assumed at the beginning of the period for the unhedged portion of Swiss francs and yen. However, these impacts will be largely offset and limited to a certain amount in the operating profit. This concludes our explanation today. For those who have viewed this video, we provide an advanced edition, which includes alternative slides and more in-depth explanations on how Chugai's financial statements change through transactions with Roche under the strategic alliance. There is also a link in the description box of this video. Please have a look.