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Genentech, Inc. (DNA)

Q2 2006 Earnings Conference Call

July 11, 2006 5:15 pm ET

Executives

Arthur D. Levinson - Chairman and Chief Executive Officer

Ian T. Clark - Executive Vice President, Commercial Operations

Susan Desmond-Hellmann - President, Product Development

David A. Ebersman - Executive Vice President and Chief Financial Officer

Kathee Littrell - Senior Director of Investor Relations

Analysts

Joel Sendek - Lazard Frères & Co.

Eric Schmidt - SG Cowen & Co.

Jason Kantor - RBC Capital Markets

Geoffrey Porges - Sanford C. Bernstein & Company, Inc.

Craig Parker - Lehman Brothers

May-Kin Ho - Goldman Sachs

Gene Mack - HSBC Securities

Steve Harr - Morgan Stanley

Christopher Raymond - Robert W. Baird & Company, Inc.

William Tanner - Leerink Swann

Mark Schoenebaum - Bear, Stearns & Co.

Jeff Meecham - JP Morgan

Elise Wang - Smith Barney Citigroup

Eric Ende - Merrill Lynch

Presentation

Operator

Good afternoon. My name is Derek and I will be your conference operator. At this time, I would like to welcome everyone to the Genentech second quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to Ms. Kathee Littrell, Senior Director of Investor Relations. Please go ahead, ma’am.

Kathee Littrell

Thank you, Derek. Good afternoon, everyone and thank you very much for joining our Q2 earnings call. We have posted an earnings call slideshow on our website at www.gene.com that follows our earnings scripts. I’ll give you a moment to go to the investor relations website and download those slides.

This call is being electronically recorded and is copyrighted by Genentech. No reproductions, retransmissions or copies of this conference call can be made without the written permission of Genentech.

We’ll be making forward-looking statements and the actual results may vary materially from the statements made. Please see the risk factors section of our Form 10-Q for the period ending March 31, 2006 that’s on file with the SEC for a discussion of the risk factors that could cause material variations from the forward-looking statements made during this conference call.

We’ll be discussing financial information that includes non-GAAP financial measures in our call today. Please refer to our website at www.gene.com under the investor tab, and click financials for the most directly comparable GAAP financial measures, with a reconciliation to the non-GAAP financial measures that we’ll be discussing today.

Today I am joined by Art Levinson, Chairman and Chief Executive Officer; Ian Clark, our Executive Vice President, Commercial Operations; Sue Hellmann, President of Product Development; and David Ebersman, Executive Vice President and Chief Financial Officer.

Now I’ll turn the call over to Art for opening comments.

Arthur D. Levinson

Thank you, Kathee. Good afternoon, and thanks for joining us. We are pleased with our financial results for the first six months of 2006, including the following: a 40% increase in total operating revenues; a 43% increase in U.S. product sales; 71% increase in non-GAAP net income; and a 73% increase in non-GAAP earnings per share, relative to the first six months of 2005.

During the first half of 2006, we have successfully executed against our key business goals. Starting with the commercial area, we achieved total U.S. product sales of $3.3 billion, continuing to grow our business across our existing product line while completing two important new launches: Rituxan, for rheumatoid arthritis; and LUCENTIS for wet age-related macular degeneration, or AMD.

In the R&D area, during the first half of 2006, we submitted four supplemental biological license applications to the FDA. Including 2005, we completed nine NDA, BLA and sBLA submissions over a period of 17 months, an accomplishment we’re very proud of. The FDA has already taken positive action on a number of these filings, giving us a new approval for Avastin, two new approvals for Rituxan, and the approval of LUCENTIS a few weeks ago.

We are particularly excited about the approval of LUCENTIS because of the impressive safety and efficacy profile of the drug, and the opportunity we have to help patients suffering from AMD.

In the manufacturing area, we are all most gratified that our manufacturing group was able to ship LUCENTIS on the same day as approval, getting the product to patients as soon as possible.

In addition, in the first half of 2006, our manufacturing group continued delivering capacity enhancement projects on schedule, as we:

  • Received FDA approval for Novartis to manufacture Xolair at their Huningue facility;
  • Submitted a supplemental BLA for another 20,000 liters of capacity to manufacture Avastin at Porrino;
  • Began qualification runs of Avastin at our Oceanside facility; and,
  • We remain on track towards initial FDA approvals for the Rituxan in Vacaville and Avastin in South San Francisco yield improvement projects by the end of this year.

Although manufacturing remains a risk for the business in the near term, we have made significant progress to date. Despite a sizable increase in the demand forecast from Roche, we now expect to be in the position to reduce our overall capacity utilization down somewhat from 100%, perhaps as soon as 2007. This will give us a modest buffer against unexpected future production problems.

Now I would like to review the key elements of our Company’s long-term strategy.

First of all, we continue to believe that over the long term, the most important area for differentiation for Genentech will be our ability to do world-class science in areas of critical medical importance. We remain focused on bringing the best people in to our R&D organization, creating an environment that stimulates and rewards innovation, and maintaining a rigorous dialog about what projects to invest in. Scientific excellence has been the starting point for the Company’s success to date, and we remain committed to this model for the future.

Second, we continue to focus on the challenge of maintaining our culture during this rapid growth period as the Company gets bigger. Genentech now has approximately 10,200 employees company-wide. We have brought in some excellent, terrific people across the Company over the past few years, and our management team is deeper and more experienced now than it has ever been in the past. We are highly focused on retaining the key elements of our work environment, our passion for science and patients, and our belief in the potential contribution of every employee in the Company.

Consistent with our desire to maintain and protect our culture, we have made a decision to continue a broad-based stock option program in 2006. We have agreed with the board that the size of our program in 2006 should be consistent with the size of programs we have seen from other companies in the pharmaceutical biotechnology industry that are similar in market cap to Genentech.

In 2005, we had net grants of 1.7% of total shares outstanding and in 2006 we expect the net grant pool to be approximately 1.58%. We believe a program of this size respects the potentially diluted impact of the stock option program while enabling us to remain competitive in terms of hiring and retention of top talent.

Third, while ensuring we execute against our near-term goals, we continue to focus our management attention on where we want to take the business over the next five to seven years. Earlier this year, we communicated to you our revised Horizon 2010 goal, and we are currently tracking well to meeting critical goals for commercial, R&D, and financial performance. We are constantly reviewing what investments we need to be making now in order to position the Company for continued growth and success in the future.

Now I would like to say a few words about some of our key business risks and challenges. I would like to start with drug pricing and reimbursement.

As I discussed at our investor meeting in March, we remain steadfast in our belief that our business model is only sustainable with premium pricing for our products, to offset the cost and risk of doing drug development in novel pathways for difficult, unmet medical needs.

Over the past few months, we have been meeting with patients groups, payers, and other stakeholders in the health-care system to understand their issues and concerns. We continue to believe that societal spend on oncology drugs, while growing, is not out of line with the unmet need and that addressing the question of rising health-care costs in this country requires a much broader conversation than one simply about drug pricing. We remain firmly committed to patient access, and we believe that we have programs in place to keep us very close to our aspiration that no eligible patient goes without a Genentech therapy for reasons of cost.

A few words about competition. We face competition from pharmaceutical and biotechnology companies and we expect that in the future we will face new competitors in our markets. Competition is a risk to our business that we take seriously and we work hard to understand where the risks are greatest and to best position the business to manage these risks.

We believe that some of the important assets in dealing with competitors include the quality of our products, quality of our people, our intellectual property, our strong understanding of the scientific pathways involved, and our rigorous and comprehensive clinical-to-trials programs that seek to best advance care for patients and, as a result, set the bar high for competitors.

All four of our oncology products have demonstrated survival benefits across multiple trials, and are well-established in their markets. We will continue to implement extensive life-cycle plans for our products in order to maximize the commercial potential, even as new entrants come forward.

Continued R&D productivity. As I said earlier, the key to the long-term future of our business will be our ability to bring forward novel molecules like Avastin and Herceptin that offer significant patient benefit. As we grow larger as a Company, we recognize we need more new molecules to drive continued growth, and we also recognize that history shows many examples of larger companies struggling to remain innovative.

There are no simple formulas to ensure continued excellence in innovation in our R&D investment, but we are geared to address this challenge by remaining true to the basic approaches and principles that have driven us for the past 30 years. We see no reason why we cannot continue to be an industry leader in terms of scientific excellence and research productivity for the next 30 years, and believe we are well-positioned to capitalize on new targets and pathways that will yield tomorrow’s breakthroughs for patients.

Let me now turn the call over to Ian Clark.

Ian T. Clark

Thank you, Art, and good afternoon, everybody. I am pleased to say we had another very strong quarter. Total U.S. sales in quarter 2 were $1.72 billion, and that represented a 41% increase versus the same quarter last year.

Today as always, I’ll be providing information on approved and unapproved product uses, and I want to remind you that Genentech policies only allow our sales force to promote products on label use.

Before updating you on product performance, I want to comment on the changes to our distribution model and the impact these changes might have had on our sales. The distribution changes we announced in March for Avastin, Herceptin and Rituxan were duly implemented on July 1. Most of our customers accepted the changes well. However, after the announcement, some hospitals expressed concern regarding the distribution change. To address these concerns, we did make some adjustments to our hospital distribution model and customer responses seem to be very positive.

In addition, the announcement has caused some unexpected daily fluctuations in orders from wholesalers. We believe these fluctuations are partly as a result of some clinics and hospitals anticipating the distribution changes. While we do not expect the net change in these distribution changes to be material for our full year 2006 results, it is possible that our second quarter sales were modestly impacted by certain clinics and hospitals in building inventory as they prepared for the change.

In contrast, however, we worked hard to ensure that there was no inventory build at the wholesale level. As a consequence, Rituxan and Herceptin wholesale inventories remain at Q1 levels and the Avastin inventory level dropped slightly.

Furthermore, we remind you that in Q3 as these changes are implemented, it will change our point of revenue recognition from the date of shipment from Genentech to the date of receipt at the distributor. The change will cause us to lose one day of sales from the third quarter.

Now on to product performance, beginning with our oncology products. Avastin U.S. sales for Q2 were $423 million, a 72% increase from the $246 million seen during the same quarter last year. The majority of these sales continue to be in the metastatic colorectal cancer setting. In the first line metastatic colorectal cancer penetration and duration remains stable compared to Q1 2006.

We believe that so much opportunity remains to increase penetration in this setting within patients subsets. However, little upside remains to increase duration, as the average length of duration for Avastin therapy from our tracking study is now in line with the mean treatment duration from our pivotal trial. When including duration estimates in sales projections, it is important to keep in mind that medium and mean duration of treatment were less than the progression pre-survival across all of clinical trials.

While there was some growth for the quarter in metastatic colorectal cancer, the primary contributors to our revenue growth were first-line non-small cell lung cancer and first-line metastatic breast cancer, both unapproved uses.

In lung cancer, while quarter-over-quarter adoption remains stable, the total number of treatments is increasing as the year progresses. In breast cancer, growth resulted from the increased adoption relative to Q1.

On May 12 this year, Avastin received Compendia listing for HER2 negative metastatic breast cancer in combination with paclitaxel. This result supports Medicare reimbursement and helps facilitate reimbursement with private payers as well. We anticipate that payers will take one to three months to update their systems.

Finally, on June 20th, the FDA approved Avastin for the treatment of second-line metastatic colorectal cancer when used in combination with 5-FU-based chemotherapy. As a result of this expanding label, we can now promote Avastin survival benefits in the second line setting conditions.

Moving on to Herceptin. U.S. sales for Herceptin in Q2 were $320 million, a 111% increase compared to the $152 million during the same quarter last year. Herceptin sales in the HER2 positive metastatic breast cancer continue to be strong, with increased first-line penetration and treatment duration relative to the same quarter last year.

We continue to see strong adoption in the adjuvant setting, an unapproved use. As you are aware, we received priority review for use in this adjuvant setting with an action date of the 17th of August of this year. As a result, we are actively preparing for a potential Q3 launch for this intention.

Next, Tarceva. Second quarter U.S. sales for Tarceva were $103 million, up 47% from the $70 million seen in the same quarter last year. Consolidating the gains seen in Q1, Tarceva’s penetration in both second-line non-small lung cancer and first-line pancreatic cancer remained steady.

Now Rituxan. Q2 U.S. sales for Rituxan reached $526 million, up 17% from the $450 million in the same quarter last year. Rituxan’s overall adoption rate in the combined markets of NHL and CLL, including approved use, was 82% in Q2 2006.

The FDA granted priority review to two Rituxan’s sBLA’s in the first-line treatment of low-grade follicular NHL patients. The first is Rituxan in combination with CVP chemotherapy, and the second for use of Rituxan following CVP chemotherapy in patients who achieved a response of stable disease or better. We are preparing for a Q4 launch for both these potential indications.

Moving now into the Immunology space and continuing with Rituxan for rheumatoid arthritis. Initial indicators suggest that our launch is going well, and is in line with our expectation. In terms of field force execution, our combined Genentech and Biogen-Idec sales forces have reached nearly 100% of our top devolution targets, and greater than 75% of the lower-tier targets. Our promotional efforts in terms of reach, frequency and time spent with physicians have been very competitive relative to other existing biologics in the RA space.

Additionally, with regard to threat physician prescribing, market research indicates that 50% of our targets have used Rituxan already for RA. Our research also suggests the majority of our target physicians with infusion capabilities are comfortable with infusing Rituxan.

These metrics are our best descriptors of our launch progress to date. As we stated previously, there are significant hurdles to reliably measuring the portion of Rituxan sales contributable to RA, including the fact that RA represents a small proportion of the overall sales. We continue to work on this issue and aim to provide more transparency on it in future quarters.

Now on to our other immunology products. U.S. sales of Xolair were $105 million in Q2, a 31% increase compared to the $80 million in the same quarter last year. U.S. sales of RAPTIVA were $22 million in Q2, representing a 5% increase versus Q2 last year.

With regard to tissue growth and repair products, U.S. sales of Nutropin were $98 million in Q2, a 1% increase compared to the same quarter last year. U.S. sales of our lytics products were $62 million in Q2, a 19% increase over the same quarter last year. We continue to see strong sales growth through increased use of Cathflo Activase in the catheter clearance market, and increased use of Activase in the acute ischemic stroke market.

Finally, U.S. sales of Pulmozyme were $47 million in Q2, and essentially flat compared to the same quarter last year.

Finally, LUCENTIS. On June 30, following priority review, the FDA approved LUCENTIS for the treatment of neovascular (wet) AMD. Our launch meeting occurred in May and our sales force were ready to promote LUCENTIS upon its approval.

We shipped $10 million of product on June 30, our only sales day in the quarter, and our fully-staffed sales team of clinical specialists began promoting LUCENTIS on July 12th. Initial feedback from customers suggests that the launch is meeting our expectations. In terms of reimbursement, LUCENTIS is covered and reimbursed by CMS, which represents 87% of our target patient population. Private payers typically follow the direction of Medicare and we expect that most insurers will update their policy soon.

To assist physician offices in reimbursement, in addition to our sales force, other customer support staff are available to help with access to LUCENTIS.

While a minority of patients -- Medicare patients without supplementary insurance, uninsured patient population -- may have higher out-of-pocket expenses, we estimate that more than 80% of patients -- Medicare patients with supplemental insurance and those that are privately insured -- will have a co-pay of $50 or less per treatment. As with our other products, we are committed to ensuring that cost does not affect access for eligible patients.

Now I’ll turn the call over to Sue.

Susan Desmond-Hellmann

Thanks, Ian, and good afternoon. The LUCENTIS and Avastin second-line colon approvals in Q2 have already been mentioned. In addition this quarter, we completed sBLA filings for Avastin in first-line non-small cell lung cancer, other than predominantly squamous histology; and Avastin for first-line treatment of locally recurrent or metastatic breast cancer. We have initiated enrolment in seven of our key clinical trials, including four in our early pipeline, and I’ll provide further details for each of these studies.

Let me begin by discussing Avastin. Q2 ’06 has been an eventful quarter for our Avastin development program. Ian mentioned the approval of Avastin for the treatment of second-line metastatic colorectal cancer patients. In the new Avastin product information, the recommended dose in combination with Bolus IFL is 5 milligrams per kilogram every 14 days until disease progression, and in combination with FOLFOX 4, it is 10 milligrams per kilogram every 14 days until disease progression. The dosing regimen is not specific to line of therapy, but rather by type of chemotherapy regimen.

We received a priority review designation for the E-4599 Avastin in first-line metastatic non-small cell lung cancer sBLA. The PDUFA date is October 11th of this year. We are also pleased that we received priority review for the E-2100 Avastin in first-line metastatic breast cancer sBLA. That PDUFA date is November 22nd.

Since E-2100 is not based on overall survival, but instead utilized a progression-free survival endpoint, the FDA has requested that we provide more documentation from the trial. The time required to respond to their requests could extend the review and potential approval beyond the November 22nd PDUFA date.

As announced, the Phase III pancreatic trial, CALGB 80303, was halted at the recommendation of an independent data monitoring board, based on an interim analysis indicating that it is very unlikely that significant differences in overall survival would occur between treatment arms as the data mature. No new safety concerns related to Avastin were observed in this trial. Data from the study will be presented at an upcoming medical meeting.

Roche will continue the AVITA trial, investigating the addition of Avastin to the new standard of care in pancreatic cancer, Gemcitabine plus Tarceva. AVITA is studying the lower dose of Avastin, 5 milligrams per kilogram every two weeks.

In April 2006, the data safety and monitoring board for AVITA conducted an unblind efficacy and safety analysis, and recommended that the study continue as planned. It is anticipated that recruitment in AVITA will be complete in 2006.

I’ll address the Avastin development programs, since it’s a large program and we receive a lot of questions about the progress of the clinical trials. The most mature ongoing study is the Avastin-based renal cell carcinoma study, CALGB 90206. The study is event rate driven, and we think it’s reasonably likely that results will be presented at ASCO 2007.

Our adjuvant colon cancer study, NSABP C-08, is enrolling quickly, and we anticipate that enrolment will be completed during the second half of this year. The timing of the results depend on the magnitude of the difference between the study arm. All three arms of Roche’s adjuvant colon trial, AVANT, have now reopened and are also enrolling well. We anticipate results from Roche’s first line colorectal cancer study of FOLFOX plus/minus Avastin and XELOX plus/minus Avastin, in the second half of 2006.

In May, we closed the Phase IV OASIS study, designed to assess use of Avastin through multiple lines of treatment due to slower than expected enrolment and premature discontinuation associated with the challenges of protocol mandated treatment. Toxicity was not a factor in this decision. We’re now in discussions with SWOG to initiate a trial investigating the impact of Avastin treatment through multiple lines of chemotherapy in colorectal cancer.

In the second half of 2006, we expect to initiate our second registry, into which approximately 6,000 patients with colorectal, breast, or non-small cell lung cancer will be enrolled. Enrolment will be triggered by the potential launch for each of these indications.

Moving on to the non-small cell lung cancer program, assuming positive FDA feedback, we anticipate that our adjuvant non-small cell lung cancer study will initiate enrolment in the second half of ’06. Plans for this study are still in development, but we do plan to include patients with both receptive squamous and non-squamous cell carcinoma. We anticipate results from the Roche AVAiL study, investigating 7.5 milligrams per kilogram versus 15 milligrams per kilogram of Avastin doses in first-line non-small cell lung cancer in 2007.

The Avastin breast cancer program is very large. We have enrolled over 50 of the approximate 200 client patients into the Phase II adjuvant breast cancer pilot study, ECOG 2104. We are in discussions with ECOG to implement Phase III adjuvant breast cancer studies in HER2 negative patients, and with the NSABP/BCIRG to implement a Phase III HER2 positive study, both in the adjuvant setting. These studies would be initiated following an evaluation of the safety results from ECOG 2104 in late ’06. We anticipate starting a study to treat patients with hormone positive first-line metastatic breast cancer later this year. We’ll update you regarding this study as plans are finalized.

Additionally, Roche continues enrolment in their Phase III AVADO study, investigating the 7.5 milligrams per kilogram, or 15 milligrams per kilogram dose of Avastin in first-line HER2 negative metastatic breast cancer. We initiated the Phase II first- and second-line Glioblastoma Multiforme study. Please refer to the website slides for an overview of studies that are either ongoing or we plan to initiate in the second half of 2006.

We’re continuing to seek broad labels studying Avastin in first line, second line, and adjuvant settings in a wide range of tumors. Our global development program currently includes more than 130 Avastin clinical trials. We are aware of the competition in the field of the antiangiogenesis. To date, we’re not aware of any data results that would imply potential product superiority to Avastin in any major tumor type where we have demonstrated positive Phase III data results.

As new targeted therapies enter the marketplace, we look forward to evaluating new combinations with a goal of demonstrating synergistic or additive efficacy while potentially reducing toxicity. We were encouraged by the positive results of the Phase II recurrent non-small cell lung cancer study exploring chemotherapy plus/minus Avastin, versus Avastin and Tarceva that was presented at ASCO in May -- or June, sorry, I’m losing track of time.

We look forward to learning more about combination therapy in non-small cell lung cancer in the larger BETA and ATLAS studies.

Turning to Herceptin, this quarter, Roche announced positive results in the tandem study, which evaluated Herceptin plus Arimidex versus Arimidex alone as first-line therapy in post-menopausal women with advanced HER2 positive and hormone receptor positive breast cancer. Patients who received Herceptin had a statistically significant improvement in progression-free survival, and overall safety data in both arms of the trial were acceptable.

At this point, over 310,000 women with HER2 positive breast cancer have been treated with Herceptin worldwide. The efficacy and safety profile is well-established, and we look forward to the potential launch of adjuvant treatment in August.

Regarding Rituxan in the oncology setting, the FDA requested that we separate our single submission of Rituxan in combination with chemotherapy as first-line treatment for low-grade or follicular CD20 positive non-Hodgkins lymphoma into three separate submissions based on CDER and CBER guidelines. We have done so, and two of the submissions have been granted a priority review in this indication. The first for Rituxan in combination with CVP chemotherapy, and the second for Rituxan following CVP chemotherapy for patients who achieved a response of stable disease or better. The anticipated action date for both of these submissions is September 29, 2006.

The third submission for Rituxan in combination with CHOP chemotherapy was accepted for standard review. However, the Phase II study that the filing is based on, 10203, was not designed as a stand-alone registrational study, and therefore we’ve withdrawn this part of the submission.

Enrolment continues in our Phase III study in relapse CLL with over 400 of approximately 600 planned patients enrolled to date. This global study is being led by Roche and compares fludarabine plus cytoxan, or FC chemotherapy, to FC plus Rituxan.

Turning to Rituxan in the immunology setting, two analyses of interest to our RA program were presented at the UR meeting last month. An analysis of the secondary radiographic endpoints from the reflux study in rheumatoid arthritis patients with inadequate response to TNF antagonist therapies demonstrated that patients treated with Rituxan in combination with Methotrexate had reduced joint erosion and joint space narrowing at 56 weeks, compared to the placebo group. These results are noteworthy, since Rituxan is now the first and only treatment that has published data demonstrating a reduction in structural damage progression in this refractory, difficult-to-treat population. Genentech plans to review and discuss future plans for this data with the FDA.

Paul Emery presented data reviewing the long-term efficacy and safety of repeat treatment with Rituxan in patients who have had an inadequate response to DMARD. As of October 2005, data from the open label extension study, our Phase IIa and DANCER studies indicate that 570 patients have received a second course of Rituxan, and approximately 150 patients have received a third course, with comparable or improved efficacy, relative to their original ACR scores. 59% of the patients that sees an ACR 20 score after their first course of treatment, while 73% achieved an ACR 20 score following their second treatment.

The safety profile was maintained over courses, in that there was a consistent rate of infections between courses and acute infusion reactions became less frequent with subsequent doses. Additional data at UR reported that the long-term safety and efficacy data of repeat treatments in patients who had had an inadequate response to one or more TNF antagonists also demonstrated subsequent courses of Rituxan produced comparable or improved efficacy, relative to baseline.

Our DMARD RA program Phase III studies will continue to help us understand safety and repeat dosing of Rituxan in the immunology setting. This quarter, we initiated a Phase II 60-patient study investigating Methotrexate plus ENBREL with or without Rituxan. The objective of this study is to investigate the safety and tolerability of Rituxan in combination with these therapies. The website slides provide an overview of the other clinical trials in the busy RA and broader immunology programs.

Regarding our second generation humanized anti-CD20 molecules, this last quarter, Genentech made a go decision for a Phase III study of our second generation humanized anti-CD 20 molecule in rheumatoid arthritis.

We also filed an IND relating to neuro-myolitis optica, or NMO, a disease that has significant neuro-muscular effect and can lead to blindness at an early age. Results from the Phase II study in RA will be presented at ACR later this year.

Biogen-Idec disagrees that Genentech has the ability to develop this molecule for NMO or rheumatoid arthritis without Biogen-Idec’s agreement, and the parties are seeking to resolve our differences relating to that disagreement.

Now turning to LUCENTIS. We were excited to receive approval for LUCENTIS as treatment for wet age-related macular degeneration, or AMD. Since results from the pivotal trial were first communicated, the LUCENTIS team has worked tirelessly to get LUCENTIS to our patients as quickly as possible. We remain interested in identifying the optimal criteria and method for individualizing treatment for LUCENTIS patients.

The SAILOR trial completed enrolment in their first cohort of approximately 2,400 patients during the first quarter of 2006. These patients will be followed for 12 months. This open-label program consists of three consecutive monthly injections, followed by pre-specified re-treatment criteria based on anatomic and visual acuity criteria. We anticipate results from this study during the first half of 2007.

Now turning to Xolair, we initiated enrolment in the Phase IIIb study, EXTRA, investigating the use of Xolair in patients with moderate to severe asthma who are inadequately controlled on high-dose inhaled corticosteroids and long-acting beta agonists.

Turning to our early development program, we’ve hit several milestones in our early development program this quarter. In tissue growth and repair, regarding our topical VEGF for diabetic foot ulcer program, in June we enrolled our first patient in the 240-patient Phase II study evaluating daily treatment with topical VEGF versus placebo in healing diabetic foot ulcers. This achievement contributes to our corporate goal of initiating three Phase II trials investigating new molecular entities in 2006.

In immunology, along with our collaborator, Biogen-Idec, we initiated enrolment in the Phase Ib BR3 study in rheumatoid arthritis. The goal of this study is to further evaluate the safety of BR3 in this population at multiple doses.

In bio-oncology, we halted the Phase I topical hedgehog antagonist clinical trial in basal-cell carcinoma and made a decision not to move forward with this molecule in this formulation. We’re currently discussing next steps for this program with Curis, and will provide updates as the plans evolve. This decision does not impact the ongoing research we’re conducting with Curis in the systemic hedgehog antagonist program.

We’re enrolling patients in the Phase I Trastuzumab-DM1 study in HER2+ metastatic breast cancer patients who have previously received Herceptin and chemotherapy. This was an important milestone for us as we began human testing of safety and tolerability of our first antibody drug conjugate product.

In June, we and our collaborator Amgen initiated Phase Ib studies of Apo2L/TRAIL and solid tumors and hematological malignancies.

The remainder of 2006 will most likely be as busy as the first half. Please see the website slides for a review of our planned milestones. Now, I will turn the call over to David.

David A. Ebersman

Thank you, Sue. As Kathee mentioned earlier, unless otherwise noted, my comments on expense and income items are on a non-GAAP basis, which exclude the impact of recurring charges related to the 1999 Roche redemption, litigation-related special items, and employee stock-based compensation expense.

Turning now to the revenue components of the income statement, adding to the U.S. product sales information already noted by Ian, sales to collaborators were $94 million this quarter, a 62% increase over Q2 of last year, primarily due to higher sales of Avastin to Roche. Looking forward for this line item, please note that we recently signed two new supply agreements with Roche, whereby we agree to supply Roche with additional Herceptin for 2007 and beyond, and extended our agreement to supply Roche with Avastin beyond 2009, when our original agreement was set to expire.

Factoring in the increased demand from Roche, we’re now expecting sales to collaborators for the full year 2006 to increase by approximately 40% over 2005 levels.

Royalty revenues were $316 million in Q2, a 58% increase over Q2 of last year, substantially driven by higher royalties from Roche, which represented 65% of our overall royalties in the second quarter.

For the full year 2006, we are now expecting royalties to increase by approximately 35% over 2005 levels.

Contract revenues were $73 million this quarter, a 38% increase over Q2 of last year. Quarter to quarter fluctuations can be expected in this line due to the varying nature and timing of the items that are recorded here. We still expect 2006 contract revenues to be relatively flat compared to 2005.

Total operating revenues were $2.2 billion in Q2 of this year, a 44% increase over Q2 2005.

Turning now to the expense line items, cost of sales was $284 million, or 16% of net product sales in Q2 of this year, a decrease from 22% of net sales in Q2 2005, due to a favorable product sales mix coupled with one-time charges we took in Q2 of last year related to the cancellation of certain manufacturing obligations.

We continue to expect cost of sales as a percentage of product sales to be approximately 16% for the full year 2006, but caution that cost of sales can always come in higher than expected if we have unforeseen manufacturing or inventory issues.

Non-GAAP R&D expenses were $356 million this quarter, a 28% increase over Q2 2005 R&D expenses. R&D was 16% of operating revenues this quarter, a decrease from 18% in Q2 last year, driven largely by higher operating revenues.

We’re still expecting R&D to be 18% to 19% of operating revenues for the full year 2006, so we are planning on a significant ramp-up in R&D expenses in the second half of the year, consistent with prior years. Some of this ramp-up will be related to our continued investment in our late-stage pipeline, and adding new, internally generated programs to the early-stage pipeline.

Much of the forecasted increase in R&D in the second half of the year is planned incremental in licensing investments. It’s normal for our deal flow to be busier during the second half of the year, and this year we’re looking to be aggressive in accessing new deals for products and technologies that can help drive our future growth.

Please note the inherent unpredictability of completing new deals add some uncertainty to what the final year R&D number will look like.

Non-GAAP MG&A expenses were $430 million this quarter, a 22% increase over Q2 2005. MG&A as a percentage of operating revenues was 20% this quarter, a decrease from 23% in Q2 2005, driven largely by higher operating revenues. We expect MG&A spending to increase during the remainder of 2006, and we expect MG&A as a percentage of operating revenues for 2006 to be between 20% and 21%.

Collaboration profit sharing expenses were $259 million this quarter, an increase of 30% over Q2 of last year due to higher sales of Rituxan, Xolair, and Tarceva.

Non-GAAP pre-tax operating margin as a percentage of total revenues was 40% this quarter, an increase from 28% in Q2 2005.

For the full year 2006, we now expect our operating margin to be approximately 37%, as compared to 32% in 2005.

Other income, net was $103 million this quarter, more than tripling our Q2 2005 number, driven by gains from certain of our bio-tech equity investments.

As we mentioned in our previous earnings call, this quarter we recognized gains from Amgen’s acquisition of Abgenix and from Pfizer’s acquisition of Rinat, together totaling approximately $63 million.

As you know, other income, net has two primary components -- interest income net of interest expense, and bio-tech stock investment gains net of investment losses. Based on higher interest rates, we continue to expect net interest income to be approximately 30% higher than 2005 levels, which were $91 million, subject of course to further changes in interest rates. We’re not forecasting significant bio-tech stock gains in the second half of the year.

On taxes, our non-GAAP tax rate was 38% in Q2, an increase from 28% in Q2 2005. The lower tax rate in Q2 of last year primarily relates to a one-time benefit from additional R&D tax credit. In addition, the higher tax rate this quarter reflects higher pre-tax income and the expiration of the federal R&D tax credit on December 31, 2005.

We now expect our tax rate for the full year 2006 to be approximately 37.7%, based on an increase and our forecasted pre-tax income. Our tax rate expectation assumes that currently proposed legislation extending the R&D tax credit is ratified later this year.

Non-GAAP net income this quarter was $602 million, or $0.56 per share, an 83% increase in net income, and an 87% increase in EPS over Q2 of last year. Weighted average shares outstanding for computing diluted non-GAAP EPS were 1.074 billion shares this quarter, compared to 1.84 billion shares in Q2 2005.

Now turning to some cash metrics, our unrestricted cash and investments portfolio totaled approximately $4 billion at June 30 2006, as compared to $3 billion at June 30 2005 and $3.9 billion at December 31 2005. Cash from operations in Q2 2006 was $454 million, and cash used for capital expenditures was $285 million.

Cap-Ex for the full year 2006 is now expected to be about $1.4 billion.

In the second quarter of 2006, we spent $313 million for gross share repurchases, with a net effect of our cash position of $174 million, including the offsetting cash in-flows to the Company from stock option exercises and the tax benefits related to those option exercises.

As announced in April 2006, our board of directors authorized the extension of our current stock repurchase program for the repurchase of up to an additional $2 billion of our common stock through June 30, 2007 and we plan to continue to repurchase shares in 2006 to offset dilution from option exercises and to maintain Roche’s ownership percentage above 55.7%.

Turning now to stock option expensing, employee stock-based compensation expense for Q2 2006 was approximately $75 million on a pre-tax basis, or $47 million after taxes, or approximately $0.04 per share. We allocated $34 million to the R&D line, $41 million to the MG&A line, and recognized a tax benefit of $28 million in the income tax line related to employee stock-based compensation expense. For the full year 2006, we continue to expect employee stock-based compensation expense to be in the range of $0.15 to $0.17 per share.

Overall, our financial forecasts have continued to evolve over the year as we get new information across the business. Recognizing that there are many factors that could change our forecast between now and the end of the year, at this point we are increasing our expectation for year-over-year non-GAAP EPS growth to approximately 55% to 60%. This change is based primarily on higher 2006 forecasts for product sales, sales to collaborators and royalties; as well as incorporating our latest thinking regarding incremental investments we are making in the business.

Now I’ll turn the call back over to Kathee.

Kathee Littrell

Thanks, David. As is our usual practice, please limit your questions to one per person to allow a larger number of investors to ask questions. Operator, I’ll turn the call over to you to queue up the questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joel Sendek with Lazard Capital Markets.

Joel Sendek - Lazard Frères & Co.

Thanks a lot. Can you give us some sense of what percentage of Avastin sales in the second quarter was off label?

Ian T. Clark

Hi, Joe, it’s Ian here. You know we don’t particularly, we haven’t so far given precise percentages, but I did in my prepared comments say that an increasingly large share of the growth is now derived from both lung and breast cancer settings, and maybe the new fact there is increased adoption in the breast cancer setting.

Joel Sendek - Lazard Frères & Co.

That growth, you mean the growth from the similar quarter last year?

Ian T. Clark

Yes.

Joel Sendek - Lazard Frères & Co.

Thank you.

Operator

Your next question comes from Eric Schmidt with Cowen.

Eric Schmidt - SG Cowen & Co.

Good afternoon. A question for Sue about the breast cancer filing based on ECOG 2100. Could you provide a little bit more information on what exactly the FDA is asking you for? If they’re asking you for some adjudication of the scan that wasn’t done and whether you have all of the scans in order to supply their request?

Susan Desmond-Hellmann

Just as a reminder, this is a filing where the action date is November 22nd, so we’re a little bit more than four months away from the action date. So as is the normal course of events, Genentech and FDA discussed the questions that they have related to the filing. As you know, the progression free survival is a softer endpoint than survival, so it requires more dialog and documentation.

We haven’t firmly established what the FDA would like. We’re in that dialog right now, but aware that that date is looming less than five months away, and that this is progression free survival, we wanted to let you know that in the course of providing that documentation, while we’ll attempt to provide the documentation within the action date timing, it could go beyond that November 22nd date.

So we haven’t firmly established exactly what the documentation will be, but in the middle of those negotiations, we became concerned about the timing.

Eric Schmidt - SG Cowen & Co.

Is there any precedent for an un-blinded PFS head point being deemed approvable by the FDA?

Susan Desmond-Hellmann

Yes. There is in at least two circumstances that I can tell you about in breast cancer, both for Taxol, which was approved on a progression-free survival endpoint, and for Herceptin, which was approved on a progression-free survival endpoint when we first got the approval for Herceptin in 1998.

Eric Schmidt - SG Cowen & Co.

Thanks a lot.

Operator

Your next question comes from Jason Kantor with RBC Capital Markets.

Jason Kantor - RBC Capital Markets

Thank you. Could you tell us if you took any price increases on any of your product? You said that there was an inventory draw-down for Avastin, which seems to go against what you were saying you were seeing for other products. Could you quantify that and explain it a little bit better?

Ian T. Clark

Hi, this is Ian. I haven’t got exact price increases in the quarter. Maybe we can give you that, or Kathee can give you them afterward if we can’t find them right now.

I was trying to give you a sort of overall balanced view in terms of the inventory. Normally we talk about inventory at the wholesale level, and there was undoubtedly a slight draw-down there, which may have been as a consequence of fairly aggressively trying to control the level, given the fluctuations we were seeing.

We don’t normally talk about the inventory level that exists at the hospital and clinic level, and there may have been a little bit of increase, although we can’t quantify that. We have no direct insight into it.

So we’re trying to give you a balance. I think on net or in balance, I think the sales you saw for Avastin probably did represent the demand in the quarter.

Jason Kantor - RBC Capital Markets

Thank you.

Kathee Littrell

There was a price increase on Xolair. If you want the actual percent, you can just call me. That was the beginning of April, and there was a price increase on Pulmozyme. Again, just call me and I can give you the specifics on that.

Jason Kantor - RBC Capital Markets

Thank you.

Operator

Your next question comes from Geoffrey Porges with Sanford Bernstein.

Geoffrey Porges - Sanford C. Bernstein & Company, Inc.

Just to talk a little bit on Herceptin, Ian, you mentioned primarily in the metastatic setting, but could you give us a sense of what the penetration of the eligible patient population is in both the metastatic and the adjuvant setting? What do you think the theoretical maximum might be in those settings?

Ian T. Clark

The penetration in the metastatic setting has been growing very consistently, and it’s now up to 70%. I’m not sure, there’s an awful lot about of upside left in that. We’ve not chosen to quantify the penetration or adoption from the adjuvant setting, and probably won’t do so until it is on-label indication. That said, it’s very clear that we’ve had significant adoption already, but I don’t think the adoption we’ve seen has been so great there won’t be some upside left for the remainder of this year.

Geoffrey Porges - Sanford C. Bernstein & Company, Inc.

Thank you.

Operator

Your next question comes from Craig Parker with Lehman Brothers.

Craig Parker - Lehman Brothers

Hi, Sue. You knew I was going to ask a question about ECOG 2100, I’m sure. Just to clarify your response to Eric’s question, is it documenting progression that is the question for FDA? Or is it also the overall survival benefit? If so, is there another six-month update to the ECOG data from the San Antonio data?

Susan Desmond-Hellmann

What has not changed is the agreement we reached with FDA previously, that a trend in survival would be sufficient for this study, though that hasn’t changed. The dialog around documentation is around response rate and progression-free survival.

Operator

Your next question comes from May-Kin Ho with Goldman Sachs.

May-Kin Ho - Goldman Sachs

Sue, you indicated that the Rituxan application was divided into three parts, and that the combination with CHOP essentially was not adequate based on the current data for submission. What are your plans for that? As we go forward and there is more scrutiny on off-label use, could this be negative for the sale of Rituxan?

Susan Desmond-Hellmann

I’ll let Ian comment on the sales question that you had in that.

What we looked at is we felt that the third study, the CHOP study, was a quite reasonable supportive trial, but when divided up on its own really wasn’t a stand-alone study. So we’re happy with the two CVP studies that I mentioned, but we’re in dialog in terms of looking at additional studies. We haven’t made a final decision on the way forward.

What has not changed on Rituxan is our strategy to acquire labels for all the uses of Rituxan, and that would include the CHOP uses. So we’re in dialog right now both with Biogen-Idec and with Roche for one of the trials we have, either already done or ongoing, that could contribute to that. For now, we’ll seek the approval limited to the two CVP studies.

Ian T. Clark

Hi, May-Kin, it’s Ian here. I think our overall goal, as Sue just mentioned, is to try and cover as many of the bases in terms of indications, and these will give us, in effect, our third and fourth, having already got the refractory and the regressive front-line and we hope in the future to get -- the CLL studies might results in indications as well.

There’s obviously an even greater goal to cover not just the indication but all of the potential combinations within that indication. I’m not sure we’ll always get that, but I’m happy we’re making very significant progress at that direction.

May-Kin Ho - Goldman Sachs

Do you know approximately how long do you have to wait before you can submit adequate data?

Susan Desmond-Hellmann

Since we don’t have a final plan, I can’t tell you how long. We’ll update you when we have more information.

May-Kin Ho - Goldman Sachs

Thank you.

Operator

Your next question comes from Gene Mack with HSBC Securities.

Gene Mack - HSBC Securities

Thanks for taking the question. Could you just go over, quickly if you have it, one-year and two-year survival from the ECOG 2100 setting? Then, could I just get Ian to repeat what he said about median and mean durations of treatment in colorectal cancer and where that has yet to go in terms of your satisfaction as far as how long clinicians are dosing up?

Ian T. Clark

Let me start with duration. I have not talked about this before, but within the studies you have a progression-free survival period, and then we have the actual duration, mean and median, in an average for use of the drug.

What we’re starting to see now -- which is less than the PFS by the way -- and what we’re now starting to see is that within our tracking studies, we are getting to that sort of level. What it’s telling us is there is limited or no upside left in duration as far as colorectal cancer is concerned.

Does that clarify the question?

Gene Mack - HSBC Securities

Yes, thank you.

Ian T. Clark

You should anticipate the same sort of dynamic evolving possibly in lung and breast, in that maybe at the get-go, we won’t see treatment up to that mean or median, but it will evolve to it, but that will still be slightly lower than potentially the overall PFS. I think that will slightly magnify the longer the PFS periods. They might be slightly greater, or a greater impact in breast than it would be in lung.

Gene Mack - HSBC Securities

Understood, thanks.

Susan Desmond-Hellmann

Your question on E2100, the San Antonio breast cancer presentation, the progression-free survival at the time of that presentation was 11.4 months versus 6.1 months, or a hazard of 0.51. The updated survival data at San Antonio was still early with a little over half of the required number of events. The interim analysis that was presented there showed a trend towards improvement in overall survival, 28.4 months versus 25.2 months.

Gene Mack - HSBC Securities

Just as far as percentage of patients alive, one year, two year?

Susan Desmond-Hellmann

That information.

Gene Mack - HSBC Securities

Okay.

Operator

Your next question comes from Steve Harr with Morgan Stanley.

Steve Harr - Morgan Stanley

I was hoping you guys could outline the path to approval for neuromyelitis optica, what studies might look like and what endpoints would be? And then address what the courses are for remediation in your disagreement with Biogen-Idec on going forward with a second generation drug.

Susan Desmond-Hellmann

So your question about NMO, we’ve had extensive dialog with FDA and with experts about the endpoints of that. I can’t outline them for you right now, but we can get one of our technical experts to give you all the finicky data on that.

Regarding the dispute, let me just repeat what I said on the call. Biogen-Idec disagrees that Genentech has the ability to develop this molecule for NMO or RA without Biogen-Idec’s agreement, and we’re seeking to resolve our differences related to that disagreement.

You know we’ve been in partnership with Biogen-Idec for 11 years, and it’s been a good collaboration, so we prefer to solve this issue privately. That’s why I don’t want to say anything additional on this call.

Operator

Your next question comes from Chris Raymond with Robert Baird & Company.

Christopher Raymond - Robert W. Baird & Company, Inc.

Thanks. I wanted to ask more of a strategic question, addressing Art’s earlier prepared comments on drug pricing. You guys have addressed this on several occasions with this audience. Are there any plans to take that message more systematically and more broadly, to address or allay the public concerns that have been seemingly increasing, either from Genentech or from bio-tech as an industry, for that matter?

Arthur D. Levinson

Art here. Let me not speak for bio-tech or pharma, as I really can’t predict what the broader communities will do. We have been giving this a lot of thought, how we get the message. I would say first and foremost our fundamental problem that we have is that it is not simple, and so many in the media are looking for the one or three-sentence sound bite, and you cannot reduce the complexity of what’s going on here to something that fits in a 15-second news clip.

So one of the things that we’ve started doing is to bring in, as I mentioned, payers, patient advocate groups, and we bring these people in not for an hour or two hours, but for a day, or a day-and-a-half. Many of us, myself included, and many of the people on the call, we take the time to spend a good four or six hours with them explaining the economics of what we do, the immense technical challenges involved in trying to develop drugs; and the $800 million figure for the cost of developing drugs on average; the 10 to 15 years of effort; and explaining the complexity scientifically of trying to do something like cure cancer. This is non-trivial stuff.

So we have been very pleased with the results that we’ve seen at the end of the day, or the end of the day-and-a-half, and we say all right, do you have a better perspective of what our challenge is, the enormity of that challenge.

I’m not going to stand here and tell you that 100% of people applaud us, but certainly something pretty close to 100% of the people really do understand the dynamics, what’s going on and the enormous challenge that we face.

We also explain to them in the area of oncology that close to half of the people in this country are going to get cancer, about 40% of them or so are going to die of cancer. When you look at the societal cost and the expense that we’re putting toward really trying to solve one of the biggest scourges that is affecting us, it’s not a lot of dollars going into this.

The other point that we always make, and it usually surprises almost everybody, is that when you look at the overall profitability of our Company over the last 12 months, it’s about 20% after-tax profit. You ask people to guess, they’ll guess 80%, 90%, 100% -- I mean, the guesses are really pretty remarkable. Those of us in the field here who work so hard and tirelessly to try to come up with these breakthrough drugs, for the life of us, we don’t understand why a 20% margin on what we sell is so outrageous when you have the Microsoft’s and the Cisco’s selling software at 30%+ margins.

I just think that if you take the time and you explain what is going on and the economics of what we’re doing, people do get it, but it’s not something that’s amenable to a three-minute discussion.

Bottom line, we’re pleased with how we’ve been testing the waters here with this type of a dialog, and I can’t speak on behalf of everybody, but most of us are pretty enthusiastic about bringing this message to a wider audience in a more thoughtful way. But in terms of exactly how we do that and when we do it, we’re still not sure.

If any of you on the other end of the call have any input or suggestion for us, we’d love to hear it, but we do recognize that it’s not simple.

Christopher Raymond - Robert W. Baird & Company, Inc.

Great, thanks very much.

Operator

Your next question comes from Bill Tanner with Leerink Swann.

William Tanner - Leerink Swann

Thanks for taking the question. Ian, maybe a question for you, just your feeling on if the Avastin for breast cancer approval is pushed rightward, how that would potentially impact sales over the balance of the year?

You did mention that obviously you have a compendia listing and Herceptin seems to have done pretty well in the adjuvant setting without a label and without the ability to actually promote that. Would you anticipate -- it seems like logically there would be a little bit of a delay in the uptake of Avastin ex the ability to actually market it, or do you think there could be a listing that is actually help carry the day?

Ian T. Clark

Let me try to answer that in two parts, specifically as it relates to the breast cancer. The action date being as late as it is, which is the back-end of November, the impact in this year is going to be somewhat limited, whatever the outcome. In fact, we were thinking we might see the alternative that the compendia listing would have very little time to have its impact before we got to the label.

That said, I think it’s clear to me that compendia listings aren’t necessarily creating the sort of step-growth that we might have seen in the past, and that because of why the concerns about reimbursement and overall the economics of the oncology office, but ultimately getting a label is critical for the overall adoption of the drugs. That does allow our sales force to speak to the extent of the survival, the dosage and everything to do with it.

So I do believe the labels are critical and when we get there, there will be a significant upside attached to them.

Operator

Your next question comes from Mark Schoenebaum with Bear, Stearns & Co.

Mark Schoenebaum - Bear, Stearns & Co.

Hi, my question is similar to the last one, but in thinking about lung penetration, I think you mentioned that penetration is stable versus last quarter. I thought last quarter you said adoption was 15%, so that trend to me is -- I’m trying to understand what to expect going forward, before you get the label. I’m wondering, what is the roadblock that your market research indicates? Is it awareness, or is it some push-back on data?

The follow-up is, when will we see publication in a peer review journal of lung data? Will that happen potentially ahead of approval?

Also, I’d like to invite Art to address the pricing question at the Bear Stearns conference. That’s a great forum.

Arthur D. Levinson

Where is it?

Mark Schoenebaum - Bear, Stearns & Co.

It’s in New York City, it’s a suburb of Connecticut.

Arthur D. Levinson

All right, well, it follows the rule of three or fewer time zone changes, so I’ll certainly consider it.

Mark Schoenebaum - Bear, Stearns & Co.

Okay, thanks, great.

Ian T. Clark

We’ll try and get through your simple one question one at a time here. I’ll let Sue talk to the publication date.

In terms of adoption, no I didn’t give you a number last time around. We typically haven’t. The reason that we see sales growth, even though adoption was somewhat steady is that with any adoption, there’s a point in time -- if it’s been a growing price lag, and when you’ve got steady quarter, you’ve still got the total quarter at the higher adoption level.

I think we see -- I go back to the prior comment. Compendia listing is not these days seen as the trigger to wide adoption. People are looking for an overall label, and I think it’s concern around practice economics and the way oncologists are approaching that. I don’t see anything else.

If your question was sort of working toward is it a question around the quality of the data, no, it’s not. They do genuinely see this as good data, but are waiting for the overall label.

Mark Schoenebaum - Bear, Stearns & Co.

And publication?

Susan Desmond-Hellmann

We’re shooting for the New England Journal of Medicine, but I don’t think we have an estimate on the date yet.

Mark Schoenebaum - Bear, Stearns & Co.

Okay, thanks, Sue.

Operator

Your next question comes from Jeff Meecham with JP Morgan.

Jeff Meecham - JP Morgan

Good afternoon, guys. A question for you on Rituxan and RA. I’m wondering if you can ballpark the number of patients so far in therapy, and where they are in the treatment paradigm? Then, whether you guys will be breaking out RA separately from Rituxan going forward?

Ian T. Clark

I wouldn’t want to give you a precise number on patients at this point at the moment. As I said in my prepared remarks, it’s going to be a little while before we can realistically quantify the RA sales for you. That said, we are seeing usage where you’d expect, in the TNF high offsetting, and it’s split approximately 80-20 or 20-80 -- 20% after one TNF, which is ideally one, in the works before, get into TNF cycling, and 80% after two or more. We’ve seen a small sprinkling of off-label usage in patients, but I’ve never had a TNF or a biologic.

Jeff Meecham - JP Morgan

Okay, thanks.

Operator

Your next question comes from Elise Wang with Citigroup.

Elise Wang - Smith Barney Citigroup

Thanks for taking my question. I just wanted to see if we could perhaps get some more color from David about the guidance. Given what you’re guiding us for the bottom line, it still clearly indicates that the sequential quarters are going to be down quarters, and yet we also see and hear commentary about inventory levels for Avastin being at low levels, meaning more in line with where it was Q1.

At the same time, given the change in distributor strategy, Q3 was kind of pinpointed as the quarter in which it would be hurt, if you wish, the most for the change, given the way that you are also changing your recognition of revenues. Yet sales to collaborators, particularly Roche, are going up fairly significantly.

Generally though, expenses are somewhat maintained along the lines of what you’ve given us in the past as a percentage of operating revenues, even though the margin to some extent appears to be going up -- I’m just trying to reconcile all those pieces of guidance to understand what pattern we should really see for Q3 and Q4.

David A. Ebersman

Well, first of all, Elise, I just want to thank you for asking me a question, because I really didn’t want to go two calls in a row without a single question. Second of all, just to comment that I think you may have come across answering the question as you went through it.

I think you get the basic concepts. We had some profits from the first half of the year that won’t recur, or we don’t expect to recur in the second half, mainly the bio-tech equity investments, and those are significant.

Other than that, we do expect the top line to continue to grow, as we’ve seen. The counter to that is, on the expense lines, particularly in the R&D area. If you look past at the last few years that the business has grown a lot, towards the end of the year, the previous year when we budget and we decide what we’re going to spend and where we’re going to spend it, and it takes a while to ramp up that spend, so you just see sort of a natural dynamic in a growth environment that R&D expenses in the second half of the year grow.

The other opportunity for us that we take seriously and that I mentioned in the call is the opportunity to do more business development deals. Again, there’s just a cyclicality to the BD world that we’ve seen, at least as long as I’ve been here, where deals tend to close in the second half of the year.

Those are two big drivers. Other than that, I think you capture the in’s and out’s reasonably well.

Operator

Your final question comes from Eric Ende with Merrill Lynch.

Eric Ende - Merrill Lynch

Thanks for taking the question. I know you don’t want to lay out the NMO clinical development plan, but what I do want to know is whether or not you see that as a way that can get second generation Rituxan to market more quickly. If that’s true, if you can kind of quantify how much more quickly then it would be coming through rheumatoid arthritis, that would be helpful.

Susan Desmond-Hellmann

So our current estimates are that the rheumatoid arthritis program could get us an approval prior to an NMO approval, but with two programs, and as much uncertainty, given that we haven’t enrolled any patients in either of the programs yet, that it provides a back-up strategy on the timelines indicates that RA goes slower, but our current estimate is that RA would be first.

Eric Ende - Merrill Lynch

Thanks.

Kathee Littrell

All right, Operator. Thank you all very much for joining us, and Sue and I will be in our office in about 10 minutes to take any further calls. Thank you very much.

Operator

This concludes the Genentech second quarter earnings conference call. You may now disconnect.

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Source: Genentech, Inc. Q2 2006 Earnings Conference Call Transcript (DNA)
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