Genentech Q3 2007 Earnings Call Transcript

| About: Roche Holding (RHHBY)

Genentech, Inc. (Private:DNA)

Q3 2007 Earnings Call

October 15, 2007 5:15 pm ET

Executives

Kathee Littrell - Senior Director, Investor Relations

Ian T. Clark - Executive Vice President, Commercial Operations

Susan D. Desmond-Hellmann - President, Product Development

David A. Ebersman - Chief Financial Officer, Executive VicePresident

Analysts

Chris Raymond - Robert W. Baird & Company

Geoff Meacham - J.P. Morgan

Joel Sendek - Lazard Capital Markets

Mark Schoenebaum - Bear Stearns

Jim Birchenough - Lehman Brothers

Mike King ­- Rodman & Renshaw

Eric Schmidt - Cowen & Company

Steven Harr - Morgan Stanley

Michael Aberman - Credit Suisse

Geoffrey Porges ­- Sanford Bernstein

Shiv Kapoor - Ferris Baker Watts

Maged Shenouda - UBS

William Sargent - Banc of America

May-Kin Ho - Goldman Sachs

Operator

Good evening. My name is Cara and I will be your conferenceoperator. At this time, I would like to welcome everyone to the Genentechquarter three 2007 earnings conference call. (Operator Instructions) I wouldnow like to turn the conference over to Kathee Littrell, Senior Director ofInvestor Relations. Madam, you may begin your conference.

Kathee Littrell

Thank you, Cara. Good afternoon, everyone and thank you forjoining our Q307 earnings call. We have posted an earnings slide set on ourwebsite. That’s www.gene.com. This call is being electronically recorded and iscopyrighted by Genentech. No reproductions, retransmissions, or copies of thisconference call can be made without the written permission of Genentech.

We will be making forward-looking statements and actualresults may vary materially from the statements made. Please see the riskfactors section of our Form 10-Q for the period ending June 30, 2007 that’s onfile with the SEC for a discussion of the risk factors that could causematerial variations from the forward-looking statements made during theconference call.

We’ll be discussing financial information that includesnon-GAAP financial measures in our call today so please refer to our website --again, www.gene.com -- under the investor tab. Click on the financials for themost directly comparable GAAP financial measures with a reconciliation to thenon-GAAP financial measures discussed today.

Today I am joined by Ian Clark, our Executive Vice Presidentof Commercial Operations; Sue Hellmann, the President of Product Development;and David Ebersman, the Executive Vice President and Chief Financial Officer.Now I am going to turn the call over to Ian.

Ian T. Clark

Thank you, Kathee and good afternoon to everybody. U.S.sales in the quarter were $2.16 billion, up 18% from Q3 of last year. Moving tothe products and starting with oncology and first of all, Avastin. Avastin U.S.sales were $597 million in the quarter, an increase of 37% over the samequarter last year. The year-on-year growth resulted from increased sales in metastaticnon-small cell lung cancer, first line metastatic colorectal cancer and metastaticbreast cancer, an unapproved use of Avastin in the U.S.

Net sales also benefited from $5 million we recognized thisquarter from the Avastin Patient Assistance Program. With fewer than anticipatedpatients enrolled in the program, we were able to release them as previously deferredrevenue, thereby increasing reported Avastin sales in the quarter.

We continue to be pleased with the success of ourpromotional efforts in lung cancer. Based on our tracking data, we estimatethat approximately 50% to 60% of first line lung cancer patients are eligible forAvastin therapy. Currently, approximately 55% of these patients are now beingtreated with Avastin. That’s implying that in the overall population,penetration continues to be approximately 30%, which is up from the 20% we saw inquarter three 2006.

With respect to dose in lung cancer, tracking data suggeststhat the percentage of patients who receive the higher [15 mg] per [KG] weeklydose dropped from 75% last quarter to 60% [inaudible]. This decrease reflectsposition adoption of the low dose, a trend that we expect to continue in thecoming quarters.

While low dose adoption ultimately settled, [inaudible]influenced by the results of the AVADO study testing the low dose in breastcancer expected in the first half of next year.

In colorectal cancer, sales growth in Q3 were due toincreasing duration of treatment in the front line setting following datapresented at ASCO. While our policies do not allow us to promote Avastin inbreast cancer, [inaudible] relative to both prior quarter and the same quarter.

Moving on to Herceptin, U.S. sales of Herceptin were $320million in Q3 of ’07, a 6% increase over the same quarter last year. Our marketresearch indicates that the overall penetration in HER2-positive adjuvantbreast cancer is holding steady at approximately 70% in Q3 of ’07. Given thisvery high penetration, we expect limited incremental growth from the additionalapprovals anticipated in early ’08. These approvals would expand the label of adjuvanttreatment options to include a [inaudible] regimen, patients at a high risk,lymph node negative patients, and an Herceptin administration schedule of everythree weeks.

Penetration and duration of Herceptin in the metastaticsetting remains stable. Current, the pattern of use appears to be primarily in laterlines of metastatic disease.

Next, Tarceva; U.S. sales of Tarceva were $101 million inthe quarter, a 1% increase over the same quarter last year. Our tracking datasuggests that penetration and duration in both lung cancer and [first line] pancreaticcancer were relatively flat compared to Q3 of ’06. However, a 12% increase ingross sales relative to Q3 of ’06 driven by price increases were almostentirely offset by an increase in our product returns reserve, which was promptedby a higher-than-expected product return during the quarter.

We do not believe the returns are significant and asignificant issue in the big picture of overall Tarceva commercialization. Incollaboration with OSI, we will be looking into the return situation in moredetail in the coming quarter and will consider changes in our distributionprogram as appropriate to best manage Tarceva’s commercialization.

Now on to Rituxan; total U.S. sales reached $572 million inthe quarter, a 12% increase over the same quarter last year. In hematology,sales growth resulted from increased use of Rituxan following first linetherapy in indolent non-Hodgkin’s lymphoma and for increased adoption in frontline CLL, an unapproved use. Rituxan’s overall adoption in other areas of NHLand CLL remain steady.

Now moving to the immunology space and continuing withRituxan, but this time in rheumatoid arthritis. Rituxan in RA continued itsmarket share growth in the TNS PNF IR segment, increasing from an estimated 7%share in Q2 of this year to greater than an estimated 10% in Q3 of ’07. Thegrowth in market share was driven by both current and new prescribingphysicians. The number of current Rituxan prescribers who have retreated atleast one patient has increased from 65% to 75% in the quarter. The averageinterval between Rituxan courses remains at six to seven months, and finally,we’ve begun preparation for the approval and launch of the PNF IR structuralbenefit claim anticipated in Q1 of next year.

On to Xolair, U.S. sales of Xolair were $121 million in thequarter, a 13% increase over the same quarter last year. In August, theNational Heart, Lung and Blood Institute published new asthma guidelines whichlist Xolair as the first and only biologic therapy for this disease.

And completing immunology, U.S. sales of Raptiva were $29million in the quarter, a 26% increase over the same quarter last year.

Now on to our tissue growth and repair products, andbeginning with Lucentis; at $198 million, Q3 sales increased 29% over the samequarter last year, but were down compared to quarter two of this year. Newpatient share also declined slightly to approximately 50%. Total patient shareremains relatively flat.

The main factor impacting Lucentis sales is the continuedoff-label use of Avastin by some retinal specialists. Reimbursement concernsare also still influencing some prescribing physicians. We anticipate that someof these concerns may be addressed when Lucentis receives a permanent J code inJanuary 2008. Sales may also have been affected by some patients not returningfor repeat injections during the summer vacation months.

As you know, we have concerns related to the sterility andrepackaging of Avastin for ocular use and so we recently decided to no longerallow compounding pharmacies the ability to purchase Avastin directly fromwholesale distributors. However, we think it is reasonable to expect that manyretinal specialists will continue to acquire Avastin through other establishedchannels.

These factors -- Avastin being a major competitor,reimbursement concerns, especially with respect to practice economics, andpossible perceptions around the discontinuation of supply to compoundingpharmacies -- have and will create a difficult environment for the promotion ofLucentis and to building relationships with our customers. We expect thesefactors to persist for the remainder of this year and the start of next yearand are likely to limit Lucentis sales growth during that period.

Finally, to our other tissue growth and repair products,U.S. sales for Nutropin were $93 million in the quarter, a 1% increase over thesame quarter last year. Thrombolytics products, U.S. sales were $67 million, a12% increase over the same quarter last year, and finally for Pulmozyme, U.S.sales were $57 million in Q3, a 14% increase over last year.

In summary, despite challenges in the quarter and the year,growth was robust at 18%. Our portfolio is strong, with 10 products allgrowing, and we remain excited about the growth prospects ahead.

Now I’ll turn the call over to Sue.

Susan D.Desmond-Hellmann

Thanks, Ian. Third quarter this year has been marked bypipeline progress and preparation for a busy year-end 2008. In Q3, weresubmitted the sBLA for Avastin with chemotherapy and first-line metastaticbreast cancer based on the E2100 data. We’ve been informed that an ODAC meetingwill occur in early December. The agenda for that meeting is determined by theFDA. However, we believe one of their objectives is to hear the ODAC view onwhether PFS -- progression-free survival -- is an acceptable primary endpointin evaluating first-line metastatic breast cancer therapies. The action date isFebruary 23, 2008.

We completed enrolment in RIBBON-1, the Phase III first-linemetastatic breast cancer study evaluating physicians choice of chemotherapywith Avastin; in REACH, the Phase III study of Rituxan in relapsed chroniclymphocytic leukemia; and the Phase II study of Topical VEGF as a treatment fordiabetic foot ulcers.

And we’ve made progress in moving new molecules forward inour early stage pipeline, with enrolment starting in our Trastuzumab-DM1 PhaseII study in HER2-positive metastatic breast cancer; the third generation Anti-CD20Phase I/II study in relapsed or refractory CLL; the PARP Inhibitor Phase Ib studyfor malignant melanoma; and MetMAb Phase I study in patients with solid tumormalignancies.

I will now review some details of our programs, startingwith Avastin. We are performing an independent radiology review of Roche’s PhaseIII AVOREN study in preparation for the first line renal cell cancer sBLA whichwe expect to submit in Q3 2008. Top line results from CALGB 90206 will also besubmitted in support of the sBLA.

We anticipate overall survival data, a secondary endpointfrom Roche’s AVAiL study, in the first half of 2008. Roche’s AVADO trial,evaluating docetaxel alone versus docetaxel with either a high dose or low doseof Avastin in first-line metastatic breast cancer is also anticipated in thefirst half of next year.

Regarding our adjuvant breast cancer program, safety datafrom the HER2-negative pilot study, ECOG 2104, will be presented at the SanAntonio Breast Cancer Symposium in December, and we expect to initiateenrolment in a Phase III HER2-negative adjuvant study, ECOG 5103, in quarterone 2008.

Roche expects to initiate two Phase III adjuvant breasttrials: BEATRICE, investigating Avastin in HER2-negative patients; and BETH,investigating Avastin in combination with Herceptin in HER2-positive patients.

We also expect to initiate a Phase III study, ECOG 1105,investigating the addition of Avastin to Herceptin plus chemotherapy for thetreatment of first-line HER2-positive metastatic breast cancer in Q1 2008.

We continue to evaluate Avastin’s efficacy in additionaltumor types and combination therapies. This quarter, we initiated our thirdAvastin plus/minus Sutent study, SABRE-R, investigating this combination infirst-line renal cancer.

We also began enrolment in a Phase III Rituxan CHOPplus/minus Avastin study, MAIN, in diffuse large B-cell lymphoma, first line,and plan to begin two new Phase III studies in late ’07 or early ’08, oneinvestigating octreotide, or Sandostatin, plus either interferon alpha orAvastin as treatment for high-risk carcinoids and the other exploring Gleevec plus or minus Avastin in gastrointestinalstromal tumors.

We look forward to the Phase II second and third line GlioblastomaMultiforme data evaluating Avastinversus Avastin plus irinotecan in Q4 of this year. This is an aggressive tumortype and an area of unmet medical needs. Historically, after the first diseaseprogression, response to chemotherapy has been rare, with typical six monthsprogression free survival of 15% and median survival of 25 weeks. The primaryendpoints for this study are six months progression free survival and objectiveresponse rates.

Now turning to our Herceptin program, regarding the sBLA forthe one-year HERA data, the FDA has requested additional review time and theaction date is now January 21st. The action dates for the sBLAs based on theBCIRG data are in Q208.

In the first half of 2008, we plan to initiate a Phase IIIstudy in HER2-positive ductal carcinoma in Situ. This study will investigateHerceptin as treatment for stage zero patients who have undergone a mastectomyor lumpectomy and examines the potential to move Herceptin into earlierdiseases and prevent the need for chemotherapy. As with other early diseasetrials, these patients may need to be followed for an extended time to evaluatethe primary outcomes.

Turning to Pertuzumab, we in Roche are preparing to initiatea Phase III Herceptin and Docetaxel plus/minus Pertuzumab trial in first-lineHER2-positive metastatic breast cancer in Q4 this year. We have decided to waitfor the final results of the Roche Phase II study investigating Pertuzumab inplatinum sensitive ovarian cancer to be disclosed in early ’08 beforeproceeding with any additional trials in ovarian cancer.

And in our Tarceva program, in the first-line metastatic non-smallcell lung cancer study called SATURN, enrolment is now expected to be completein the first half of 2008. An objective of this study is to evaluate efficacyin EGFR positive patients versus all patients. We anticipate data from Roche’sPhase III Tarceva plus/minus Avastin pancreatic study, AVITA, later this yearand from our Phase III Tarceva plus/minus Avastin study in second-linenon-small cell lung cancer, BETA Lung, in the second half of ’08.

Turning to our epitosis development program, the Phase IIstudy investigating Apomab incombination with Rituxan as treatment for indolent non-Hodgkin’s lymphoma isexpected to begin by year-end.

Regarding the Anti-CD40 development program, by year-end aPhase IIb study in combination with Rituxan plus or minus ICE immunochemotherapy as treatment of relapsed diffuse large B-cell lymphoma will beinitiated. In addition, four Phase Ib studies are preparing to start in Q407and Q108.

Now turning to our immunology program, starting withRituxan. In rheumatoid arthritis, the sBLA action date for the radiographicdata from REFLEX is January 26th. In October, we completed enrolment in IMAGE,the Phase III radiographic study in Methotrexate Naïve RA patients. Inhibitionof structural damage and physical function will be evaluated in these patientsat 52 weeks.

We anticipate data late this year or early ’08 in the PhaseIII RA studies, SERENE and SUNRISE, evaluating Rituxan in Methotrexate andanti-TNF Inadequate Responders respectively, and are looking forward to theresults of the Phase II/III OLYMPUS study in primary progressive MS, as well asthe results from the Phase II/III Systemic Lupus

Erythematosus study, EXPLORER, in the first half of 2008.

Among the data presented at ECTRIMS earlier this week wasthe 48-week data from the Phase II RRMS study, HERMES, which indicated that asingle treatment course of Rituxan significantly reduced MRI evidence ofdisease activity by 91% at 24 weeks, with a continuation of this reductionthrough 48 weeks, and improved clinical outcomes by reducing the proportion ofpatients experiencing relapse by 49% over 48 weeks.

In the second generation humanized Anti-CD20 program, we arepreparing to initiate two lupus studies, one in extra-renal and the other in LupusNephritis in late ’07 and early ’08 respectively.

We have agreed with the FDA on a strategy for the RRMSclinical trials. Recommendations from the European regulatory agencynecessitated a Phase II study. Given our desire to have one global developmentprogram, our next step will be a Phase II RRMS trial expected to initiate inthe first half of 2008.

Turning to Lucentis, the 24-month peer data will bepresented at the American Academy of Ophthalmology in November. In the firstquarter of ’08, the one-year follow-up safety data from SAILOR will bepresented.

As Ian mentioned, as of November 30th, Genentech will nolonger allow compounding pharmacies to purchase Avastin directly from wholesaledistributors. A series of events contributed to this decision. Of greatest importancewas the FDA approval and broad availability of Lucentis for patients with WetAMD. Subsequent to this approval, the FDA raised concerns related to thesterility and repackaging of Avastin for ocular use and a warning letter to acompounding pharmacy.

Additionally, the FDA raised concerns about the ongoingocular use of Avastin during a routine FDA inspection of our south San Francisco manufacturing facility, since it is notdesigned, manufactured, or approved for this use.

For these reasons, we made the difficult decision to nolonger actively supply compounding pharmacies with Avastin, though we doanticipate that hospitals and physicians in the ophthalmology community willcontinue to be able to access Avastin by other means.

I’ll close by highlighting the anticipated news flow foryear-end and early ’08 events. Please refer to the slide deck for additionaldetails and milestones.

We anticipate data from the Phase II BRAIN study evaluatingAvastin in glioblastoma

Multiforme; Roche’s Phase III AVITA study in pancreaticcancer; Roche’s high and low dose Avastin metastatic breast cancer study,AVADO; Roche’s Phase II Pertuzumab in platinum-sensitive ovarian cancer; twoRituxan rheumatoid arthritis studies, SERENE and SUNRISE; Topical VEGF Phase IIstudy in diabetic foot ulcers; the first cohort of the Phase IIIb LucentisSAILOR study.

Upcoming presentations of interest include the safetyresults from the Phase II Avastin in adjuvant breast cancer in San Antonio inDecember; the Lucentis two-year peer study at AAO; at ASH, four presentationsof data from our follicular non-Hodgkin’s lymphoma registry, Lymphacare. Thisis the largest NHL registry to date, with approximately 2,700 patients andrepresents an opportunity to study the natural history of this disease; and atATR, two oral presentations regarding RA, one reviewing the efficacy of repeattreatment with Rituxan and the second reviewing 72-week data for the secondgeneration Anti-CD20.

Potential regulatory activity includes the FDA response tothe REFLEX radiographic sBLA; the ODAC and action date for the ECOG-2100 sBLA;and the FDA response to the Herceptin sBLA submission based upon the one-yearHERA data.

Now I will turn the call over to David.

David A. Ebersman

Thank you, Sue and good afternoon, everyone. Unlessotherwise noted, the financial figures in my comments are non-GAAP numberswhich exclude the effects of recurring charges related to the 1999 Rocheredemption, litigation related special items, employee stock compensationexpense, and accounting for our acquisition of Tanox.

I will start off with a few words on our acquisition ofTanox. On August 2nd, we completed the transaction for a net purchaseinvestment of approximately $731 million. Our GAAP financial statements for Q3include a one-time charge of $77 million for the write-off of in-processR&D and a one-time gain of $121 million, driven by the valuation of Tanoxintangible assets, according to purchase accounting guidance in circumstanceswhere our previous business relationship already exists.

The GAAP numbers also include certain items which will recurin future quarters, including $11 million for the amortization of intangibleassets resulting from the acquisition and $3 million of royalty revenue.

I’d be happy to discuss the acquisition accounting in moredetail during the Q&A or after the call.

Now let me turn to the revenue components of the incomestatement. Sales to collaborators were $166 million this quarter, a 50%increase over Q3 2006. Increases relative to last year were due to highervolumes of Rituxan and Avastin.

As you know, sales to collaborators vary from quarter toquarter based on the production and order plan and based on contractualcommitments and requirements, so our quarterly sales to collaborators do notdirectly predict our collaborator sales to end users outside the United States.

We now expect that full year 2007 sales to collaboratorswill increase by approximately 90% relative to the $471 million reported in2006.

Royalty revenues were $521 million, a 43% increase over Q32006 due to stronger sales by Roche and Novartis and some smaller items,primarily related to timing differences.

For the full year 2007, we expect royalties to growapproximately 40% over 2006, so we continue to see healthy growth here throughQ3 though, excuse me, though Q3 does have some timing-related items that bringthe number above the trendline.

Contract revenues were $63 million this quarter, a 20%decrease over Q3 2006 and we continue to expect contract revenues in 2007 toremain relatively flat compared to 2006.

Total operating revenues were approximately $2.9 billionthis quarter, a 22% increase over Q3 2006.

Turning now to the expense line items, non-GAAP cost ofsales was $390 million, or 17% of net product sales this quarter. The increasefrom 15% in Q3 2006 was primarily due to a one-time charge of approximately $53million taken in the current quarter resulting from our decision to cancel andbuy out a future manufacturing campaign we had planned at one of our contractmanufacturing sites.

Based on the CMO’s successful production through fourcampaigns to date, we did not feel that we needed the inventory from anadditional campaign and decided that buying our way out was better for usfinancially than incurring the costs of completing the remaining campaign.

As I’ve previously mentioned, we continually work toconfigure our supply chain to balance our objectives of mitigating supply riskwhile managing within our cost of sales targets.

For 2007, we continue to expect cost of sales to beapproximately 16% of product sales, barring any unforeseen manufacturing ofinventory issues.

Non-GAAP R&D expenses were $578 million this quarter, a38% increase over Q3 2006, as we continue to invest in our late stage pipelinewhile ramping up spending on the early stage pipeline.

R&D was 20% of operating revenues this quarter, anincrease from 18% in Q306 and for 2007, we expect R&D expense to beapproximately 20% of revenues, if not fractionally higher depending upon newbusiness development deals from the fourth quarter.

Non-GAAP MG&A expenses were $497 million this quarter,an 8% increase over Q3 2006. MG&A as a percentage of operating revenues was17% this quarter, a decrease from 19% in Q3 2006.

We expect MG&A expenses to ramp up significantly in thefourth quarter as many of our major 2007 activities in this area are planned tooccur towards the end of the year. For 2007, we expect MG&A as a percent ofrevenues to come in just under 18%.

Collaboration and profit sharing expenses were $276 millionthis quarter, an increase of 10% over Q3 2006. Non-GAAP pretax operating marginas a percentage of total revenues was 40% this quarter, comparable to thepercentage in Q3 2006, and for the full year 2007 we continue to expect anoperating margin of about 40%.

Other income net was $66 million this quarter. In 2007, weexpect other income net to be approximately 90% of the 2006 figure.

On taxes, our non-GAAP tax rate was 37% this quarter,comparable to the rate for Q3 2006, and we continue to expect our tax rate forthe full year 2007 to be approximately 37%.

Non-GAAP net income this quarter was $778 million, or $0.73per share, a 22% increase in net income and a 24% increase in EPS over Q3 lastyear. For the full year 2007, we continue to expect our non-GAAP earnings pershare to increase by approximately 28% to 32% relative to 2006. This translatesto $2.85 to $2.95 per share.

Employee stock-based compensation expense was approximately$97 million on a pre-tax basis, or $59 million after taxes or $0.06 per sharethis quarter, compared to $0.04 per share in Q3 2006.

Now turning to some cash metrics, cash from ongoingoperations in the quarter was approximately $700 million and our free cash flowfor Q3 was approximately $500 million, up from $62 million in Q3 2006.

Year-to-date free cash flow is approximately $1.5 billion.

In Q3, cash used for capital expenditures was approximately$200 million and for the full year 2007, we estimate that capital expendituresshould come in at approximately $1 billion.

In Q307, we spent $148 million for gross share repurchases,with a net effect on our cash position of approximately negative $10 million,including the offsetting cash inflows from stock option exercises and the taxbenefits related to those exercises.

As of September 30, 2007, our unrestricted cash andinvestments portfolio totaled approximately $4.9 billion compared to $4 billionas of September 30, 2006.

Let me close now by saying that we are pleased with our Q3and year-to-date results. We achieved significant profit growth whileincreasing our investment in internal R&D and making important newin-licensing investments totaling more than $180 million on a year-to-datebasis.

As you know, the fourth quarter is a big investment quarterfor us, usually driven by new business development arrangements and the timingof internal R&D and commercial activity, and we expect that trend tocontinue in Q4 2007.

In the fourth quarter, we also turn our attention toplanning for 2008 and beyond. While we recognize that our revenue and earningsgrowth rates are likely to come down relative to the past few years as thecompany grows and some of our product lines mature, we remain optimistic thatwe can continue to grow the business successfully over the long run bycapitalizing on great science and bringing forward important new molecules andindication that help patients, create value for shareholders, and enableGenentech to continue to be a special place to work for our employees.

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

Kathee Littrell

Thank you, David. Operator, we will be taking questions atthis point. I would like to ask each of you that you limit your questions toone per person to allow more individuals to ask questions. Operator, will youqueue up the questions, please?

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes from ChrisRaymond with Robert W. Baird & Company.

Chris Raymond -Robert W. Baird & Company

Thanks for taking the question. I just wanted to -- David, Iknow you touched on the net sales to collaborators number and you gave someyear-end guidance, but I wonder if you could walk through the dynamics of howthat works in terms of the fluctuation quarter to quarter. Is this based onRoche inventory fluctuations that’s responsible for essentially for thatfluctuation or is there some other thing going on there?

David A. Ebersman

There are a lot of variables that impact it, so let me startfrom the basics of how the arrangement works. If -- we don’t make all of ourproducts on a consistent basis throughout the year. We campaign and there areprocess differences that, relative to the approved processes for the sameproduct in the United States and outside the United States, so we will oftenfind ourselves in a situation where we will make all of the X product thatRoche needs from us in a certain period of time during the year. We’ll justcampaign it then because it is most economical to stay making one product consistentlyfor as long as you need to, and then we’ll sell it to Roche after its release.So they will end up with an increase in their inventory relative to where theywere before, and then they will work that off over a period of time.

So it is very hard to -- it is actually fairly predictablewhat sales to collaborators are going to look like, but it is fairlyinconsistent depending upon the production plan, the release plan, the orderplan, and just how the contracts are written, which is modestly differentlydepending upon the products.

Chris Raymond -Robert W. Baird & Company

So to be clear then, we should be looking at royalties asthe better indicator of natural demand for Roche?

David A. Ebersman

Yes, that’s very consistent with how I would encourage youto look at it. I think looking at sales to collaborators and trying totranslate that into some knowledge of what’s going on in the ex-U.S. markets isvery difficult.

Chris Raymond -Robert W. Baird & Company

Thank you.

Operator

Your next question comes from Geoff Meacham with J.P.Morgan.

Geoff Meacham - J.P.Morgan

A question for you on second generation CD-20 in multiplesclerosis. I think you guys said in the last conference call that you are inPhase III preparation. Now on this slide, it looks like you are back to thedrawing board and Phase II beginning in 2008. What’s driving your thinkingthere?

Susan D.Desmond-Hellmann

As I mentioned in my comments, if we had a U.S. aloneprogram, we did feel enabled to go into Phase III. And we sat down with ourcollaborators at Roche as well as Biogen Idec, and we realized that two thingswere true. One was that in Europe, there was a wish for additional doseranging, and two was that to maximize the speed of patient enrolment, we neededa global program.

And so we feel that despite that addition of the Phase II,we’ll be able to move quickly into Phase III and we’ve worked hard to minimizethe timing impact of the new Phase II study but we will have a Phase II trialin the MS program now.

Geoff Meacham - J.P.Morgan

So just all about trial execution but nothing, no signals oranything that you’ve seen in the development?

Susan D.Desmond-Hellmann

No, there is not new information in terms of data but wewanted to have a global program and so needed the dose ranging.

Geoff Meacham - J.P.Morgan

Thank you.

Operator

Your next question comes from Joel Sendek with LazardCapital Markets.

Joel Sendek - LazardCapital Markets

Thanks a lot. I have a question about two of the companiesyou have deals with that are exploring their strategic alternatives and I amwondering whether you can discuss your view and what the best outcome forGenentech might be regarding the fate of TDL and Biogen. Thanks.

David A. Ebersman

We try and be generally pretty forthcoming with ourdisclosure and the one major exception to that is when asked about othercompanies that we either do or don’t have interactions with, so that’s an areawe’re just more comfortable not commenting at all.

Joel Sendek - LazardCapital Markets

Okay. Thank you.

Operator

Your next question comes from Mark Schoenebaum of BearStearns.

Mark Schoenebaum -Bear Stearns

It’s Mark Schoenebaum of Bear Stearns. David, I wanted toask you about a bunch of other companies, if you don’t mind. No, I’m justkidding. Maybe I could just ask -- sorry, Joel, I was just kidding -- maybe Icould just ask Sue, if you don’t mind, you’ve got two Phase III’s coming up inthe first half of ’08. Very exciting. It’s been a while since we’ve seen majorPhase III’s but in -- for Rituxan for primary progressive MS and lupus, youanswered a few questions about that. But can I just ask you, if you don’t mind,to opine on number one, your -- kind of the way you are trying to frameprobability of success in those trials, especially on the primary progressiveMS trial?

And then also, you mentioned -- this is a related question,it’s not a second question. But on the Lupus program, is that going to be afile-able study or, if not, what do you need to wait for to file on the Lupusprogram, please? Thanks.

Susan D.Desmond-Hellmann

So related rather than a second question, that was good. Letme start with Lupus. We are really excited about Anti-CD20 in Lupus. We’veconsistently seen more case series related information but I would say agrowing belief amongst the thought leaders in this area that we may have animportant new medicine for patients with Lupus.

So while we are relatively optimistic about the use ofRituxan in Lupus, the caution would need to be that this is a veryheterogeneous patient population and is a study area that has a long history ofdisappointment. So we certainly don’t want to overreach until we see the data,despite our optimism for our approach.

Whether we will need addition work or approach the filingreally depends on the data and the degree of import of Rituxan in helpingpatients with Lupus. We’ll make those decisions when we see the informationfrom the first trial. So that’s Lupus. Stay tuned. We’ll have a lot moreinformation on that when we see that study.

In PPMS, as you know, there are no approved therapies andthere are some who question whether the biology in PPMS is similar to that inRRMS, so we think this is a more risky study area and unlike what I said aboutLupus, we have much less information and therefore less optimism.

That said, if we do see positive information, it would beextremely exciting for patients and for us to see for the first time a therapybe successful in MS and of course, the RRMS data achieved endpoints thatexceeded our expectations. So that’s how I would think about those two trialprograms.

Mark Schoenebaum -Bear Stearns

Okay, I really appreciate that. Thanks.

Operator

Your next question comes from Jim Birchenough with LehmanBrothers.

Jim Birchenough -Lehman Brothers

Just a follow-up question for Sue on the Lupus trial; Sue,there’s been a number of trials initiated with different endpoints. I’m justwondering if you could remind us what the primary endpoint is in the Lupusstudy and what discussions you’ve had with the FDA on approvability on thatendpoint?

Susan D.Desmond-Hellmann

It is, as has been true in the past, a composite endpoint.I’ll have to look up. I can’t keep track of the alphabet soup, so let me lookthis up for you. Let’s see -- it’s a major clinical response or partialclinical response at 52 weeks, based on the BILAG score in the Lupus trial. Andwe have had discussions with the FDA about that endpoint and its approvability.There are secondary endpoints as to activity, safety, and tolerability.

Jim Birchenough -Lehman Brothers

Very helpful. Thank you.

Operator

Your next question comes from Mike King with Rodman &Renshaw.

Mike King ­- Rodman& Renshaw

I was wondering if I could come at Joel’s question adifferent way and that is, David, if you could just remind us, what areGenentech's rights under the Rituxan agreement with Biogen Idec in the event ofa change in control?

David A. Ebersman

We have the option, if we choose to, to trigger what isoften referred to as a Dutch auction, where we can try to make a bid on theoutstanding rights, or the rights we don’t have on Rituxan and the relatedmolecules.

Mike King ­- Rodman& Renshaw

So we should look at it from the standpoint of the profitshare that you provide to Biogen Idec as your right to buy that income streamback at some point, should a change of control be triggered?

David A. Ebersman

Would you repeat the question for me, Mike? I’m sorry.

Mike King ­- Rodman& Renshaw

If you look at the profit share to Biogen Idec on theirincome statement, with their share of the profits of Rituxan, you have therights to buy that income stream back. Is that technically correct?

David A. Ebersman

We have the option, if we choose to exercise it, to make abid on those. If you read the agreements which had been filed when we did theoriginal deals, you can get a lot more details on how that would work.

Mike King ­- Rodman& Renshaw

Okay. Thank you.

Operator

Your next question comes from Eric Schmidt with Cowen &Company.

Eric Schmidt - Cowen& Company

Good afternoon. Sue, it sounds like this FDA panel meetingis going to be, the ODAC meeting, that is, is going to be about PFS as anendpoint in first-line metastatic breast. Can you just give us your bestarguments as to why that ought to be an approvable marker?

Susan D.Desmond-Hellmann

Let me just start by -- understand that the FDA sets theagenda and the questions for the panel, so I am trying to give you our bestsense, given the discussions we’ve had with the FDA. But of course, up to andincluding the day of the panel meeting, that can change. I don’t want to speakfor the FDA.

We think that PFS should be an approvable endpoint becausewe think the way Avastin performed in this trial was consistent with clinicalbenefits. It had a large magnitude of difference. We’ve carefully reviewed andconfirmed the magnitude of the difference, barely a doubling in progressionfree survival.

Importantly, there’s a long history in breast cancer infirst-line metastatic breast cancer of approvals based on progression freesurvival and part of the reason for that is that these patients go on tomultiple other therapies, including, for example, Avastin, which is out andapproved and other indications. So we don’t control the post-Avastin therapythat patients get.

So when you take that all into account, we think that thisshould be an approvable endpoint.

Eric Schmidt - Cowen& Company

Thank you.

Operator

Your next question comes from Steve Harr with MorganStanley.

Steven Harr - MorganStanley

David, could you just give us an update on where thingsstand in the arbitration with Biogen Idec around rights to second generationCD20?

David A. Ebersman

Not much really new relative to what we’ve disclosed before.These things take time to play out, as you know. I think our current thinkingis that there’s a reasonable probability that it could be that the arbitrationcould be complete by the end of next year. But the timing will -- if you’vebeen through these things before, you know you learn more as you go in terms ofwhat the timelines are going to look like.

Steven Harr - MorganStanley

Can you just walk through each of the issues that are up fordispute?

David A. Ebersman

Well, the primary issue that flows in to sub-issues is aquestion of decision-making rights and whether or not we’re allowed to proceedwith certain studies if Biogen Idec doesn’t think we should.

Steven Harr - MorganStanley

Thanks.

Operator

Your next question comes from Michael Aberman with CreditSuisse.

Michael Aberman -Credit Suisse

I have a question about the use of a low dose Avastin. Wesaw an increase of I think from 25% to 40% of doctors or is it patients who aregoing that way? And if you can just talk a little bit about what it’s like inthe field and whether you expect that to increase, what chemotherapies areusing, and whether you’d expect similar migration if the AVADO trials shows asimilar result, breast cancer.

Ian T. Clark

I thought I might get away without a question today. What Isaid in the prepared remarks, this is share of patients, not physicians. Use ofthe high dose has come down from 75%, which is pretty much where we were at formost of the previous couple of years, down to 60% in the quarter. And recall,it really wasn’t until ASCO that physicians got a chance to properly look atthis data, so quite a reasonable fall in one quarter and as I said in theprepared remarks, we have reason to think that may not be the end of it. Wemight see some further drop in usage.

AVADO is similar in trial design to AVAiL. We don’t tend totalk a lot about data of unapproved uses but I can tell you from what we knowat the moment, the off-label use of breast cancer is mostly at the high doseand I would expect therefore that if the results similar, we would see somesort of similar drop in the use of the high dose and more use of the low dose.

I don’t actually think that the precise chemo combination isso critical to that. I do think that, particularly in AVAiL, the fact that thecombination was not typically used in the U.S. was a good reason for somephysicians to discount that study to some degree. It might be less so with caseof AVADO.

Michael Aberman -Credit Suisse

You had argued in the past that they wouldn’t translate thatto carbotaxel use. Are you seeing the lower dose in combination with thoseother -- with carbotaxel or no?

Ian T. Clark

We are just seeing lower dose use generally. I don’t thinkit’s specific to do with any one combination. There often is not a patientselection element to it. There are certain patients where they think maybe theyare more concerned about some of the side effects and the lower dose might bepreferable.

Michael Aberman -Credit Suisse

Okay. Thanks.

Ian T. Clark

It is fair to say that different physicians are reacting indifferent ways. It’s not kind of a blended 60% across the board.

Michael Aberman -Credit Suisse

Okay, so some physicians use both high and low dose?

Ian T. Clark

Nearly all of them use some. The split -- this is a goodmultiple question, isn’t it? The split varies and I would point out that we’vealways seen some high dose use in the colorectal cancer population, despite thefact that was approved at the low dose.

I think most physicians will continue to use both but we areseeing a trend to more low doses generally.

Michael Aberman -Credit Suisse

Thanks.

Operator

Your next question comes from Geoffrey Porges with SanfordBernstein.

Geoffrey Porges ­-Sanford Bernstein

Thanks very much for taking the question. Ian, you are stillon the hook. Your 18% U.S. product sales growth was by my count the slowestyou’ve seen since 2003. You had a weak result relative to people’sexpectations, anyway, for Herceptin, Tarceva, Rituxan and some of the othersmaller products, but particularly on oncology you seemed to be lagging.

Could you comment on what you are seeing out there in theenvironment? Has there been any change in inventories out there? Are yougetting push-back from payers? I mean, what’s causing the slowdown and is thatthe direction you see the business going?

Ian T. Clark

No, I wouldn’t -- I think 18% given the size of the base ofthe portfolio is still good and solid growth. I wouldn’t throw a blanket acrossthe oncology products. I think we’ve got very different dynamics on each of thefour. Avastin clearly is growing. Rituxan, it has its ups and downs. If youlook back over the last eight quarters, we’ve had an increase followed by aminor decline sequentially for the last eight quarters in a row and therefore,I would see this quarter as just a continuation of that pattern.

Herceptin, by contrast, I think there is some significantsuggestion now that we are heavily penetrated and growing that product is goingto be harder but that’s to do with the penetration of that market, not to dowith payers. And as I said in my prepared remarks, we do seem to have at leasta relatively short-term impact of Tarceva in terms of the returns issue, whichI would hope with the right planning would go away. Having said that, I wouldlike to see some underlying growth and penetration in Tarceva as well.

So different dynamics for different products.

Geoffrey Porges ­-Sanford Bernstein

And the channel inventory? What do you know?

Ian T. Clark

Pretty much where you’d expect it and pretty much where itwas last quarter -- nothing worth commenting on.

Geoffrey Porges ­-Sanford Bernstein

Thank you.

Operator

Your next question comes from Shiv Kapoor with Ferris BakerWatts.

Shiv Kapoor - FerrisBaker Watts

Thanks for taking my question. I want to understand howbroad the Anti-CD20 collaboration is with Biogen Idec. I understand you havebetter economics on the second generation Anti-CD20 programs but beyond that,if you use some of the newer technologies that you have, you’ve collaboratedon, do your economics look better than even the second generation? And doesBiogen and Roche, do they still have some economics?

David A. Ebersman

You’re going a little deeper than we’ve gone in our prepareddisclosures before in terms of these other molecules. I guess I would point youto the agreements that we filed. In general, as you know, the economics wouldchange with the approval of a next generation product. There isn’t muchcontinued change from there based on additional molecules we would bringforward in a collaboration.

Shiv Kapoor - FerrisBaker Watts

So as of now, you will have the same economics as the secondgeneration programs?

David A. Ebersman

The revised economics would remain in place as futuremolecules within the collaboration came forward.

Shiv Kapoor - FerrisBaker Watts

Okay, thanks.

Operator

Your next question comes from Maged Shenouda with UBS.

Maged Shenouda - UBS

Thanks for taking my question. I also have a question forIan. Ian, you mentioned that Lucentis growth should rebound in 2008 and beyond.Maybe you could just walk us through your assumptions there.

Ian T. Clark

That’s not quite what I said. What I was trying to encapsulatein my comments was that we feel we are facing really quite a difficultenvironment. Avastin itself is an unusual and rather difficult competitor, ifyou will, to deal with, certainly from our point of view. The reimbursementsituation remains a challenge and certainly we’ll do some [inaudible] with the Jcode. It often does for a month or two after the J code, and much as we didbelieve that we did what was precisely the right thing with the compoundingpharmacies, we don’t necessarily expect everybody to see it that way. And allof that makes a difficult environment for the promotion of Lucentis and thegrowth of Lucentis.

I think that’s going to persist certainly through the end ofthis year and quite possibly into the first quarter of the following year. Iwould then hope that maybe when that starts to come behind us, we will see somereturn to growth. But it is going to be a difficult process, from our point ofview.

Maged Shenouda - UBS

Thank you.

Operator

Your next question comes from William Sargent with Banc ofAmerica Securities.

William Sargent -Banc of America

Thank you for taking my question. Just to follow up, Ian,with the Wet AMD market, there had been some estimates that that market, atleast for new patients, has been split roughly 50-50 between Avastin andLucentis. I was wondering if you could comment about how much you think thischange with the compounding could affect that market share split.

Ian T. Clark

In terms of the -- why don’t I just comment on where we’reat at the moment? We’ve quoted the Lucentis market share at approximately 50% andit is fair to say that the vast majority of the rest of the market is Avastin,although there is some remaining Macugen and Visidyne use.

I want to say a little bit of background about thedistribution. The way we normally distribute our products is we sell towholesalers and then the wholesalers just then sell on to the end user. Thatwould be a physician or a hospital.

We’ve typically not wanted to have any what we callsecondary distribution. The reason we don’t particularly want to do that, wedon’t think we need it and we also think that’s the point within the tradewhere counterfeit sometimes enters. And it’s also the point in the past,companies have seen arbitrage around price and constant stockpiling them.

We specifically took the step to stop that for all of ourproducts last year. The only window we left open was for Avastin because wefelt prior to the approval of Lucentis, there was an unmet need. We don’t thinkthat’s there now.

That said, physicians can still acquire Avastin either by orderingdirectly themselves or by hospitals. And as I said in my remarks, we expectthem to do so.

There may be some choppiness in sales, but we don’t thinkthat this will necessarily affect the sales and we didn’t do it because wethought it necessarily would. We thought it was the right thing to do.

Kathee Littrell

Operator, we are going to take our last question now.

Operator

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

May-KinHo - Goldman Sachs

Most of my questions have been answered but I have aquestion for Ian; when you talked about Herceptin, you didn’t mention anythingabout the duration of therapy. Are you seeing earlier stoppage of Herceptin atthis point?

Ian T. Clark

We measure the duration in both settings. The duration inthe adjuvant setting remains robust and strong. It is typically in the mid-40number of weeks, which is good. We have two measures in the metastatic setting,just that in the first line in use and then through multiple lines of use.That’s pretty much stayed where it was. You might have expected maybe somechange in duration, if we’d seen more the pattern of use. As of now, we are notseeing a change in duration there either.

May-Kin Ho - GoldmanSachs

I was really referring to the number of weeks, sorry, on thefirst line and the other lines.

Ian T. Clark

I was referring to number of weeks as well, so 45 weeks inthe adjuvant setting, about 32, 33 weeks in first line metastatic, and about 60weeks throughout the whole of metastatic.

Operator

Ms. Littrell, do you have any closing remarks?

Kathee Littrell

We want to thank all of you for joining us. Sue Morris and Iwill be back in our offices and you can feel free to give us a call if there’sany follow-up questions. Thank you very much.

Operator

This concludes today’s conference call. You may nowdisconnect.

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