Genentech, Inc. (Private:DNA)
Q4 2007 Earnings Call
January 14, 2008 5:15 pm ET
Kathee Littrell - Senior Director, Investor Relations
Arthur D. Levinson Ph.D. - Chairman of the Board, ChiefExecutive Officer
Ian T. Clark - Executive Vice President, CommercialOperations
Susan D. Desmond-Hellmann - President, Product Development
David A. Ebersman - Chief Financial Officer, Executive VicePresident
Geoff Meacham - J.P. Morgan
Mark Schoenebaum - Bear Stearns
Joel Sendek - Lazard Capital Markets
Katherine Kim - Banc of America Securities
Michael Aberman - Credit Suisse
Jim Birchenough - Lehman Brothers
Jason Zhang - BMO Capital Markets
Mike King - Rodman & Renshaw
Ian Somaiya - Thomas Weisel Partners
Steven Harr - Morgan Stanley
Eric Schmidt - Cowen & Company
May-Kin Ho - Goldman Sachs
Geoffrey Porges - Bernstein
Welcome, ladies and gentlemen. My name is Gerald and I willbe your conference operator. At this time, I would like to welcome everyone tothe Genentech Q4 and year-end earnings conference call. (Operator Instructions)It is my pleasure to introduce Ms. Kathee Littrell, Senior Director of InvestorRelations.
Thank you, Gerald. Good afternoon, everyone and thank youfor joining our Q4 year-end ‘07 earnings call. We have posted an earnings callslide set on our website at www.gene.com. This call is being electronicallyrecorded and is copyrighted by Genentech. No reproductions, retransmissions, orcopies of this conference call can be made without the written permission ofGenentech.
We’ll 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 September 30, 2007that’s on file with the SEC for a discussion of the risk factors that couldcause material variations from the forward-looking statements made during thisconference call.
We’ll be discussing financial information today thatincludes non-GAAP financial measures. Please refer to our website -- again, underthe investor tab, please click financials for the most directly comparable GAAPfinancial measures and that has a reconciliation to the non-GAAP financialmeasures discussed today.
I am joined by Art Levinson, Chairman and Chief ExecutiveOfficer today; Ian Clark, Executive Vice President of Commercial Operations;Sue Hellmann, President of Product Development; and David Ebersman, ourExecutive Vice President and Chief Financial Officer. Now I’ll turn the callover to Art.
Arthur D. LevinsonPh.D.
Thank you, Kathee and good afternoon, everyone. 2007 wasanother year of significant growth for Genentech. For 2007, non-GAAP totaloperating revenues were $11.7 billion, increasing 26% from 2006 and ournon-GAAP earnings per share were $2.94, up 32% from 2006. We also made somesignificant progress building our early stage pipeline and positioned thecompany for future success.
In the short term, Genentech's continued growth will bedriven by our ability to increase sales of our marketed products while addingnew indications for our existing products, Avastin and Rituxan. Potentialnear-term growth opportunities for Avastin include metastatic breast cancer, renalcell carcinoma, Glioblastoma Multiforme, and adjuvant colon cancer. And we areevaluating Rituxan in earlier RA disease as well as in multiple immunologicaldisorders, including Lupus and multiple sclerosis.
For the long-term, continued growth will depend upon ourability to bring new molecules to the market that make a meaningful differencefor patients and provide significant commercial opportunities. As a companybuilding our pipeline and advancing potentially important NMEs into late stagedevelopment is our number one focus and priority. In 2007, we announced ourgoal to add a total of 30 molecules into development during the five-yearperiod from the beginning of 2006 to the end of 2010 and we feel good about theprogress we’ve made during the last two years.
In 2007, we added eight NMEs to the development pipeline, sotwo years into the five year period we have added 15 molecules intodevelopment. We now have 20 new molecules in the development pipeline, mosttargeting novel mechanisms based on promising biology and five of these newmolecules started Phase II clinical trials during 2007.
We are also pleased with our robust late stage researchprogram, which we expect will provide most of the additional molecules toenable us to meet our 2010 NME goal.
We continue to be excited about our exploration of newscientific pathways and approaches to treating unmet medical needs and I willnow highlight just one of the many new molecules that we are studying.
We and our collaborator Curis have a small molecule hedgehogantagonist that we are evaluating in the Phase I study of solid tumors that arerefractory to standard therapy. We have seen regression of establishedmetastatic basal cell tumors in Phase I trials and have observed a long halflife and excellent exposure of the compound, and we have also observedsignificant blockade of expression of Gli1, a marker of hedgehog activity inhumans. We are preparing to begin Phase II trials in 2008.
This pathway may offer the potential for important newtherapies as we seek to prevent tumor progression in cancers that are hedgehogdependent. Similar to hedgehog, we are also encouraged by early clinical datawith our proapopotic agents and with our antibody drug conjugates.
In 2007, we had our share of business challenges. Data fromthe AVAiL study evaluating high and low dose of Avastin led to a decline in theuse of high-dose Avastin in non-small cell lung cancer. Additionally, we weredisappointed in the outcome of the December ODAC meeting assessing Avastin as apotential therapy for patients with metastatic breast cancer. We continue tobelieve that Avastin is an important new therapy option for these patients andwe will work with the FDA closely to try to address their questions andconcerns.
Another important challenge for us in 2007 was in the AMDmarketplace. As you know, we launched Lucentis in this market in mid 2006. Wedesigned Lucentis in the mid-1990s with a specific scientific objective ofmaking the best possible molecule for the AMD setting where we believe that thefollowing factors -- small size to enable optimal diffusion, extremely tightVEGF finding, short systemic half life, and the absence of an FC region toattract the immune system -- might all be important to maximize safety andefficacy in AMD and we are extremely proud of the benefits Lucentisdemonstrated in multiple large Phase III trials.
As you know, since launch Lucentis’ primary competition hascome from off label use of intra-vitriol Avastin. In October 2007 we announcedour decision to discontinue actively supplying Avastin to compoundingpharmacies. It is important to understand that this decision was not motivatedby an expectation that we would eliminate or reduce Avastin use or that wewould increase Lucentis profits, but rather we acted based on our belief thatGenentech continuing to play an active role enabling distribution tocompounding pharmacies would represent a business risk.
We continue to believe that Lucentis, which has beendesigned, formally studied, and approved for treatment of wet AMD is theappropriate treatment for these patients. However, we respect that physicianshave a right to make whatever prescribing choice they believe is best for theirpatients.
Over the past few months, before our supply of Avastin tocompounding pharmacies ended on January 1st, we worked with the medicalorganizations, AAO and ASRS, and determined that physicians can purchaseAvastin from authorized distributors and ship to the destination of thephysician’s choice, including to compounding pharmacies.
Using this approach, we expect Avastin to continue to beavailable, albeit in a manner in which Genentech is no longer directlysupplying it. This issue has been a difficult and complex one with multiplestakeholders and we believe that we have found a path that balances everyone’sinterest and protects as best we can our relationships with this importantphysician group.
In the meantime, we remain committed to ensure that patientshave access to our therapies and we are proud of the programs we have in placeto ensure eligible patients can receive Lucentis regardless of their ability topay.
Looking now to 2008, it should be a busy year for us interms of news flow. We expect an FDA decision on Avastin in metastatic breastcancer, typical clinical data for Rituxan on Lupus and MS, progress in ourearly stage pipeline, and other news in areas such as the City of Hope appealand the Cabilly proceedings.
We also have the potential to see data from the Avastin adjuvantcolon trial if one of the 2008 interim looks crosses a pre-specifiedstatistical boundary, although of course we are not predicting that this willhappen in the coming year.
We look forward to these pieces of new information and willcontinue to manage through them with the intent of creating value for ourshareholders over the long run. We remain confident in our approach to runningthe business and will continue to focus on excellent science, planning, andinvesting for the long term, disciplined execution against our aggressivegoals, and a passionate commitment to patients and our employees.
As a scientist, I continue to be enthusiastic about thetremendous advances occurring in understanding the biological basis of manydebilitating diseases and we believe these advances play to Genentech'sgreatest strengths as we try to translate the biology into new drugs.
We continue to embrace and nurture our unique culture, whichwe believe offers us a competitive advantage in recruiting and retaining highlytalented people and stimulating innovation and efficiency, and we will continueto make decisions that take into consideration the complexity and risk in drugdevelopment and commercialization.
We believe that if we continue to invest wisely and appropriatelyin R&D, we expect to be able to develop first and/or best-in-classmolecules for significant unmet medical needs and to deliver long-term growthfor shareholders.
Now, let me turn the call over to Ian Clark.
Ian T. Clark
Thank you, Art and good afternoon, everybody. The increasingdiversification across our strong portfolio of oncology, immunology and tissuegrowth and repair products contributed to the continued growth and we arepleased with our U.S. product sales of $2.2 billion in the quarter, up 7% fromquarter four 2006 and up to $8.54 billion for the full year 2007. That was up19% compared to 2006.
Moving to the products and starting with oncology and firstof all Avastin; Avastin U.S. sales were $603 million in quarter four of last yearand $2.3 billion in the full year 2007, an increase of 32% over the full year2006. Year-over-year growth resulted from increased sales in metastaticnon-small cell lung cancer and metastatic breast cancer, an unapproved use of Avastinin the U.S.
Net sales also benefited from $5 million we recognized thisquarter from the Avastin patient assistance program. As previously noted, sincefewer-than-anticipated patients enrolled in the program, we got to release someof the [inaudible] for that revenue, increasing reported Avastin sales in thequarter.
In the first-line metastatic lung cancer setting, trackingdata indicates that overall penetration is at approximately 35% and among theapproximately 50% to 60% of patients in this setting who are eligible forAvastin therapy, we estimate that the drug penetration is thereforeapproximately 60%.
We continue to closely monitor dosings indication. Q4estimates of the percentage of patients receiving the higher 15 mg per kg Q3weekly dose of Avastin is at approximately 60% to 65%, which is in line withour estimate from Q3.
While use of the high dose in this indication appears tohave stabilized for now, physician adoption of the low dose will likely beinfluenced by the results from two clinical studies expected during the firsthalf of the year, the AVADO study testing low dose in breast cancer and thefollow-up survival data from the AVAiL study testing low dose in lung cancer.
With respect to colon cancer, performance in the first andsecond line settings in Q4 was stable relative to the same quarter in 2006. Asdiscussed in prior calls, we’ve seen increased competition in second line coloncancer which negatively impacted Avastin usage in the first half of 2007. So weare pleased to report in spite of this competition, Avastin use in this settingis rebounding to the levels seen in Q4 2006.
Our policies do not allow us to promote Avastin in breastcancer; however, our market research tracks Avastin use in metastatic breastcancer patients who have not previously received chemotherapy and among thosepatients, adoption in Q4 was at approximately 25%. The majority of this use is atthe 10 mg per kg Q2 weekly dose that was studied in the E2100 study.
Avastin use in this setting has been supported by favorablereimbursement, which is partly due to a compendia listing. If Avastin does notreceive regulatory approval, compendia listing may be at risk and that couldnegatively impact reimbursement for some patients. We anticipate increased useof Avastin breast cancer, of course, if we do receive the FDA approval.
Moving on to Herceptin, U.S. sales of Herceptin were $327million in Q407 and $1.29 billion for the full year 2007, a 4% increase overthe full year 2006. Our market research indicates that the overall penetrationin HER2-positive adjuvant breast cancer remains stable in the mid 70s in Q407relative to the prior quarter of that year.
Despite new competition, Herceptin’s penetration in thefirst line metastatic setting also remains stable at approximately 70%.Currently, the pattern of use appears to be limited primarily to later lines ofmetastatic disease.
Next is Tarceva; U.S. net sales of Tarceva are $112 millionin Q4 and $417 million in 2007, a 4% increase compared to 2006. Our tracking datasuggests that penetration and duration in both second line lung cancer andfront line pancreatic cancer remains stable in Q4. Tarceva product returns,which negatively impact reported sales in both Q2 and Q3, did not have animpact on sales in Q4.
Now on to Rituxan, total U.S. sales reached $596 million inthe quarter and $2.29 billion in 2007, a 10% increase over 2006. In hematology,sales growth resulted from an increased use of Rituxan following first linetherapy in indolent NHL and from increased adoption in front line CLL, anunapproved use. Rituxan’s overall adoption in other areas of NHL and CLL remainsteady.
Moving on to our immunology and continuing with Rituxan,this time for RA; 2007 sales of Rituxan in immunology estimates to have been between$240 million and $260 million in the full year. This represents an 80% to 90%growth over 2006.
Growth during the year was driven primarily by increasedpatient share in the anti-T and FIR segment, and increasing the total number ofprescribers, now estimated to be 80% of target hematologists, and a [inaudible]treatment in [inaudible] averaging between six and seven months.
2008 will be a really exciting year for us in this area. Weare expecting new data from many of our key clinical trials for Rituxan in alsoimmune disease, including PBMS, Lupus, and more data in the RA setting.
On the Xolair, U.S. sales of Xolair were $120 million in thequarter and $472 million in the year, an 11% increase over full year 2006.
And completing immunology, U.S. sales for Aptiva were $28million in the quarter, $107 million for the year, a 19% increase over 2006.
Finally, our tissue growth and repair products, andbeginning with Lucentis; at $197 million, Q407 sales were down 9% over the samequarter for 2006. For the full year, sales were $815 million. New patient shareis relatively stable at approximately 15% and in November, CMS released a newpermanent J code for Lucentis and we anticipate that some physicianreimbursement concerns will be addressed when this code comes into effect thismonth.
Finally, on to our other tissue and repair products, U.S.sales of Nutropin were $371 million for the year, a 2% decrease over the fullyear 2006, due to increased managed care contracts and heightened competitiveactivity. For our lytics products, U.S. sales were $268 million in the year, a10% increase over full year 2006, and finally for Pulmozyme, U.S. sales were$223 million this year, a 12% increase over the full year 2006.
In summary, despite facing come challenges during the year,growth was robust at over 19% and we are pleased with the increasingdiversification of our portfolio and excited about the growth prospects ahead.
Now I’ll turn the call over to Sue.
Thanks, Ian. I’ll start by providing my perspective on theAvastin sBLA filing for metastatic breast cancer. As Art mentioned, we weredisappointed in the spit vote from ODAC in December. We continue to believestrongly that the E2100 data set should support the approval of Avastin andthat the combination of Avastin and Paclitaxel has demonstrated a meaningfulnet clinical benefit by increasing timed progression by five-and-a-half months,as assessed by an independent review facility with an acceptable safety profile.
However, as you saw at ODAC, the FDA has concerns about thequality and integrity of the E2100 data despite the independent radiologyreview. We continue to have a dialog with the FDA regarding their concerns inadvance of the action date of February 23rd.
The potential outcomes of the Avastin metastatic breastcancer sBLA filing include an approval on the action date likely with specificpost-approval commitments, or a non-approval complete response which sends usback to the drawing board in terms of trying to get Avastin approved formetastatic breast cancer.
Any number of outcomes in between is also possible where wedo not receive approval on the action date but emerge with an agreed upon pathforward for what additional information we would need to produce for FDA inorder to obtain a future approval.
In these scenarios, potential delays before we obtainapproval could be short or quite long, depending on the additional informationrequired by the FDA, which might include further analysis from E2100, or datafrom additional Avastin trials such as AVADO, from which data is expected inthe first half of this year. Data is also expected from RIBBON 1, although thatdata will not be available until the second half of 2008.
As of now, we cannot predict the final outcome of the FDAdeliberations but we will continue to work towards the most rapid possibleapproval of Avastin for progressed cancer.
Moving on now to some other Avastin trials, enrolment in twoPhase III HER2-negative adjuvant breast cancer studies, E5103 and Roche’sBEATRICE, has begun. Both of these studies will investigate the equivalent offive milligrams per week dose of Avastin for 12 months, with disease-freesurvival as the primary endpoint.
The results of the Phase II Avastin study in relapsedGlioblastoma Multiforme demonstrated positive results in that 36% of patientstreated with Avastin alone and 51% of patients treated with Avastin incombination with Irinotecan lived without cancer progression for six months.
These are exciting results when compared to historical datain this setting, in which only an estimated 15% of patients with relapsed GBMlive without their cancer advancing within six months. We have a meetingscheduled with the FDA to discuss the feasibility of submitting Phase II dataand are planning a Phase III study in first line GBM.
During the second half of this year, we anticipate resultsfrom our first Phase III study investigating the combination of targetedtherapies, the BETA lung study in second line non-small cell lung cancer. Thisstudy includes two arms only -- one with Tarceva as mono-therapy and a secondincluding Tarceva plus Avastin.
In December, we informed investigators in our Sutent plusAvastin SABRE clinical trial program of toxicity concerns noted in a Sutentplus Avastin metastatic renal cell cancer investigator sponsored trial. In thisstudy, two of 12 patients receiving the higher dose of Sutent or 50 milligramsin combination with Avastin experienced reversible microangiopathic hemolyticanemia. The event was not observed in patients receiving Avastin with lowerdoses of Sutent.
One additional case of this anemia has been observed in theSABRE R study and Genentech has made the precautionary decision to close thestudy and remove patients from treatment. The SABRE B and SABRE L studies inbreast and lung cancer are continuing to enroll patients and careful safetymonitoring is ongoing.
Microangiopathic hemolytic anemia has not been observed inan NCI study using this combination in multiple tumor types. We will continueto work with our collaborator and the FDA to evaluate the safety andtolerability of this combination and plan next steps.
Now turning to our immunology program, starting withRituxan. In quarter four 2007, we received positive results from the Phase IIISUNRISE study investigating controlled retreatment of patients who areinadequate responders to TNF therapies. In this study, patients with activedisease 24 to 40 weeks following an initial course of Rituxan were randomizedto receive either a second course of Rituxan or placebo.
The primary endpoint was achieved with significantly morepatients achieving an APR 20 score after 48 weeks with Rituxan treatmentfollowed by Rituxan retreatment, as compared to Rituxan treatment followed byplacebo. A preliminary review of the safety data has revealed no new safetysignals.
We are in the process of obtaining and evaluating all of thesafety and efficacy data and look forward to presenting the data at an upcomingmeeting.
In Q1 this year, we anticipate results from the Phase IIISERENE study investigating the safety and efficacy of Rituxan in the earlierdisease setting, the Methotrexate inadequately responding RA patients.
We completed enrolment in the IMAGE study in Q4. The primaryendpoint is inhibition of structural damage measured by x-ray at 52 weeks inearly RA patients. Results from these studies are of particular interest to usbecause of the theoretical potentials of impacting the course of disease byinitiating B cell mediated therapy in early RA patients. There is also ascientific interest in the question of whether selective B cell depletion canhelp to reset the immune system.
In the first half of 2008, we anticipate results fromEXPLORER, the Phase III Rituxan and FLE study. The British Isles LupusAssessment Group scale, or BILAG, will be used to assess FLE disease activityin this study. We chose this scale because it has been shown to becomprehensive, reliable, sensitive to change, and effective in capturing thewaxing and waning nature of Lupus. Whether patients in this study have achievedand maintained a major or partial clinical response will be assessed at 52weeks.
Later this month, we will also complete enrolment in theRituxan Lupus Nephritis study called LUNAR. The primary endpoint for LUNAR isrenal response at 52 weeks and we expect results in early 2009.
In the first half of 2008, we also will have results fromOLYMPUS, the Rituxan in primary progress MS study. The primary endpoint forthis study is time to disease progression as measured by the expandeddisability status scale at 96 weeks.
Let me turn now to early development. We’ve made goodprogress in moving eight new molecules into early clinical development in 2007.We also removed five new molecules, including the topical VEGF molecule,telbermin, for which we made a no-go decision following negative Phase II datain diabetic foot ulcers. At this time, we do not plan to move forward with thismolecule in this indication.
Additionally, Genentech and Innotech have terminated ouragreement for the discovery, development, and manufacture and commercializationof the PARP inhibitor to the potential treatment of cancer.
While of course we would prefer all of our early programs tobe successful, if they are going to fail we want them to do so early indevelopment whenever possible and before the investment has grown large. Wework hard to design early trials to provide us with clear answers and ourprograms are held up to a high standard for continued development.
Now I’ll review the planned Phase III milestones and data inthe first half of 2008. We expect first patient in in Phase III studies for:second generation anti-CD20 for Lupus Nephritis; Herceptin plus Pertuzamab forHER2-positive metastatic breast cancer study; Avastin CALGB hormone study forfirst line metastatic breast cancer; Herceptin plus Avastin combination study,ECOG 1105, in first line metastatic breast cancer; Herceptin plus Avastin BETHcombination study for adjuvant HER2-positive breast cancer; Avastin SWOG 502study for gastrointestinal stromal tumors; Avastin SWOG 518 study for high riskcarcinoids.
We also expect to complete enrolment in LUNAR, the LupusNephritis Rituxan study this month; SATURN, the Tarceva first line metastaticnon-small cell lung cancer maintenance study; and ATLAS, the Avastin andchemotherapy plus/minus Tarceva in second line non-small cell lung cancerstudy.
And we expect data results in Phase III Rituxan, inmethotrexate IR rheumatoid arthritis, the SERENE study; the PPMS study withRituxan called OLYMPUS; the Rituxan SLE study, EXPLORER; Roche’s Avastin PhaseIII AVADO study in metastatic breast cancer; Novartis’ Phase III Xolairpediatric asthma study; Roche’s Phase II chemotherapy plus/minus Pertuzamab inplatinum sensitive ovarian cancer; the Phase I data from the hedgehogantagonist study in solid tumors; and the SAILOR data to be presented at Angiogenesisin February of 2008.
Now I will turn the call over to David.
David A. Ebersman
Thank you, Sue and good afternoon, everyone. Let me startwith a legal update; the California Supreme Court is now scheduled to hear ourappeal in the City of Hope matter on February 5th and we expect a ruling within90 days of that hearing date. The compensatory and punitive damages originallyawarded to City of Hope in 2002 as well as the accumulated interest are fullyaccrued on our balance sheet as a short-term liability of $776 million.
Turning then to the financials, as Kathee mentioned earlier,unless otherwise noted the financial figures in my comments are non-GAAPnumbers which exclude the effects of recurring charges related to the 1999Roche redemption, litigation related and similar special items, employee stockcompensation expense, and accounting for our acquisition of Tanox.
I will start then with the revenue components of the incomestatement. Sales to collaborators were $150 million this quarter and $903million for 2007, representing a 21% decrease from Q406 and a 92% increase forthe year.
For 2008, we are currently planning that sales tocollaborators will increase by approximately 15%, but please remember thatthese sales vary from quarter to quarter based on the production and order planand other contractual requirements.
Further, please keep in mind that the favorable Herceptinpricing terms from Roche will conclude at the end of 2008, which will lead to asignificant reduction in sales to collaborators in subsequent years.
Royalty revenues were $554 million in Q4 and $1.98 billionfor 2007, increases of 42% and 46% over Q4 and full year 2006, substantiallydriven by higher royalties from Roche, which represented 64% of Q4 and 61% offull year 2007 royalties.
We also benefited from Novartis’ sales of Lucentis in 2007and from growth in Cabilly related royalties, which totaled $256 million in2007 and made a net contribution of $0.08 to EPS.
For 2008, we are planning for royalties to grow byapproximately 10% to 15% over 2007. Our royalty forecast for 2008 relies primarilyon collaborators and analyst sales forecasts and assumes no material change inthe intellectual property situation for our patents, including Cabilly.
Contract revenues were $63 million this quarter and $297million for the full year 2007. In 2008, we are planning for contract revenuesto increase by approximately 10%. However, contract revenue is difficult toforecast because it can vary based on many factors, including opt-in andmilestone payments received and the mix of spending by us and ourcollaborators.
Turning now to the expense line items, cost of sales was 14%of product sales this quarter, a decrease from 15% in Q4 2006 primarily due tolower production costs and a favorable product mix.
For 2008, we expect cost of sales to be approximately 16% ofsales, consistent with 2007. As always, cost of sales may be higher than weexpect if we have unplanned manufacturing or inventory issues.
R&D expenses were $579 million this quarter and $2.3billion for the year 2007. R&D was 20% of revenues this quarter and for thefull year 2007.
For 2008, we are planning for R&D expense to remain atapproximately 20% of revenues as we continue to invest in our late stagepipeline and add new molecules and indications to the early pipeline.
MG&A expenses were $650 million this quarter and $2.1billion for 2007. Q4 2007 MG&A expenses as a percentage of revenues was22%, an increase from 20% in Q4 2006 due to increased headcount relatedexpenses, timing of marketing programs, and increased charitable contributions,primarily funding for co-pay assistance programs.
Full year MG&A expenses as a percentage of revenue was18% in 2007, a decrease from 20% for the full year 2006 and in 2008, we expectMG&A as a percent of revenues to be approximately 16% as we continue tomanage our infrastructure costs.
Collaborator profit sharing expenses were $275 million forthe fourth quarter and $1.1 billion for 2007, driven by sales of Rituxan,Tarceva, and Xolair. Our pretax operating margin as a percentage of totalrevenues was 38% this quarter, same as in Q4 of last year, and for the fullyear 2007, operating margin was fractionally less than 41%, an increase from39% in 2006. In 2008, we expect our operating margin to improve slightly over2007 to the 41% to 42% range.
Other income net was $18 million this quarter and $197million for 2007. The decrease in other income from $59 million in the fourthquarter of 2006 was due to write-offs of $46 million this past quarter relatedto a fixed income investment and certain biotech equity investments.
In 2008, we are planning for other income to increaseapproximately 25% compared to 2007. Of course, actual results for other incomewill depend on interest rates and potentially on changes in our biotech stockportfolio.
On taxes, our non-GAAP tax rate was 36% this quarter and 37%for the year, representing decreases from 40% in Q406 and 38% in 2006 fullyear.
For 2008, we expect our non-GAAP tax rate to be 36% to 37%,barring any changes in tax regulations or any material adverse results from taxexaminations.
Non-GAAP net income this quarter was $737 million, or $0.69per share, a 12% increase in net income and a 13% increase in EPS over Q4 lastyear and for 2007, non-GAAP net income was $3.1 billion, or $2.94 per share, a31% increase in net income and a 32% increase in EPS over 2006.
Now turning to some cash metrics, cash from operations in2007 was $3.5 billion. Cash used for capital expenditures was $1 billion, soour free cash flow for 2007 was approximately $2.5 billion. In 2008, we expectcapital expenditures to be flat at approximately $1 billion.
In 2007, we spent about $1 billion for gross sharerepurchases, offset by cash in-flows to the company from stock option exercisesof about $452 million and the tax benefits related to those option exercises ofabout $177 million, for a net impact on our cash position of negative $415million from share repurchases.
Our unrestricted cash and investments portfolio totaledapproximately $6.1 billion at December 31, 2007, compared to $4.4 billion as ofDecember 31, 2006.
Overall, we are pleased with our 2007 results. This year’sperformance marks our tenth consecutive year of double-digit growth for bothrevenue and non-GAAP EPS.
Looking forward to 2008, this is a difficult year for us toprovide you with earnings expectations because there is some significantnear-term business uncertainties; in particular, the FDA review of Avastin forbreast cancer, which has an action date in six weeks.
What we can say is that internally, we are currentlyplanning for a range of $3.30 to $3.45 for 2008 non-GAAP earnings per share. Wewill likely need a timely approval of Avastin in metastatic breast cancer toget to the high end of this EPS range and of course, certain combinations ofevents in the business could cause us to trend to an earnings forecast outsideof this range, so we’ll update you on subsequent quarterly earnings calls asnew information comes in.
Even more important, please also note that while we believein setting short-term financial goals as a means of promoting focus anddiscipline in the business, we are always prepared to adjust our plan if wefind valuable opportunities to increase spend in 2008 in a manner that webelieve will create long-term value for our shareholders.
We look forward to assessing these kinds of trade-offs andwe remain optimistic that the investments we are making will enable us tocontinue to grow the business over the long-term in a manner that helpspatients, creates value for shareholders, and makes Genentech an exciting placeto work.
2008 promises to be a busy year for us in terms of news flowand we are looking forward to what might be in store.
Now I will turn the call back over to Kathee.
Thank you, David. Operator, we are going to start thequestion-and-answer session. However, I would like to ask that as per ourusual, that we limit it to one question per person so we can take as manyquestions as possible. Operator.
(Operator Instructions) And your first question comes fromGeoff Meacham of J.P. Morgan.
Geoff Meacham - J.P.Morgan
Just a question for David on guidance; I just wonder if youcan tell us, to the extent that you can, what’s implied in terms of growth ofAvastin in breast this year of any line? And then obviously if you haveanything in the model or in your forecast for an up-tick in adjuvant colon.
David A. Ebersman
Well, as you can imagine for these kinds of binary events,you sort of have to plan it both ways and take a look at what the outcome ofthe numbers looks like, particularly for the Avastin breast where we know wewill get some answer in a few weeks time.
So the range we have provided attempts to really accommodatethe range of outcomes that we see as likely for the Avastin breast filing, soas I said, I think if we get the approval in a timely fashion, it opens up theupper end of the range I provided and if we don’t, I think we’ll have a hardtime being in the upper end of that range. The range we provided doesaccommodate the possibility that we won’t get an approval for Avastin in breastcancer this year.
In terms of the adjuvant, we really haven’t factored that inso obviously we’re hopeful that that trial comes in positive and comes in assoon as possible, but as you can imagine, it’s much easier to run the businesswith an upside surprise than a downside surprise, so we’ve chosen not to bakethat into our financial planning.
Your next question comes from Mark Schoenebaum of BearStearns.
Mark Schoenebaum -Bear Stearns
I have a question please for Ian and perhaps for Sue, andthat is can Avastin without an approval in breast cancer, can it grow in 2008?And can you help convince us of the case for growth without an approval?Because if you take out the deferred revenue this quarter, it looks like enduser demand is roughly flat quarter over quarter. So I’m just trying to get apicture internally, you guys, is there an opportunity for Avastin growth,double-digit growth in 2008 without a breast cancer approval?
Ian T. Clark
Let me take it first, and by the way on the deferredrevenue, just bear in mind that we also added the 5 in quarter three, so youkind of -- if you want to do that, you need to take it out of both quarters.
Mark Schoenebaum -Bear Stearns
Okay. That’s fair.
Ian T. Clark
I’d think about it this way when you think about the revenue-- I find it interesting; in quarter three, we had a good increase in revenueand yet I couldn’t report an increase in penetration in lung cancer and youguys asked me a lot of questions about it. This time around, I’ve got almostthe reverse; I’ve got a good increase in lung cancer penetration but not quiteso much increase in revenue. And if you had to ask me which I’d take, it’salways the underlying demand increase is the thing I really want to see.
Penetration in lung cancer is good but still only 60% ofeligible, so to my mind there’s growth left there. As you say, breast cancer isunknown. It was good to see that the colorectal cancer sales were solid and atthe same level as the prior year, because if they weren’t that could kind ofweaken the growth.
And then we do have the possibility of growth that mightoccur as a consequence of any renal cell or Glioblastoma indication as well. SoI think there is definitely room for growth; clearly not as much room as wemight get should we get the approval for breast cancer. Sue.
I would just echo what Ian said about Glioblastoma, which wethink is really important new data that was just presented near the end of lastyear and we continue to believe in Avastin for renal cell.
Going back to metastatic breast cancer, I talked about therange of possibilities in terms of how the FDA thinks about E2100 and theapprovability. I would just say two other points in terms of Avastin formetastatic breast cancer; first of all, we continue to believe in Avastin formetastatic breast cancer based on the really strong, literally unprecedented increasein PFS that we saw in E2100 but it isn’t just Genentech.
As you heard me articulate, the field believes that Avastinis adding value for breast cancer or the oncology thought leaders wouldn’t putAvastin in the adjuvant setting for breast cancer, and I just think that’s areally important aspect of thinking about Avastin.
The belief based on this data that we have so far is one,Avastin added substantial value in progression free survival. While not apre-specified endpoint, we also statistically significantly increased survivalat the six month and 12-month periods of time in the trial and while we didincrease toxicity, much of the increase in grade three to five toxicity wasasymptomatic hypertension that was treatable with medication.
I do think the AVADO study, which will be available in thefirst half of this year regardless of FDA action, will have an impact on thebelief that the field has about the use of Avastin in the first line metastaticbreast cancer setting. So I think answering your question as it relatesspecifically to breast cancer will now rely in part on not only the February23rd action date but the AVADO data.
Your next question comes from Joel Sendek of Lazard.
Joel Sendek - LazardCapital Markets
I had a question on Rituxan and Lupus. In particular, withthe EXPLORER study, is this enough if the data is good for you to file forapproval or will you want to wait for the LUNAR study? Can you just talk alittle bit about that? Thanks.
I would have to say that this is one of those where it willvery much depend on the data. As you know, systemic Lupus is a very large unmetmedical need but I expect that both the thought leaders, as well as Genentechand our collaborators and FDA will look at both the magnitude of the differencein EXPLORER in SLE but also the safety. So I think for us to depend on thatstudy will absolutely depend on the benefit risk and there could be a spectrumof outcomes, one where there’s benefit but more risk and we would probably needthe second trials, and another where there’s extreme benefit and the riskbenefit looks good, at which point we would definitely go into FDA with asingle study.
It will depend on how big the difference is and the netclinical benefit.
Your next question comes from Katherine Kim of Banc ofAmerica Securities.
Katherine Kim - Bancof America Securities
My question is do you have any assumptions for impact onAvastin due to competition in frontline lung cancer, such as Herbitux orNexavar? And then the second question I have is, is there any precedent fordrugs that have had compendia listing removed prior to approval? Thank you.
Ian T. Clark
In terms of when we look at our sales forecast, we look atall possible competition and we build them into the models that we have aroundour sales. That said, and Sue may want to add to this, it’s interesting thatthat study still yet hasn’t been reported in terms of the results. I think whatwe hear from our customers is that if there is going to be use, it might wellbe predominantly in patients who are currently not on Avastin and therefore,should there be an impact, then maybe it won’t be too significant. Do you wantto add to that, Sue? And then I’ll come back to your reimbursement question.
I think it is extremely difficult to comment on thenon-small cell lung cancer study with Herbitux in the absence of data. Thereport suggests that it’s statistically significant but I think we have to waitfor ASCO and I’ll look for safety and efficacy in that trial to benchmark it.
Thought leaders are concerned that they haven’t seen thedata and are talking about the question of whether or not it could helppatients who aren’t eligible for Avastin, but it’s too soon to comment. We needto see the data.
Ian T. Clark
So let me come back to the reimbursement and precedent --it’s a complex situation. We’ve looked back at situations in the past whereinmaybe people have had a compendia listing and have been removed. In theinstances we can find, at least recently, it’s usually as a consequence of asubsequent piece of data, which was negative. And I can give you a couple ofexamples -- there was a change to the reimbursement of VSAs and we ourselves,when we got our not positive Avastin pancreatic data had a compendia which wastaken away.
That’s clearly not our situation. That said, if the FDAdoesn’t approve the drug, you could interpret that as a negative view of thequality of the data. But then again, you could go on and say we’ve got areasonable chance of two other sets of data in the same setting and if thosestudies are positive, which we hope they would be, you are not seeing negativedata. You are seeing more positive data.
If it could possibly get more complicated, it does becausewe are in the midst of a shift of U.S. PDI being the principal source ofinformation for compendia listing, which has gone away as of the end of lastyear. It’s being replaced by Drug Points, which it’s not so clear it’s going tohave the same authority. And then you have the AHFS list and the NCCNguidelines.
And for what it’s worth, all of those at the momentcurrently do list Avastin for breast cancer. So I think the bottom line isthere is some risk here but I think what precedent we could find would suggestthat the risk should not be too high.
Your next question comes from Michael Aberman of CreditSuisse.
Michael Aberman -Credit Suisse
Talking about -- going back to breast cancer again and theAVADO trial, my recollection -- and correct me if I’m wrong -- but AVADO doesnot have an independent review, and if the FDA’s concern is about data quality,do you think an additional progression free survival endpoint withoutindependent review would be sufficient? Or do you think RIBBON might be a moreimportant data point, if I have that correct?
And also, can you comment commercially what the impact mightbe in AVADO if you see similar outcomes from the high and low dose, both in thebreast cancer setting where you see already the majority of the patients in theU.S. are on the higher dose, as well as whether there’d be spillover into lungcancer and how that plays into your forecasts?
The Roche trial, AVADO, is a placebo control trial. It is acompany sponsored placebo control trial, so many of the concerns that wereexpressed at the advisory committee in terms of corporate sponsorship andmonitoring, et cetera, that the criticisms of the Quattro Group trial will notbe potential criticisms of AVADO. AVADO does not have an independent review oran IRF as the regulatory requirements in Europe are different than in the U.S.And you are right that RIBBON 1 does have an independent review.
I’ll give you my personal point of view, and as I mentioned,we are still discussing all of these details with the FDA, but I think a secondprogression free survival Phase III in light of the strong and retrospectivelyIRF reviews, E2100 data, I think that would be compelling and I certainly thinkagain in the field with a 5.5 median, a positive one year survival in E2100,and you add on AVADO on top of that, I think that’s very compelling data thatwould suggest Avastin is safe and effective on top of the E2100 that’s alreadyvery strong. But I can’t read the tea leaves. The data is going to speak foritself.
Ian, did you want to comment on the dose?
Ian T. Clark
Yes, so if AVADO was to have a similar sort of result to AVAiLin terms of as a consequence of that, people thinking maybe they could adoptthe lower dose, where would we go -- well, a couple of things.
It’s sort of interesting, as I just said in my preparedremarks, with lung cancer we’ve seen a drop but not a lot of a drop. We’ve seenit stabilize and one could speculate you might see the same sort of thing withbreast cancer. That said, if you compare the two studies, the lung cancer studywas with a chemo backbone typically not used in the U.S., whereas in the breastcancer study, it is with chemo that U.S. oncologists do use, so there might bea willingness to interpret more completely as a consequence of that.
Plus the fact you’ll have two studies rather than one study,which possibly support the lower dose, so I think it would be a reasonableconclusion that if AVADO looks like AVAiL, you will see a greater adoption ofthe lower dose in the breast cancer setting than we’ve seen so far.
Michael Aberman -Credit Suisse
Shouldn’t you consider changing your adjuvant trials ifthat’s the case to lower the risk of toxicity, if efficacy appears to be betterwith a low -- or equivalent with a low dose?
The adjuvant therapy trials were, as was the case with thePhase III, completely data driven and so the data in the adjuvant therapytrials followed our Phase II and Phase III trials in the U.S., and when we didget AVAiL, specifically in the lung cancer setting, we went back to the thoughtleaders who continued to feel that in non-small cell lung cancer, we should usethe higher dose based on all the data that had been seen with Taxol-Carbo inthe U.S.
So we have looped back with investigators on the lungcancer. It’s hard to speculate about breast cancer before we see the AVADOdata.
Your next question comes from Jim Birchenough of Lehman.
Jim Birchenough -Lehman Brothers
A question for Sue on Rituxan; Sue, just wondering if youcould comment on whether there’s any studies to evaluate a Rituxan half dose?In particular in SUNRISE, just wondering if there’s a half-gram dose that’sbeing evaluated and if so, what the implications would be commercially if alower dose was proven to be as effective as the higher dose.
In the Rituxan trials and specifically in SUNRISE, we’reusing 1,000 milligrams of Rituxan day one and day 15. It’s important to notewith Rituxan, we do have some constraints in how low we can go. That’s one ofthe reasons for our enthusiasm about a humanized antibody as compared to thechimera, so we’ve been cautious about lowering the doses of Rituxan, concernedthat in the absence of full B cell depletion we could run into [HAKA] issues.So specifically in SUNRISE, it’s a 1,000 milligram dose.
Jim Birchenough -Lehman Brothers
Are there any other studies looking at a lower dose?
There is. The SERENE trial does have a 500 milligram dose,so in SERENE in the methotrexate inadequate responder patient population, wewill have one study that does look at the lower dose.
Jim Birchenough -Lehman Brothers
And just to follow that through, if it turns out as we’veseen with Avastin, that you’ve got a comparable effect in a lower dose, how doyou think about that commercially in terms of maybe lower toxicity concern,broader use but lower reimbursement?
Ian T. Clark
I think that inevitably, if it turns out the lower dose is asgood and you get a wider adoption, there would be some impact on the sales. Ithink where the dynamic is somewhat different from Avastin is that you do gofrom a potential annual cost here which is not dissimilar to competitors to acost that might be considerably less than the competitors. And you rightlypoint out there might be a benefit from the side effects, so I’m not suggestingthey entirely balance but there might be some upside to a lower dose as well assome downside.
Operator, would you remind everyone, one question perperson, please?
(Operator Instructions) Your next question comes from JasonZhang of BMO Capital Markets.
Jason Zhang - BMOCapital Markets
My question is for Sue; you mentioned that AVAiL trialsurvival data would be available sometime this year. Have you considered therisk of that trial not showing a statistical difference of survival, given thatthe progression free survival we have seen last year was much shorter than yourtrial with Carbo-Taxol backbone in the U.S.?
Well, let me start by saying that the AVAiL study was -- theprimary endpoint in the AVAiL study was progression free survival. It was not atrial that was designed to look at a survival question. So I would start there.
It is hard to predict what the outcome of AVAiL will be onsurvival. We know from our colleagues at Roche that they expect to updatesurvival in the first half of this year but yes, you’re right that themagnitude of the difference in the primary endpoint was less than what we hadseen in the U.S. and we talked a lot and I would say speculated about why thatmay have been the case.
I do think, just to re-emphasize a point that Ian made, it isvery hard to compare AVAiL to 4599. 4599 was a well-powered, primary endpointsurvival Taxol-Carbo study. AVAiL is a Gem-Cis study with a somewhat differentstudy conduct that was carried out in Europe. In fact, we were concerned thatthe duration of chemo plus Avastin could have been short in the AVAiL study andbecause of that, the investigators in AVADO were encouraged to continue withconcurrent chemotherapy and Avastin as per protocol, with a Taxotere backgroundin chemotherapy.
So while it’s pure speculation why the differences may havebeen there, I would agree with you that the magnitude of the difference was notas impressive in the U.S. trial that was the basis for our approval.
Your next question comes from Mike King of Rodman & Renshaw.
Mike King - Rodman& Renshaw
I was wondering, can you comment about when the last interimlook was taken on NSAVP, Sue?
It was in quarter four of 2007 and we expect interims inquarter two and quarter four this year. It’s every six months as per theprotocol.
Mike King - Rodman& Renshaw
Okay, but you won’t say what month?
Mike King - Rodman& Renshaw
Okay. Thank you.
Your next question comes from Ian Somaiya of Thomas WeiselPartners.
Ian Somaiya - ThomasWeisel Partners
Thanks. Just a quick question on Rituxan and MS; can youjust review for us the statistical powering of the OLYMPUS study and what typeof treatment benefit you need to see in that trial for that trial to besuccessful?
Why don’t we take another question and I will look up thestatistical power for you while we are taking the other question, okay?
Your next question comes from Steve Harr of Morgan Stanley.
Steven Harr - MorganStanley
This is a question probably for David and Ian. I’m justtrying to understand what the potential impact is of Avastin in breast cancerif or when it’s approved, and that would be -- the specific question is whether-- actually, what is your median duration of therapy right now? And withapproval as patients go and this patient cap, what kind of an early hit do youexpect to see and how much penetration growth do you need to even see flatrevenue, let alone an accelerated revenue in that indication?
Ian T. Clark
Let me try and be clear on what you are saying -- in termsof -- we have an existing set of revenue based on adoption without the labeland absent of a major challenge of compendia, I’d expect us to retain themajority of that revenue and to Sue’s point, should we -- even if we fail interms of the label, at least in the short-term we might get some sort ofbenefit of a positive AVADO and/or RIBBON.
So in terms of -- I don’t see any likelihood it’s going togo down much.
Steven Harr - MorganStanley
I’m thinking more with approval as you move into patientcap.
Ian T. Clark
I wouldn’t comment on duration at the moment because it’searly days. What I would say is that I mentioned in my prepared remarks thatthe penetration is only about 25%. We think the eligible population is maybe ashigh as 90%, so there’s a huge amount of upside attached to that.
And obviously we’re only going to hit the cap if we getpatients on the higher dose for a substantial period of time, in which case Ithink we’d be in positive territory regardless. David, do you want to add?
David A. Ebersman
I just want to make sure people understand the dynamics ofSteve’s question, which is a good one. The patient assistance program, whichprovides a cap of the Avastin price at $55,000 over a 12-month period foreligible patients only applies to approved indications, so the logic behind thequestion is that a disease where the high dose is used for long durations in anunapproved fashion, you actually -- the cap doesn’t come into play and it wouldupon its approval. So that is a dynamic that would play out in the marketplace.
As Ian said, in the long run we obviously view it as a netsignificant positive to have the label and be able to promote. There wouldlikely be some ups and downs in the short-term.
The only reason I’m not that concerned about the impact isthat our experience with the program to date is that enrolment is slow.
Before we take the next question, let me come back to thequestion about the primary progressive MS. So as is typical, we don’t share thepower of our trial but it is a trial that is a Phase II/III, planned for 435subjects. And as I mentioned in my prepared remarks, the primary outcomemeasure is time to confirmed disease progression and we use the expandeddisability status scale. So if the primary endpoint is a times progressionendpoint based on the patient’s baseline expanded disability status scale, andI can assure you that the trial is well powered, the key risk to the trialisn’t the powering -- it’s that no therapy has shown benefit in primaryprogressive MS and so that is a risk factor that we pointed out in the past.But it is a well-powered, 435 patient trial.
And your next question comes from Eric Schmidt of Cowen& Company.
Eric Schmidt - Cowen& Company
A question for David on the royalty line; I noted that theguidance for ’08 has decreased from your previous guidance of 20% to 25%year-over-year growth. Were there any changes to the analyst expectations thatyou used to guide that line? Or what was the reason for the change?
David A. Ebersman
A couple of things, and the comparison that Eric is makingis to the guidance we gave in March of this year when we had the analystmeeting and we projected forward to 2008. The first is that subsequent to thatMarch meeting, we did a deal which involved us licensing in some assets and inexchange essentially forgiving a royalty obligation over the next couple ofyears which, from an accounting standpoint, we then booked in the middle of theyear as a large acceleration of royalty revenue. So that bumped up the 2007number by taking royalties that we had been expecting out of 2008 and 2009, soit hurts you on the comparison on both sides. It increases 2007 without anoffset in 2008.
And no, not so much on the analyst expectations. Anotherthing that is part of that trend is that the Lucentis sales that we had beenforecasting before outside the United States ramped up more quickly in 2007 inEurope, as we saw in the U.S. as well but we didn’t know what to predictoutside the U.S. So again, just sort of an acceleration of where we expected toget to more in 2007 than 2008.
Nothing else really materially impacts the change coming down.
Eric Schmidt - Cowen& Company
You also gave 2009 guidance at the time back in March. Couldthat have changed too?
David A. Ebersman
We’ll update that in March of this year when we come to NewYork, and I won’t do it now because I don’t know the answer.
Your next question comes from May-Kin Ho of Goldman Sachs.
May-Kin Ho - GoldmanSachs
This is a question for Ian; looking at the usage of Rituxanin rheumatoid arthritis, and thinking about how many patients actually refractory,is it lower than you expected? And if so, why do you think that is? And if thedata were positive in early RA, how do you think that might change it?
Ian T. Clark
We’re very pleased with the progression of Rituxan, theTNFIR population so far. It’s pretty much meeting our expectations and ourmarket share is still relatively low in that patient population, so I thinkthere’s a lot of room for growth.
Clearly like any disease area, if we can get data in anearlier and larger disease population, then we would expect an acceleration ofsales in that place, so so far, so good and if the data is good, a greaterchance of growth in the RA setting.
Operator, this will be our last question.
Your final question comes from Geoffrey Porges of Bernstein.
Geoffrey Porges -Bernstein
This is for Sue, related to clinical trials, particularlyfor metastatic breast cancer, you’ve got AVADO and RIBBON coming in andpotentially others there as well. Could you give us a sense if the FDA stuck totheir guns and said we need to see at least no negative effects on overallsurvival, and ideally an improvement in overall survival as well as animprovement in progression free survival, when would those two trials or anyother trials show an improvement in overall survival, or at least no negativeeffect on overall survival for Avastin in metastatic breast cancer? Thanks.
Let me say two things; first of all, just to recall thenon-voting discussion at the advisory committee, my takeaway from thatdiscussion was that the advisory committee input to FDA was that progressionfree survival should be an approvable endpoint in first line metastatic breastcancer. And so that is my takeaway and was my takeaway from the advisory committee.
Neither the AVADO nor the RIBBON 1 trial are powered assurvival trials, so I think that that’s an important thing to note about bothof those trials. They are both company sponsored, well conducted, rigoroustrials with all the monitoring that one would expect on both safety andefficacy but they are not powered for overall survival.
But there would be a read on the trend in survival at thesame time that PFS is reported, so I would expect a preliminary assessment ofsurvival, again under-powered and early, but one could rule out a negativeimpact on survival in the first half of the year for AVADO and at the end ofthe year for RIBBON 1, but with all the caveats that go along with that,under-powered and it would be very early to look at survival. But if onehypothesized that there’s a negative impact, one could see a negative impactearly.
So I would say that those trials will be unblinded in thefirst half and second half, as I said earlier.
Thank you all very much for your questions today and SueMorris and I will be back at our offices to take calls.
Ladies and gentlemen, this does conclude today’steleconference. You may now all disconnect.
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