Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Kathee Littrell - Senior Director, Investor Relations

Arthur D. Levinson Ph.D. - Chairman of the Board, Chief Executive Officer

Ian T. Clark - Executive Vice President, Commercial Operations

Susan D. Desmond-Hellmann - President, Product Development

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

Analysts

Chris Raymond - Robert W. Baird

Joel Sendek - Lazard Capital Markets

Geoffrey Porges - Sanford C. Bernstein

Geoffrey Meacham - J.P. Morgan

Yuron Fervor - Citigroup

Steven Harr - Morgan Stanley

Jim Birchenough - Barclays Capital

Eric Schmidt - Cowen & Company

Jason Kantor - RBC Capital Markets

May-Kin Ho - Goldman Sachs

Mark Schoenebaum - Deutsche Bank

Bret Holley - Oppenheimer & Company

Maged Shenouda - UBS

Katherine Kim - Banc of America Securities

William Tanner - Leerink Swann

Genentech, Inc. (DNA) Q3 2008 Earnings Call October 14, 2008 4:45 PM ET

Operator

Good afternoon, ladies and gentlemen. My name is Gerald and I will be your conference operator. At this time, I would like to welcome everyone to the Genentech third quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Ms. Kathee Littrell, Vice President of Investor Relations. Ms. Littrell, you may begin.

Kathee Littrell

Thank you. Good afternoon, everyone and thank you for joining our Q308 earnings call. We have posted an earnings call slide set to our website at www.gene.com. This call is being electronically recorded and is copyrighted by Genentech. No reproductions, retransmissions, or copies of this conference call can be made without the written permission of Genentech.

We’ll be making forward-looking statements and actual results may vary materially from the statements made. Please see the risk factors section of our Form 10-Q for the period ending June 30, 2008 that’s on file with the Securities and Exchange Commission for a discussion of the risk factors that could cause material variations from the forward-looking statements made during this conference call.

We’ll be discussing financial information that includes non-GAAP financial measures in our call today. Unless otherwise noted, the financial figures in David Ebersman’s comments are non-GAAP numbers which exclude the effects of recurring charges related to the 1999 Roche redemption, litigation related and similar special items, employee stock compensation expense, accounting for our acquisition of Tanox, and certain costs related to the 2008 Roche acquisition proposal.

Please refer to our website at www.gene.com under the investor tab; click on financials for the most directly comparable GAAP financial measures with a reconciliation to the non-GAAP financial measures that will be discussed today.

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

Arthur D. Levinson Ph.D.

Thank you, Kathee and good afternoon, everyone. During the course of this quarter, we have continued to make good progress throughout the business. Non-GAAP total operating revenues for the first three quarters of 2008 were $9.7 billion, up 11% from the same time period in 2007 and non-GAAP earnings per share for the first three quarters of 2008 were $2.47, up 10% from the same time period of 2007.

In development, we have submitted two sBLAs to the FDA and we made significant advances in our pipeline, including a Phase II go decision for MetMAb in non-small cell lung cancer and a Phase III go decision for GDMI and HER2 positive metastatic breast cancer.

We initiated 11 clinical trials, eight investigating new molecular entities and added two new molecules to our pipeline, one in immunology and a second from a collaboration with Roche, GA101.

Additionally, we recently learned that for 2008 Genentech was ranked by Science Magazine as the number one life science employer. We have ranked in the top position for six of the seven years that Science has issued the survey. We consider this ranking to be an important recognition as we place significant value on attracting and employing scientists at the top of their field. We remain energized by the continued scientific advances that are helping us to better understand the basic biology in key diseases of interest. For example, in September, several notable studies by Academic Research Group published in Science And Nature reported the results of detailed genetic analyses of glioblastoma tumors in pancreatic cancer. While the work identified hundreds of gene mutations associated with these cancers, as well as a high degree of heterogeneity between each patient, the wide array of genetic alterations appear to function to a relatively limited number of pathways and processes. These findings support our strategy of oncology drug development as we develop therapeutics that target these critical pathways, such as anti-angiogenesis, apoptosis, hedgehog signaling, and [rash] signaling. Genentech's growing pipeline with agents that target these key pathways positions us at the forefront of the scientific effort.

Accordingly, we continue to design and conduct clinical trials built on the hypothesis that combining therapies that target multiple pathways will result in either additive or synergistic outcomes for patients with cancer. For combination therapies to meet the threshold required to change clinical practice, they must meet a high bar of efficacy and safety measured against clinically important endpoints, such as survival. Sue will speak to the recent results from our Phase III beta lung trail, in which Avastin did not provide incremental overall survival benefit with Tarceva in the second line non-small cell lung cancer setting. Although disappointed by these results, they do not dampen our interest in the potential of combinations of targeted therapy. Although it may be variability in effect based on disease stage, tumor type, and mechanism of action, we continue to see the combination of targeted therapies as an important area of exploration with the potential to advance treatment regimens in oncology.

Our objective is to explore molecular pathway combinations across a broad number of tumor types. We not only have studies evaluating the combination of our marketed products, such as Avastin, Rituxan, Tarceva, and Herceptin, but we are also preparing to initiate trials that combine experimental products such as TDM1 and Pertuzamab. Studies combining experimental targeted molecules are complex and we are working with the FDA to identify the best regulatory path forward in these circumstances.

Outside of oncology, we are seeing analogous scientific progress in other areas, such as neuro-science, and we look forward to translating the science into new development programs in the years ahead.

Regarding the Roche proposal, on August 13th a special committee of independent directors concluded, after careful consideration, that Roche’s unsolicited proposal to acquire the outstanding public shares of Genentech for $89 a share substantially undervalues the company. The special committee announced that it would consider a proposal that recognizes the value of Genentech and reflects the significant benefits that would accrue to Roche as a result of full ownership. We will not be discussing anything further on the call today related to the Roche proposal.

Genentech employees, including senior management, remain focused on running the business and developing molecules that we believe will make an important difference for patients. In the 12 weeks since the Roche proposal, we have seen no increase in employee turnover compared to the same period of time preceding the proposal. Our employees remain committed to the company and to building a successful future together. The retention program approved by the special committee and implemented in lieu of the 2008 stock option program helps positions us to manage through this period of uncertainty. We continue to actively recruit candidates for our open positions and recently announced that Dr. Morgan Chang has been hired as our new VP of neuro-science research. Morgan comes to us from MIT where he was a Howard Hughes Medical Institute investigator and a Fellow of the Royal Society. Morgan will be leading an important new area for the company as we have initiated major projects in neuro-degenerative diseases and we are beginning to consider expansion into new areas, such as pain and psychiatric disorders.

I want to close by noting that in the face of difficult conditions in the capital markets, we believe that our strong financial position will continue to serve us well as we implement our business plan and build long-term value in the company. With approximately $8.6 billion in cash and investments, a limited amount of debt, and robust ongoing free cash flow, we are well-positioned not only to fund our business operations while managing risk and downside possibilities, but also to consider potential acquisitions of products or companies that hold promise of a good return on investment. We are committed to maintaining our focus on managing the business at hand to create value over the long run and to bring forward new medicines that help patients.

Let me now turn the call over to Ian.

Ian T. Clark

Thank you, Art and good afternoon to everybody. U.S. sales in Q3 of this year were $2.45 billion, up a solid 14% from Q3 of last year.

Moving to the products and starting with oncology and of course first of all Avastin; U.S. Avastin sales were $704 million in Q3, an 18% over Q3 of last year. Year-over-year growth resulted primarily from increased sales in metastatic breast cancer. In breast cancer, overall penetration in first-line HER2-negative metastatic breast cancer was approximately 40% in Q3, an increase over the approximate 35% penetration we reported in Q2.

According to our tracking data, Avastin plus Paclitaxel is now the most common used regimen in metastatic breast cancer. Approximately 75% of Avastin use in this setting in Q3 was at the 10 mgs/kg two weekly approved dose, unchanged from Q2. This highlights AVADO has not had a downward effect on the dosing.

In metastatic lung cancer, recall we estimate approximately 50% to 60% of first line patients are eligible for Avastin. We estimate that penetration in this Avastin eligible population is approximately 65%, in line with most recent quarters. The percentage of lung cancer patients receiving the standard 15 mgs/kg two weekly dose Avastin was approximately 70% in Q3, unchanged also from Q2.

In general, the use of approved of Avastin in both breast and lung cancer appears to have stabilized as physicians have become more comfortable the U.S. label dose in these indications.

Finally, penetration in first and second line colorectal cancer is stable relative to Q2.

Moving on to Herceptin, U.S. sales of Herceptin were $368 million in the quarter, a 15% increase over the same quarter last year. Herceptin sales in the quarter benefited from a one-time increase in inventory levels of approximately $12 million, primarily due to a logistical issue at a wholesaler. The end user demand level of sales in the quarter were $356 million. That’s $368 million that I mentioned minus the $12 million. If this wholesaler [over-supply] is resolved in the fourth quarter, we would expect to see lower sales to this wholesaler accordingly.

Overall penetration in HER2-positive adjuvant breast cancer remains strong and was approximately 80% in Q3, in the range with previous quarters, and penetration in first-line HER2-positive metastatic setting also remains steady at this period at approximately 75%.

Next is Tarceva; U.S. net sales of Tarceva were $110 million in the quarter, a 9% increase compared to the same quarter of last year. This growth was dampened by a net negative reserve adjustment of $11 million, primarily related to product returns. However, we have generated sequential quarterly volume growth for Tarceva throughout 2008. We estimate that the current Tarceva penetration in second-line treatment of non-small cell lung cancer remains stable at around 30% compared to the same period of 2007, and in the first-line pancreatic setting, we estimate the current Tarceva penetration was nearly 45%, also in line with the same period of last year.

Now on to Rituxan, total U.S. sales of Rituxan were $655 million, representing a 15% increase over the same quarter last year.

In hematology, sales growth continues to be driven primarily by the use of Rituxan following first line therapy in indolent non-Hodgkin's lymphoma. Use also increased though in front-line and relapsed indolent NHL as well as in CLL, an unapproved use of Rituxan.

We were pleased with the positive results of the REACH trial, which demonstrated that adding Rituxan to chemotherapy improved progression free survival in relapsed CLL patients. While adoption of Rituxan is already high in this setting, if we file our sBLA and receive approval of relapsed CLL, that will allow us to promote for that indication. We also believe it will allow us to defend this space from future competitors, including Ofatumumab.

Moving on to our immunology portfolio and continuing with Rituxan, this time in RA, we continue to see strong year-over-year growth, driven by the launch of our joint protection claim. We are looking forward to the ACR meeting which is coming up in a week or two’s time, where we are presenting key data further strengthening our safety profile, which will help to address a significant barrier to increased uptake.

On to Xolair, U.S. sales of Xolair were $136 million in the quarter, an increase of 12% over the same period last year. The ongoing growth trend is consistent with our promotional efforts to increase adoption of the NHL BI guidelines, ASMA guidelines, which incorporate Xolair as a standard part of therapy.

Completing immunology, U.S. sales of Raptiva were $28 million in the quarter, a 3% decrease over the prior year.

Now on to our tissue growth and repair products and starting with Lucentis; at $225 million, Q3 sales were up 14% over the same quarter in 2007 and up 4% versus Q2 of this year. Our latest market research indicates that new patient share has remained broadly stable in 2008. We believe the primary driver of growth has been dosing frequency. Our most recent market research on dosing has shown an increased number of Lucentis [dosing] in the patient’s second year of treatment. In spite of the growth noted, this does remain a tough market.

Finally, on to our other tissue growth and repair products, U.S. sales of Nutropin were $95 million in the quarter, up 2%. Thrombolytics products U.S. sales were $66 million in Q3, down 1%; and finally for Pulmozyme, U.S. sales were $65 million in Q3, up 14%.

Finally and in summary, please note that Q3 was a long-ish quarter in terms of business days and caution should be exercised as you extrapolate this into Q4. That said, we had a strong quarter and we look forward to the growth prospects ahead.

I will now turn the call over to Sue.

Susan D. Desmond-Hellmann

Thanks, Ian and good afternoon, everyone. I am going to highlight some recent key development activity, starting with Avastin. In Q3, we submitted an sBLA for Avastin in first-line metastatic renal cell carcinoma based on AVOREN, a Phase III study evaluating the efficacy and safety of interferon alpha plus or minus Avastin. We remain on track for a Q4 2008 sBLA submission requesting accelerated approval of Avastin in relapsed glioblastoma multiforme based on results from our Phase II BRAIN study. As discussed with the FDA, the submission is for an indication of Avastin as mono-therapy for relapsed GBM.

As you know, the next interim analysis for the Phase III NSABT CO8 study of Avastin in adjuvant colon cancer will occur in Q4 2008. If the study continues beyond this interim analysis, our current estimate suggests that the final analysis will likely occur in mid-2009. We do however remind you that the exact timing of the final analysis is dependent on the future timing of disease progression events. Please note that given the important of the adjuvant colon trials, we are currently planning to issue a press release after the next interim look, regardless of the outcome.

Regarding our Avastin plus Tarceva program, the Phase III beta lung study evaluating Tarceva plus or minus Avastin in second line non-small cell lung cancer did not meet its primary endpoints, although we did see clear evidence of clinical activity with improvements of PFS and objective response rates in the Avastin and Tarceva arm. Median survival was similar in both arms of this study with a median survival of 9.2 months in the Tarceva placebo arm. No new or unexpected safety signals for either Avastin nor Tarceva were observed.

There are a number of factors that may have influenced overall survival in this combination study. Second line non-small cell lung cancer is a difficult patient population to treat as disease progression is very rapid and life expectancy is short. We have had positive signs that the longer the duration of Avastin, the better the outcome. An additional factor may have been that study patients had subsequent therapies available to them upon disease progression. Therapeutic options that may improve survival in lung cancer patients have increased since Tarceva and Avastin were first approved for treatment in 2004 and 2006 respectively. And in the BETA trials, we saw that many patients received additional therapies post progression.

The bottom line is that the results from the BETA lung trial by no means diminish the strength of evidence from E4599 and BR21 and the subsequent clinical experience demonstrating activity of Avastin and Tarceva in non-small cell lung cancer. The full results from BETA are expected to be presented at the multi-disciplinary symposium in thoracic oncology in November.

We continue to think of Tarceva as an important targeted therapy in non-small cell lung cancer and look forward to the results of SATURN, Roche’s Phase III study of Avastin and Tarceva in the first line setting, by the end of this year. We remain committed to exploring whether efficacy can be improved through combination regimens and expect results from ATLAS, the Avastin and Tarceva study in first line non-small cell lung cancer, in the first half of next year. We are also planning to initiate two more Phase II combination trials in the first half of 2009 -- a single-arm Tarceva plus Pertuzamab study in second-line non-small cell lung cancer and a Tarceva plus/minus MetMAb study in second and third line non-small cell lung cancer.

Now turning to our HER pathway program, we are expanding the breadth of our antibody drug conjugate program. This quarter we initiated enrolment in two Phase II studies evaluating T-DM1, one in the first line and another in the third line setting for patients with HER2-positive metastatic breast cancer. Should the third line study yield compelling data, we plan to discuss an accelerated approval path with the FDA. Additionally, we recently made a Phase III go decision for T-DM1 in the second line setting and plan to initiate a study comparing TDM1 to a Capecitabine plus lapatinib combination in the first half of 2009.

In our Anti-CD20 oncology program, as Ian mentioned we are very pleased with the results from REACH, the Phase III trial of Rituxan in combination with chemotherapies and the data has been submitted for a late breaker presentation at ASH. The study met the investigator assessed primary endpoint of improving progression free survival in patients with previously treated CLL compared to chemotherapy alone. We are currently reviewing the investigator assessed data and after an independent review of the PFS data from REACH, we plan to discuss our findings with the FDA.

In the first line CLL setting, we were encouraged by Roche’s announcement of the positive results of their CLL 8 study investigating Rituxan in combination with chemotherapy versus chemotherapy LM. The results of this study will be presented at ASH in December. We are planning to meet with the FDA and discuss CLL 8 and determine the appropriate next steps.

We recently announced a collaboration agreement with Roche to jointly develop and commercialize the GA101 molecule, a humanized Anti-CD20 [inaudible] antibody for the potential treatment of hematologic malignancies. This molecule is currently in Phase I too and we believe that entering into this agreement now provides us with the opportunity to collaborate on the Phase II study design and to follow the science to develop an Anti-CD20 molecule that could lead to improved outcomes in hematologic malignancies.

Now turning to our immunology and tissue growth and repair program, in Anti-CD20 for immunology this quarter we submitted an sBLA for the use of Rituxan in patients with moderately to severely active Rheumatoid Arthritis with an inadequate response to one or more disease modifying anti-rheumatic drug therapies, such as Methrotexate. The submission included data from the SERENE Phase III study as well as data from other supporting studies, such as SUNRISE.

We initiated our Phase II trial of Ocrelizumab in relapsing remitting MS in Q3 2008. This trial is a 2000-patient, four-arm placebo and Avonex controlled study. Evaluating the safety and efficacy of two doses, the objective of this study is to determine whether Ocrelizumab is effective in reducing MS disease activity as well as relapse rate.

We presented data from OLYMPUS, our Phase II/III of Rituxan in primary progressive MS at the World Congress on Treatment and Research and Multiple Sclerosis. Although this trial did not meet its primary endpoint, a secondary analysis of change in T2 lesion volume suggested that Rituxan had biologic activity.

Furthermore, predefined sub-group analyses suggested that Rituxan may prolong the time to disease progression in patients younger than 51 and/or those with an active inflammatory component to the disease. We believe there is evidence of an opportunity for Rituxan to help some patients with progressive MS and we are working with the FDA to determine next steps for this program.

We expect results from the Phase III Rituxan Lupus Nephritis study, LUNAR, in the first half of 2009. Relative to the EXPLORER trial in SLE, which was not successful, this study includes a more homogeneous patient population with confirmed active disease and the primary endpoint is based on quantitative laboratory analysis of kidney functions.

In our Xolair program, we plan on submitting an sBLA for Xolair in pediatric asthma either late this year or early next year based on positive data from the Phase III Novartis study recently presented at the European respiratory society.

Regarding Raptiva, we recently sent a dear healthcare provider letter reporting a case of PML in a 70-year old man with chronic plaque psoriasis who had received Raptiva for more than four years. The patient, who had no confounding factors associated with PML, has subsequently died. We are working with the FDA, key stakeholders, and physicians to more thoroughly evaluate the risks and benefits of Raptiva and prepare for next steps, which we expect to include an update of the label with a new box warning for PML, as well as other potential actions related to risk management. The new label will also include warnings for risks of serious infection and neurologic events. Another dear healthcare provider letter will be issued to communicate the planned label changes once they are finalized.

Now turning to our early development program, we also initiated Phase I studies in Anti-A Beta for Alzheimer’s disease, Anti-Beta 7 for ulcerative colitis, Anti-CD4 for rheumatoid arthritis, and two additional new molecular entities for cancer. And in Q4 we plan to initiate the Phase II study of our hedgehog signaling inhibitor in advanced ovarian cancer. This study will evaluate GDC-0449 as maintenance therapy in patients with ovarian cancer in a second or third complete remission.

Finally in Q4 and early 2009, we anticipate data from RIBBON-1, the Avastin Phase III study in first line metastatic breast cancer; BRIDGE, the Avastin Phase II study in squamous non-small cell lung cancer; PASSPORT, the Avastin Phase II study in non-squamous, non-small cell lung cancer patients with previously treated brain metastases; and IMAGE, the Rituxan radiographic study in rheumatoid arthritis.

For a thorough review of upcoming events, you can see our webcast slides. And now I’ll turn the call over to David.

David A. Ebersman

Okay, thanks, Sue and good afternoon, everyone. Let’s start today with the remaining revenue components of the income statement. Sales to collaborators were $182 million this quarter, a 10% increase from Q3 2007. In the fourth quarter, we expect to record significantly higher sales to collaborators and for the full year 2008, we currently forecast sales to collaborators to increase by approximately 15% relative to 2007.

Non-GAAP royalty revenue was $683 million this quarter, a 31% increase over Q3 2007, mainly due to growth in ex-U.S. sales of our products by Roche and Novartis. Q3 royalty revenue included an $11 million benefit from foreign exchange rates relative to Q3 last year and Q3 also benefited by approximately $30 million from one-time adjustments related to prior periods, including true-ups of actual Q2 sales of licensees being higher than we had estimated when we accrued and recorded Q2 royalties.

As we’ve previously discussed, royalties are difficult to forecast because of the number of products involved, ongoing licensing and intellectual property issues, and the volatility of foreign exchange rates.

While keeping these uncertainties in mind, we now forecast royalties for 2008 to grow by approximately 30% to 35% over 2007 levels.

Contract and other revenues was $91 million this quarter, a 44% increase over Q3 last year and for 2008, we continue to forecast contract revenue to be generally flat compared to 2007.

Total operating revenue was approximately $3.4 billion this quarter, a 17% increase over Q3 2007.

Turning now to the expense line items, non-GAAP cost of sales was $389 million, or 15% of net product sales this quarter, compared to 17% in Q3 2007. Our cost of sales in Q2 2008 included a charge of $23 million primarily related to delays in the start-up of one of our new manufacturing facilities.

As you know, we are completing a number of manufacturing start-ups and technology transfers in 2008 and 2009 in our California and Oregon and two Singapore facilities, so we may have some choppiness in this expense line if we face challenges with these start-ups. We remain confident in our ability to meet demand, even in upside demand scenarios.

Our current cost of sales expectation for 2008 continues to be approximately 16% of product sales. However, this percentage could be higher if we have any additional unplanned manufacturing or inventory issues.

Non-GAAP R&D expenses were $738 million this quarter, a 28% increase compared to Q3 2007, primarily due to $105 million of expense recorded in the third quarter for our GA101 collaboration, as announced previously. R&D expense was 22% of operating revenues this quarter, compared to 20% in Q3 2007.

For 2008, absent any significant new in-licensing opportunities in Q4, we currently forecast R&D expense to be a little under 20% of revenues, perhaps around 19.5%.

At this point, I also want to note the impact of the retention program on our financial results. As Art stated earlier in the call, on August 18th the special committee adopted a broad-based employee retention program in lieu of our planned 2008 stock option grant. The cost of the retention program approximates the estimated cost of the stock options that we would have otherwise granted but it’s important to note that the retention program costs will be included in our non-GAAP and GAAP result, since it’s a cash program, whereas the stock option program would have been included only in our GAAP results. So the retention program does have a meaningful impact on our non-GAAP expense line and EPS forecasts for the next few years.

For Q3 2008, our results include retention program costs of $22 million each in R&D and MG&A, totaling $44 million or $0.03 per share. Overall the EPS impact of the retention bonus program is expected to be $0.08 in 2008, $0.12 in 2009, and $0.02 in 2010, but the timing of these costs could be accelerated under certain circumstances if a Roche deal is consummated.

Non-GAAP MG&A expenses were $546 million this quarter, a 10% increase over Q3 2007, primarily due to costs related to the retention program and higher royalty expenses. MG&A as a percentage of operating revenues was 16% this quarter, compared to 17% for Q3 2007. For the full year 2008, we now forecast MG&A to be approximately 16% to 17% of revenue, up from our prior guidance primarily due to the cost of the retention program.

Collaboration profit sharing expenses were $315 million this quarter, an increase of 14% over Q3 2007, primarily driven by higher sales of Rituxan.

Non-GAAP pretax operating margin as a percentage of total revenues was 42% this quarter, compared to 40% for Q3 2007. For 2008, we continue to forecast an operating margin of about 42%.

Our other income expense line item for Q3 2008 shows a net other expense of $58 million versus a net other income of $66 million in Q3 2007. In addition to some smaller investment losses, the biggest single impact on this line item was from impairment charges of $67 million resulting from investments we held in certain financial institution preferred securities.

In light of current market conditions, we have been and will continue to move our investment portfolio to a conservative posture and for the full year 2008, we now forecast other income net will be lower by approximately 50% relative to 2007.

On taxes, our non-GAAP tax rate was 37% this quarter, flat compared to Q3 2007 and we continue to forecast our tax rate for the full year 2008 to be about 37%, which factors in the recent two-year extension of the federal R&D tax credit.

Non-GAAP net income this quarter was $863 million, or $0.81 per share, an 11% increase in net income and EPS compared to Q3 last year.

Turning now to some items that we include in our GAAP results, employee stock-based compensation expense was $103 million on a pretax basis, $71 million after taxes, or approximately $0.07 per share this quarter, compared to $0.06 last year. Our Q3 2008 GAAP results also include $40 million, or $0.02 per share in costs, related to our longstanding contract dispute with the City of Hope, specifically related to the status of negotiations on additional amounts owed to the City of Hope for a time period subsequent to the original court judgment in 2002. Q3 GAAP results also included certain costs related to the Roche proposal which total less than $0.01 per share.

Now turning to some cash metrics, cash from operations in the quarter was approximately $1.3 billion, an increase from approximately $700 million in Q3 2007. Cash used for capital expenditures in Q3 was approximately $200 million, so our free cash flow for Q3 was approximately $1.1 billion, an increase from approximately $500 million in Q3 2007.

We now forecast that CapEx for 2008 will total approximately $800 million.

In Q3 2008, we also received $491 million in net cash inflows from option exercises and the associated tax benefits.

In Q3, we repurchased 5.5 million shares from the $500 million prepaid share repurchase program we entered into at the end of Q2 and as of September 30th, Roche’s ownership position in the company was approximately 55.8%.

Our cash and investments portfolio totaled approximately $8.6 billion at September 30, 2008, including the previously restricted $788 million of cash and investments balance related to the City of Hope litigation.

As of September 30th, we had approximately $2 billion in long-term debt and about $550 million in short-term debt or commercial paper outstanding. Given the state of the credit markets, we do not currently plan to roll over our existing commercial paper as it matures, so this should modestly impact our cash position in Q4.

In closing, we’re now forecasting full year 2008 non-GAAP earnings per share to be in the range of $3.40 to $3.45 per share, narrowed from $3.40 to $3.50 per share, due primarily to the $0.08 per share cost of the employee retention program.

The forecast could change if we face any unplanned business events, such as a big in-licensing deal, further investment portfolio write-downs, or certain negative outcomes from the Raptiva PML situation.

We are looking forward to the fourth quarter and to turning our attention to planning for 2009 and beyond, looking as always for opportunities to help patients to create long-term value for the company, and to ensure Genentech remains a special place to work for our employees.

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

Kathee Littrell

Thank you, David. Prior to opening the lines for the question-and-answer session, I would just like to remind you that we will not be discussing anything further on the call today related to the Roche proposal, so please limit your questions to other business related topics. As per our usual practice, please limit your questions to one per person so that we can take as many questions as possible.

Thank you and Operator, we’re ready to start the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chris Raymond with Robert W. Baird.

Chris Raymond - Robert W. Baird

Thanks for taking the question. I have a Roche question but I think a safe one -- I’m wondering what’s going on -- if you can give a little bit more detail on what’s happening with the net sales to collaborator line. Looking at some of the stuff on your website that gives more detail, it looks like Herceptin was maybe the bigger driver of the shortfall. Should we expect just a big [bounce] of this number in Q4 and could you maybe give a little bit of color as to why?

David A. Ebersman

Sure, so Chris, that is a Roche question that’s very much in place, so thank you for that. Sales to collaborators, as we’ve discussed before, is not a line item that tracks directly with the underlying demand that Roche might have in their markets, or any other collaborator might have. It really reflects the production schedule and the release schedule of our lots. And then Roche, for most of the product we sell, we sell in bulk that they turn around and fill at whatever schedule they need before it makes its way to market. So I really wouldn’t read anything into quarterly fluctuations in this, other than we may have in one quarter had a manufacturing campaign that was for our markets and then changed the process around to run a campaign for their market the next quarter.

So what I would expect is, as you know, our guidance is for an increase in this line item in 2008 by 15% and if you do the math, that leads you to a very strong fourth quarter and that’s what we would expect at this point, is that the absolute amount that you will see for 2008 is very much in line with what we set out for the year, just not in a manner spread over the quarters evenly.

Chris Raymond - Robert W. Baird

Great. Thank you.

Operator

Your next question comes from Joel Sendek with Lazard Capital Markets.

Joel Sendek - Lazard Capital Markets

I have a question on BETA -- you gave a good explanation as to why your hypothesis, it didn’t work but I’m wondering why you didn’t use PFS as a primary endpoint. And then just as it impacts ATLAS, I’m wondering if you are more or less confident on ATLAS post BETA.

Susan D. Desmond-Hellmann

I’ll answer your ATLAS question first -- I think our internal experts are slightly more confident about ATLAS based on BETA, and I would emphasize the word slight but based on the PFS specifically. I think when you look back on studies, there’s two ways to look at the selection of survival versus PFS. At the time this study was planned, I don’t think anybody expected that second line lung cancer patients would have many options and so post progression treatment was not felt to be a key variable. I think we are still looking through the data but we are speculating that post progression therapy maybe in retrospect should [inaudible] to a PFS rather than a survival endpoint, so I think that’s a fair retrospective criticism.

I will also note though that in many of the trials where we had survival as an endpoint, we’ve been thrilled to see survival and we see a lot of use of our products based on that kind of definitive nature of the data. So I think in the end what I said remains true -- Avastin and Tarceva are very active agents to non-small cell lung cancer and while I’m disappointed that we didn’t hit the primary endpoints, I think it sets us up for continuing to explore the best use of both of these agents.

Joel Sendek - Lazard Capital Markets

Okay, thank you.

Operator

Your next question comes from Geoffrey Porges with Sanford Bernstein.

Geoffrey Porges - Sanford C. Bernstein

Congratulations on a very solid result with a lot of distractions. Speaking of distractions, maybe Ian, could you comment on for your principal cancer products, do you have any sense of what the percentage of the patient volume is that has exposure to significant co-pay? And what I’m trying to get at is to what extent could a significant change in the welfare of the consumer affect your revenue, which most people assume is pretty resilient? Thanks.

Ian T. Clark

Thanks, Geoff and thanks for the comment on the quarter. So I’m sure you know we are exposed to two types of co-pay -- there’s the sort of fixed co-pay which you can get to get higher billable range, you know, in this sort of -- less than $100. That doesn’t tend to have any sort of impact on our usage. The people who are badly exposed are the ones who have a percentage co-pay.

It does vary. It’s not very significant but I won’t give you the numbers for each product but it’s not trivial. We’ve not seen as yet any significant impact to usage as a consequence of that. You can imagine that we monitor it very closely and as you know, we invest pretty heavily in a whole range of reimbursement support options such that if patients do get caught like this, if it’s reasonable than we try and step in and help them. That’s obviously not always the case but certainly things like co-pay [inaudible].

So so far, no impact. I agree with you that because we have drugs which largely, certainly in cancer, treat life threatening diseases we may be less exposed but there may be more exposure in the current environment than there’s been in the past.

Geoffrey Porges - Sanford C. Bernstein

Thanks very much.

Operator

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

Geoffrey Meacham - J.P. Morgan

I also want to offer my congratulations on the quarter. A question for you on Avastin and GBM -- I wonder if you can tell us the rate limiting steps for the sBLA and then what you are seeing post-ASCO in terms of first and second-line use, or maybe just second-line use? Thanks.

Susan D. Desmond-Hellmann

Why don’t I start and then Ian can talk about use? The rate limiting step is gathering the data and putting it together for FDA in the kind of formatting that most easily allows them to review the submission. There are no special issues with submitting the GBM data so it’s basically just block-and-tackle, put in the submission and answer the questions.

Ian T. Clark

And in terms of the usage, we don’t comment on -- specifically on usage for non-label indications. I think it’s fair to say we have seen some adoption and we’ve seen greater adoption in the later lines, as you might expect, with the BETA.

Geoffrey Meacham - J.P. Morgan

Okay. Thank you.

Operator

Your next question comes from [Yuron Fervor] with Citigroup.

Yuron Fervor - Citigroup

Thanks for taking my question. I have a follow-on to Geoff’s question about how the potential macro environment is affecting sales, and it’s actually more from the angle of the wholesalers or distributors. Given the high cost of capital right now, do you see them lowering their inventories? And do you have in the inventory management agreement that stipulates they’ve got to hold inventory within a certain [pipe bandwidth]? Thanks.

Ian T. Clark

I’ll take that one. We’ve not seen any change. You are correct. We have inventory management agreements with all of the wholesalers in relation to all of our products. We’ve always had a policy of request that they hold at the thin end of the range, because we think that gives us a better understanding of what’s happening in the marketplace. Most of our products, the approximate inventory is about 15 days. It’s hard for them actually to go much lower than that and still have flexibilities [by the marketplace]. So one we’re pretty much locked in by the agreements and two, I doubt it would change even if they weren’t.

Operator

Your next question comes from Steven Harr with Morgan Stanley.

Steven Harr - Morgan Stanley

Given some of the uncertainty with the company right now, are you guys seeing any impact in your business development relationships? And is it any way impacting your thoughts around your use of your large balance sheet, given some of the asset prices that are out there in some of the smaller companies?

Arthur D. Levinson Ph.D.

Thanks for the question. We are running the business exactly as usual, so the business development group continues to look at opportunities, clearly as the market has caused the valuations of some companies to decline in some cases precipitously. We see this as a possible opportunity to use some of the cash to acquire technologies or companies even potentially or products at a price that might not have been available to us year or two or three ago. But I will say that it’s not just the business development group but every single group of the company, we’re committed to absolutely run the business as usual and we are not looking sideways on it.

Operator

Your next question comes from Jim Birchenough with Barclays Capital.

Jim Birchenough - Barclays Capital

Just a question on the Avastin adjuvant interim -- with events occurring more rapidly, just wondering how that impacts the powering of the interim. And a follow-on to that -- if we don’t see the studies stop at the interim with the final data targeted for just roughly six months later, how should we think about that in terms of getting that incremental benefit over the next six months?

Susan D. Desmond-Hellmann

Let me just make sure that we are all clear -- in terms of the timing of the final analysis of the study, when we communicated that the timing would be in 2009 for final analysis rather than 2010, which was our original expectation, that was based on two main factors -- most importantly the proportion of patients who were stage three versus stage two, and therefore their risk of progression should be accordingly different. And secondly, the pace with which NSABT was collecting data was slightly better than we had planned. So I can’t -- I wouldn’t speculate on the pace of events, which was the start of your question. So I just want to be clear on why the timing is what it is.

So the -- if we continue the trial at the interim analysis, my expectation would be that the flow of events, specifically disease recurrences, would be as we expected in the protocol and that we would by mid-2009 see the final results, so that crossing or not as an interim means that something is happening before you expected it when you planned out the study. So if it continues, it’s more as we originally expected.

Jim Birchenough - Barclays Capital

Okay, thanks for the clarification.

Operator

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

Eric Schmidt - Cowen & Company

I won’t ask a Roche question but I think I will ask you to explain your policy or defend your policy of not taking any such questions. I know from following Genentech now for many years that transparency has been one of the tenants of your investor relations policy and I think a lot of us on the call are a little bit frustrated with the lack of transparency that this process is being conducted under.

David A. Ebersman

Well, we regret your frustration but we’ve been advised not to answer any questions related to the Roche proposal beyond what Art said in his prepared remarks.

Operator

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

Jason Kantor - RBC Capital Markets

I wanted to just probe a little bit on this narrowed EPS guidance -- it would seem that the guidance is somewhat bullish, given that you gave your original guidance before you had the retention plan, before you did the GA101 deal, before you took the write-downs -- I’m wondering if any of those events had been previously anticipated and if not, what’s changed to be able to still be able to have guidance at the 345 level?

David A. Ebersman

That’s a good question -- I mean, every time we get new news in the business, we think about what the implications are and I would say all of the issues you asked about, we would respond to differently. So let me kind of take the easiest one, which is the GA101 deal -- when we originally set out for the year, we didn’t have in mind that deal but we did have in mind that we would spend a fair amount of money on in-licensing, that that’s an important business strategy for us and so we budget for it. So doing that deal didn’t cause us to really be in a different place than we expected -- it caused all of the expense or all that expense to happen in the third quarter where we were planning for a big deal.

The investment portfolio write-downs, our normal response to something like that would be to find a way in the business to offset the expense. If we have something in the business that doesn’t go the way we had planned or expected it to go, we want to try to make up for it in some other way so we’ve certainly looked at that expense as something we should try and offset.

The retention program on the other hand we very consciously looked at and said we didn’t want to find an offset -- I shouldn’t say didn’t want to but we weren’t going to look for an offset because it was really just a replacement of the stock option program that was in our plan. It makes the P&L look different but it’s not really a different impact to the business fundamentally. So that was the one where we really didn’t seek to sort of change our plans.

The reason the guidance currently falls where it does is you can sort of do the math, is we were coming out at the top of the old range we had, just based on things going well in the business -- sales, royalties, et cetera and the new range seems to be an appropriate place for us to try and steer the business towards with three months left in the year.

Arthur D. Levinson Ph.D.

And Jason, let me just chime in here in case it wasn’t clear from David’s answer on one of the points -- we did not in any way anticipate the effects of that, of the cost of the retention plan when we issued our previous guidance. So as we’ve said I think repeatedly, we were surprised, as was everybody, when [Roche made their] announcement, so in no way was it [factored in] when we issued this guidance.

Jason Kantor - RBC Capital Markets

Thank you.

Operator

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

May-Kin Ho - Goldman Sachs

I have a question about the balance sheet -- in terms of corporate bonds, you have some asset-backed securities in there. Can you give us a little bit more detail on what kind of investments you have and what are the exposures in terms of further impairment?

David A. Ebersman

Sure. So as I said, we have about $8.6 billion in cash and investments. Broadly categorizing them, about -- say about $3 billion of it is invested in government and other -- government agency securities, about $4.5 billion is in money markets, commercial paper, and other corporate bonds. About $400 million is in biotech equities and hedged instruments that we have associated with them, and then the remainder is made up of smaller investments we have in other asset classes, like the auction rate securities we talked about last quarter, or two quarters ago, municipal bonds, and we have a small exposure to some asset-backed securities as well.

So our objective is to have a diversified portfolio that is appropriately conservative. The average duration of the assets we own is about a year to a year-and-a-half, so it’s pretty short-term, and the average credit rating is double A, so we try and make sure that we are positioned in a way that appropriately protects the business.

Looking forward, we are comfortable with where we are but it doesn’t mean there aren’t any risks. We are obviously exposed to risks of inflation, changes in rates, changes in spreads, and the underlying credit worthiness of the assets that we own, so we’ll continue to monitor that closely.

May-Kin Ho - Goldman Sachs

So for the $4.5 billion in money markets, what are the underlying securities for those?

David A. Ebersman

The $4.5 billion is money markets, commercial paper, and bonds, so it’s sort of a big category. The money market securities that we own are safe -- as safe money market investments as we can find. I can’t tell you the exact underlying assets of each one of them but we think they are pretty high up on our list of things that are safe to own and not risky but that’s not $4.5 billion. That’s a piece of that. The rest is in corporate, commercial paper, and corporate bonds.

Operator

Your next question comes from Mark Schoenebaum with Deutsche Bank.

Kathee Littrell

Mark?

Mark Schoenebaum - Deutsche Bank

Sorry about that -- one quick comment; if this happens to be your last quarterly call as a standalone company, I just want to say you will be missed and David, if you want to come back to the sell side, just give me a call.

The question I had actually was for -- it doesn’t pay like it used to, but that’s fine. The adjuvant, I wanted to ask a question for Sue, please, if possible on the adjuvant trial. I think Jim asked something similar to this but I just want it drilled down -- so since the final analysis will be in mid-2009, do you anticipate that there will be another interim analysis after the one that is expected to occur this quarter, prior to the final analysis?

And also Sue, has your thinking around the probably of success for this trial changed at all in the last year?

Susan D. Desmond-Hellmann

Let me answer the second question to start with -- there was -- I slightly increased my likelihood of success based on the presentation at ASCO of the safety data, in terms of the risks around the adjuvant trial, the relative safety of the combination arm versus the standard arm was a risk factor and I was pleased to see the results of the safety analysis that was presented at ASCO. In terms of efficacy, there’s no information for me to base a change of likelihood of success but I do think the safety was helpful.

As I mentioned in my remarks, we now expect the final results to be in approximately mid-2009 based on modeling. It would be my expectation that if that occurs, that if Q4 this year would be the final interim analysis, if the pace of events is such that NSAVP has -- seed their final analysis later in 2009, it is possible that they could add an additional interim analysis next year, given that. But that’s not our current expectation but that is possible.

Mark Schoenebaum - Deutsche Bank

Okay, that’s really helpful. I appreciate it.

Operator

Your next question comes from Bret Holley with Oppenheimer & Company.

Bret Holley - Oppenheimer & Company

Thanks for taking the question. I have actually a follow-up to Mark’s question -- the question I have is if the interim analysis on CO8 actually crosses the pre-specified barrier in fourth quarter, what might the DSMB do? Don’t they have latitude to say well, the data will -- well, the data looked positive but why don’t we run this trial out to its final data so we get the full view of the data. Do they have that latitude?

Susan D. Desmond-Hellmann

The DSMB is in charge of the conduct of the study, so they do have full latitude. They also have pre-specified boundaries that call for stopping the trial. Among the different things that the data safety monitoring board needs to balance are safety, safety events, trends over time, as they see the events, and additionally they have to balance that if patients [inaudible] are not getting Avastin today and they do cross a boundary, they need to make sure that they wouldn’t be in a position of denying patients an active therapy. But they also don’t want to stop the study prematurely if there’s a chance of it changing over time.

So the single most important aspect of the DSMB has to weigh as they make their decision is how likely is it that the answer will change if the study matures over the next several months? And that really is why we put those pre-specified boundaries, based on is it going to change or not. When it is extremely unlikely for it to change, that’s the time to stop the study.

Bret Holley - Oppenheimer & Company

Okay. Thank you.

Operator

Your next question comes from Maged Shenouda with UBS.

Maged Shenouda - UBS

You reported a PML case with Rituxan’s use in RA. I’m just wondering how that’s impacted the commercial opportunity for the product. And then also, if that’s impacted your plans for Ocrelizumab.

Susan D. Desmond-Hellmann

Let me just -- in terms of the Rituxan PML, I want to make sure that -- you’re talking about something we did some time ago?

Maged Shenouda - UBS

Right, that was in the quarter?

Susan D. Desmond-Hellmann

Okay, because the recent case was in a patient who was treated with Raptiva. Just from a clinical standpoint and then I’ll let Ian answer the commercial question, with Rituxan, it remains the case that including our most recent report, any patient who has been on Rituxan who has experienced PML has been either a cancer patient, a patient in the [inaudible] area, or a patient who appears to be immuno-suppressed, or has very complicated conditions, including Vasculitis or Lupus or a complex auto-immune disease. There’s been over a million patients treated with Rituxan as well, so you should put into context the reports that you’ve seen.

So clinically I think that it’s really important to think these are essentially the sickest patients and we have a very, very large group of treated patients.

Ian T. Clark

In terms of the impact on sales, this was a rare and largely confounded event. That said, as we’ve mentioned in the past, one of the concerns that rheumatologists have is about the long-term safety of Rituxan in the setting so they are continually trying to sort of find their feet there. So anything like this kind of disturbs folk who might have been already slightly nervous.

That said, I mentioned that we’ve got the upcoming American Congress of Rheumatology in a couple of weeks time. We have a large swath of safety data coming out in that space and I think that will be timely and useful.

So to date, we’ve not seen an impact but it doesn’t help us build a long-term safety picture, so I’m not saying it’s completely irrelevant, okay?

Maged Shenouda - UBS

Okay. Thank you.

Operator

Your next question comes from Katherine Kim with Banc of America Securities.

Katherine Kim - Banc of America Securities

Congratulations on the quarter and my question has to do with the interim analysis -- how soon would we hear if there is going to be a push-out in the final analysis? Because you did mention that if there was a push-out, then there would be another interim before the final.

Susan D. Desmond-Hellmann

So as I mentioned in my remarks, if we are notified by the NSAVP of an observation of the study -- for example, if NSAVP tells us either that the study will continue or that the study will stop, we will put out a press release. That’s our intention for quarter four and that would be our intention next year.

Katherine Kim - Banc of America Securities

So it is possible that at the next interim analysis that there might be -- you might give an update where there might be another interim before the final?

Susan D. Desmond-Hellmann

Yes, so my expectation -- and again, this is speculation, because our current best estimate is that the study will be final in mid-2009 and if that happens, they would have a final analysis and we would put out a release. If in mid-2009 the DSMB notifies us that they think the final answer will come later and they do plan to do an additional interim analysis, I would expect that we would also publicize that information in terms of a press release.

Katherine Kim - Banc of America Securities

Okay. Thank you.

Kathee Littrell

Operator, this will be our last question, please.

Operator

Your final question comes from Bill Tanner with Leerink Swann.

William Tanner - Leerink Swann

Thanks for taking the question. Sue, just a question for you on your BETA [inaudible] antibody program -- curious your thoughts on that program now in light of the [inaudible] was presented at [inaudible] in July.

Susan D. Desmond-Hellmann

We’ve gone back with our technical experts internally and I think the short answer is that we feel like we have a decent understanding of the results that have been presented, both at the meeting and from other potential competitors. We think in terms of the issues and challenges that we have a way around them, so we continue to feel good about that but you know, this is a tough area so we have our own particular hypothesis of how we could overcome the barriers to making a new therapy. And so I think the hypotheses we have are reasonable and we’ll be testing them as early as Phase II.

Kathee Littrell

All right, thank you all for joining us on the call today. Sue Morris, Dennis [Darka] and myself will be back in our offices in about five minutes so feel free to give us a call if you have further questions. Thank you very much.

Operator

Ladies and gentlemen, this does conclude the Genentech third quarter 2008 earnings conference call. You may now all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Genentech Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts