Edgar Filing: GENENTECH INC

dna-10q_0108.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________________

FORM 10-Q

________________________

(Mark One)
þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

Commission File Number: 1-9813

GENENTECH, INC.

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or organization)

94-2347624

(I.R.S. Employer Identification Number)

1 DNA Way, South San Francisco, California 94080-4990

(Address of principal executive offices and Zip Code)

(650) 225-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ	Accelerated filer o
Non-accelerated filer o (do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of the latest practicable date.

Class	Number of Shares Outstanding
Common Stock $0.02 par value	1,050,891,782 Outstanding at April 30, 2008

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GENENTECH, INC.

TABLE OF CONTENTS

		Page No.
	PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)	3

	Condensed Consolidated Statements of Income— for the three months ended March 31, 2008 and 2007	3

	Condensed Consolidated Statements of Cash Flows— for the three months ended March 31, 2008 and 2007	4

	Condensed Consolidated Balance Sheets— March 31, 2008 and December 31, 2007	5

	Notes to Condensed Consolidated Financial Statements	6-16

	Report of Independent Registered Public Accounting Firm	17

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18-42

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	43

Item 4.	Controls and Procedures	43

	PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	44

Item 1A.	Risk Factors	44-56

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	57

Item 6.	Exhibits	58

SIGNATURES		59

In this report, “Genentech,” “we,” “us,” and “our” refer to Genentech, Inc. “Common Stock” refers to Genentech’s Common Stock, par value $0.02 per share, “Special Common Stock” refers to Genentech’s callable putable common stock, par value $0.02 per share, all of which was redeemed by Roche Holdings, Inc. (RHI) on June 30, 1999.

We own or have rights to various copyrights, trademarks, and trade names used in our business, including the following: Activase® (alteplase, recombinant) tissue-plasminogen activator; Avastin® (bevacizumab) anti-VEGF antibody; Cathflo® Activase® (alteplase for catheter clearance); Genentech®; Herceptin® (trastuzumab) anti-HER2 antibody; Lucentis® (ranibizumab) anti-VEGF antibody fragment; Nutropin® (somatropin [rDNA origin] for injection) growth hormone; Nutropin AQ® and Nutropin AQ Pen® (somatropin [rDNA origin] for injection) liquid formulation growth hormone; Pulmozyme® (dornase alfa, recombinant) inhalation solution; Raptiva® (efalizumab) anti-CD11a antibody; and TNKase® (tenecteplase) single-bolus thrombolytic agent. Rituxan® (rituximab) anti-CD20 antibody is a registered trademark of Biogen Idec Inc.; Tarceva® (erlotinib) is a registered trademark of OSI Pharmaceuticals, Inc.; and Xolair® (omalizumab) anti-IgE antibody is a registered trademark of Novartis AG. This report also includes other trademarks, service marks, and trade names of other companies.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

GENENTECH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In millions, except per share amounts)

(Unaudited)

	Three Months Ended March 31,
	2008			2007
Revenue
Product sales (including amounts from related parties: 2008–$140; 2007–$266)	$	2,379		$	2,329
Royalties (including amounts from related parties: 2008–$423; 2007–$260)		616			419
Contract revenue (including amounts from related parties: 2008–$31; 2007–$70)		68			95
Total operating revenue		3,063			2,843
Costs and expenses
Cost of sales (including amounts for related parties: 2008–$66; 2007–$124)		389			392
Research and development (including amounts associated with related party collaborations: 2008–$79; 2007–$68) (including amounts where reimbursement was recorded as contract revenue: 2008–$50; 2007–$46)		617			610
Marketing, general and administrative		517			491
Collaboration profit sharing (including related party amounts: 2008–$41; 2007–$47)		279			252
Recurring amortization charges related to redemption and acquisition		43			26
Special items: litigation-related		(301	)		13
Total costs and expenses		1,544			1,784

Operating income		1,519			1,059
Other income (expense):
Interest and other income, net		74			74
Interest expense		(18	)		(18	)
Total other income, net		56			56
Income before taxes		1,575			1,115
Income tax provision		592			409
Net income	$	983		$	706

Earnings per share
Basic	$	0.93		$	0.67
Diluted	$	0.92		$	0.66

Shares used to compute basic earnings per share		1,053			1,053
Shares used to compute diluted earnings per share		1,068			1,071

See Notes to Condensed Consolidated Financial Statements.

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GENENTECH, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In millions)

(Unaudited)

	Three Months Ended March 31,
	2008			2007
Cash flows from operating activities
Net income	$	983		$	706
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		139			106
Employee stock-based compensation		110			100
Deferred income taxes		75			(81	)
Deferred revenue		(9	)		(15	)
Litigation-related special items		(302	)		13
Excess tax benefit from stock-based compensation arrangements		(39	)		(99	)
Gain on sales of securities available-for-sale and other		(7	)		(8	)
Loss on sales and write-downs of securities available-for-sale and other		31			3
Loss on property and equipment dispositions		1			11
Changes in assets and liabilities:
Receivables and other current assets		(11	)		(31	)
Inventories		22			(115	)
Investments in trading securities		(6	)		(9	)
Accounts payable, other accrued liabilities, and other long-term liabilities		12			179
Net cash provided by operating activities		999			760

Cash flows from investing activities
Purchases of securities available-for-sale		(654	)		(122	)
Proceeds from sales of securities available-for-sale		341			37
Proceeds from maturities of securities available-for-sale		75			126
Capital expenditures		(200	)		(209	)
Change in other intangible and long-term assets		22			31
Net cash used in investing activities		(416	)		(137	)

Cash flows from financing activities
Stock issuances		147			174
Stock repurchases		–			(392	)
Excess tax benefit from stock-based compensation arrangements		39			99
Net cash provided by (used in) financing activities		186			(119	)
Net increase in cash and cash equivalents		769			504
Cash and cash equivalents at beginning of period		2,514			1,250
Cash and cash equivalents at end of period	$	3,283		$	1,754

Supplemental cash flow data
Cash paid during the period for:
Interest	$	42		$	42
Income taxes		129			163
Non-cash investing and financing activities
Capitalization of construction in progress related to financing lease transactions		42			57

See Notes to Condensed Consolidated Financial Statements.

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GENENTECH, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In millions)

(Unaudited)

	March 31, 2008		December 31, 2007
Assets
Current assets
Cash and cash equivalents	$	3,283	$	2,514
Short-term investments		1,574		1,461
Restricted cash and investments		788		788
Accounts receivable—product sales (net of allowances of: 2008–$135; 2007–$116; including amounts from related parties: 2008–$47; 2007–$2)		889		847
Accounts receivable—royalties (including amounts from related parties: 2008–$541; 2007–$463)		701		620
Accounts receivable—other (net of allowances of: 2008–$5; 2007–$0; including amounts from related parties: 2008–$139; 2007–$233)		228		299
Inventories		1,469		1,493
Prepaid expenses and other current assets		645		731
Total current assets		9,577		8,753
Long-term marketable debt and equity securities		2,201		2,090
Property, plant and equipment, net		5,135		4,986
Goodwill		1,577		1,577
Other intangible assets		1,127		1,168
Other long-term assets		378		366
Total assets	$	19,995	$	18,940

Liabilities and stockholders’ equity
Current liabilities
Accounts payable (including amounts to related parties: 2008 and 2007–$2)	$	278	$	420
Commercial paper		600		599
Deferred revenue		78		73
Taxes payable		517		173
Accrued litigation		473		776
Other accrued liabilities (including amounts to related parties: 2008–$176; 2007–$230)		1,711		1,877
Total current liabilities		3,657		3,918
Long-term debt		2,460		2,402
Deferred revenue		424		418
Other long-term liabilities		348		297
Total liabilities		6,889		7,035
Commitments and contingencies
Stockholders’ equity
Common stock		21		21
Additional paid-in capital		11,245		10,695
Accumulated other comprehensive income		123		197
Retained earnings since June 30, 1999		1,717		992
Total stockholders’ equity		13,106		11,905
Total liabilities and stockholders’ equity	$	19,995	$	18,940

See Notes to Condensed Consolidated Financial Statements.

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GENENTECH, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.

Summary of Significant Accounting Policies

Basis of Presentation

We prepared the Condensed Consolidated Financial Statements following the requirements of the United States (U.S.) Securities and Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. generally accepted accounting principles (GAAP) can be condensed or omitted. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2007. In the opinion of management, the financial statements include all adjustments, consisting only of normal and recurring adjustments, considered necessary for the fair presentation of our financial position and operating results.

Revenue, expenses, assets, and liabilities can vary during each quarter of the year. Therefore, the results and trends in these interim financial statements may not be the same as those expected for the full year or any future period.

Principles of Consolidation

The consolidated financial statements include the accounts of Genentech and all of our wholly owned subsidiaries. Material intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make judgments, assumptions, and estimates that affect the amounts reported in our Condensed Consolidated Financial Statements and accompanying notes. Actual results could differ materially from the estimates.

Recent Accounting Pronouncements

In February 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Position (FSP) No. 157-2 which delays the effective date of FASB Statement of Financial Accounting Standard (FAS) No. 157, “Fair Value Measurements” (FAS 157) for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value on a recurring basis (items that are remeasured at least annually). The FSP defers the effective date of FAS 157 until our fiscal year beginning on January 1, 2009.

In March 2008, the FASB issued FAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (FAS 161). FAS 161 requires us to provide greater transparency about how and why we use derivative instruments, how the instruments and related hedged items are accounted for under FAS 133, and how the instruments and related hedged items affect our financial position, results of operations, and cash flows. FAS 161 is effective for us beginning on January 1, 2009. The principal impact to us will be to require us to expand our disclosure regarding our derivative instruments.

Revenue Recognition

We recognize revenue from the sale of our products, royalties earned, and contract arrangements. Certain of our revenue arrangements that contain multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. The consideration we receive is allocated among the separate units based on their respective fair values, and the applicable revenue recognition criteria are

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applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

The Avastin Patient Assistance Program is a voluntary program that enables eligible patients who have received 10,000 milligrams (mg) of Avastin in a 12-month period to receive free Avastin in excess of the 10,000 mg during the remainder of the 12-month period. Based on the current wholesale acquisition cost, 10,000 mg is valued at $55,000 in gross revenue. We defer a portion of our gross Avastin product sales revenue to reflect our estimate of the commitment to supply free Avastin to patients who elect to enroll in the program. To calculate our deferred revenue, we estimate several factors, most notably: the number of patients who are currently being treated for U.S. Food and Drug Administration (FDA)-approved indications and the start date of their treatment regimen, the extent to which patients may elect to enroll in the program, the number of patients who meet the financial eligibility requirements of the program, and the duration and extent of treatment for the FDA-approved indications, among other factors. We will continue to update our estimates each reporting period as new information becomes available. Based on these estimates, we defer a portion of the Avastin revenue on product vials sold through normal commercial channels. The deferred revenue is recognized when free Avastin vials are delivered or after the associated patient eligibility period has passed.

Earnings Per Share

Basic earnings per share (EPS) are computed based on the weighted-average number of shares of our Common Stock outstanding. Diluted EPS are computed based on the weighted-average number of shares of our Common Stock and other dilutive securities.

The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations (in millions):

	Three Months Ended March 31,
	2008		2007
Numerator
Net income	$	983	$	706
Denominator
Weighted-average shares outstanding used to compute basic earnings per share		1,053		1,053
Effect of dilutive stock options		15		18
Weighted-average shares outstanding and dilutive securities used to compute diluted earnings per share		1,068		1,071

Outstanding employee stock options to purchase approximately 49 million shares of our Common Stock were excluded from the computation of diluted EPS for the first quarter of 2008 because the effect would have been anti-dilutive.

Comprehensive Income

Comprehensive income comprises net income and other comprehensive income (OCI). OCI includes certain changes in stockholders’ equity that are excluded from net income. Specifically, we include in OCI changes in the estimated fair value of derivatives designated as effective cash flow hedges, and unrealized gains and losses on our securities available-for-sale. The gains or losses and prior service costs or credits related to our post-retirement benefit plan that arise during the period, but are not recognized as components of net periodic benefit cost, have also been recognized in OCI.

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The components of accumulated OCI, net of taxes, were as follows (in millions):

	March 31, 2008			December 31, 2007
Net unrealized gains on securities available-for-sale	$	205		$	219
Net unrealized losses on cash flow hedges		(74	)		(14	)
Accumulated changes in post-retirement benefit obligation		(8	)		(8	)
Accumulated other comprehensive income	$	123		$	197

The activity in comprehensive income, net of income taxes, was as follows (in millions):

	Three Months Ended March 31,
	2008			2007
Net income	$	983		$	706
(Decrease) increase in net unrealized gains on securities available-for-sale		(14	)		5
(Increase) decrease in net unrealized losses on cash flow hedges		(60	)		3
Comprehensive income, net of income taxes	$	909		$	714

The increase in net unrealized losses on cash flow hedges during the first quarter of 2008 was primarily due to the weakening of the U.S. dollar during this period. However, in the periods in which these cash flow hedges expire, the losses will be offset by revenue denominated in the underlying foreign currency.

Fair Value of Financial Instruments

The fair value of our financial instruments reflects the amounts that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The fair value estimates presented in this report reflect the information available to us as of March 31, 2008 and December 31, 2007. See Note 4, “Fair Value Measurements.”

Derivative Instruments

Our derivative instruments, designated as cash flow hedges, consist of foreign currency exchange options and forwards. As of March 31, 2008, unrealized net losses of $87 million are expected to be reclassified from accumulated OCI to earnings within the next 12 months. If realized, these amounts are expected to be reflected primarily as a reduction of the underlying foreign-currency-denominated royalty revenue over this same 12-month period.

Note 2.

Employee Stock-Based Compensation

Stock-Based Compensation Expense under FAS 123R

Employee stock-based compensation expense was calculated based on awards ultimately expected to vest and has been reduced for estimated forfeitures. FAS No. 123(R), “Share-Based Payment” (FAS 123R), requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

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Employee stock-based compensation expense recognized under FAS 123R was as follows (in millions):

	Three Months Ended March 31,
	2008		2007
Cost of sales	$	22	$	16
Research and development		42		38
Marketing, general and administrative		46		46
Total employee stock-based compensation expense	$	110	$	100

As of March 31, 2008, total compensation cost related to unvested stock options not yet recognized was $750 million, which is expected to be allocated to expense and production costs over a weighted-average period of 32 months. The portion allocated to production costs will be recognized as cost of sales (COS) when the related products are estimated to be sold.

The carrying value of inventory on our Condensed Consolidated Balance Sheets as of March 31, 2008 and 2007 includes employee stock-based compensation costs of $70 million and $71 million, respectively.

Valuation Assumptions

The employee stock-based compensation expense recognized under FAS 123R was determined using the Black-Scholes option valuation model. Option valuation models require the input of subjective assumptions, and these assumptions can vary over time. The weighted-average assumptions used were as follows:

	Three Months Ended March 31,
	2008			2007
Risk-free interest rate		2.7	%		4.6	%
Dividend yield		0.0	%		0.0	%
Expected volatility		25.0	%		27.0	%
Expected term (years)		5.0			4.6

Due to the redemption of our Special Common Stock in June 1999 by Roche Holdings, Inc. (RHI), there is limited historical information available to support our estimate of certain assumptions required to value our employee stock options. In developing our estimate of expected term, we have assumed that our recent historical stock option exercise experience is a relevant indicator of future exercise patterns. We base our determination of expected volatility predominantly on the implied volatility of our traded options with consideration of our historical volatilities and the volatilities of comparable companies.

Note 3.

Condensed Consolidated Financial Statement Detail

Inventories

The components of inventories were as follows (in millions):

	March 31, 2008		December 31, 2007
Raw materials and supplies	$	116	$	119
Work-in-process		1,122		1,062
Finished goods		231		312
Total	$	1,469	$	1,493

Included in work-in-process as of March 31, 2008 are approximately $46 million of Rituxan inventories that were manufactured through a process that is awaiting regulatory licensure.

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Note 4.

Fair Value Measurements

On January 1, 2008, we adopted FAS 157, which established a framework for measuring fair value in GAAP and clarified the definition of fair value within that framework. FAS 157 does not require assets and liabilities that were previously recorded at cost to be recorded at fair value. For assets and liabilities that are already required to be disclosed at fair value, FAS 157 introduced, or reiterated, a number of key concepts which form the foundation of the fair value measurement approach to be used for financial reporting purposes. The fair value of our financial instruments reflects the amounts that we estimate to receive in connection with the sale of an asset or paid in connection with the transfer of a liability in an orderly transaction between market participants at the measurement date (exit price). FAS 157 also established a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:

Level 1—quoted prices in active markets for identical assets and liabilities.

Level 2—observable inputs other than quoted prices in active markets for identical assets and liabilities.

Level 3—unobservable inputs.

The adoption of FAS 157 did not have an effect on our financial condition or results of operations, but FAS 157 introduced new disclosures about how we value certain assets and liabilities. Much of the disclosure is focused on the inputs used to measure fair value, particularly in instances where the measurement uses significant unobservable (Level 3) inputs. The substantial majority of our financial instruments are valued using quoted prices in active markets or based on other observable inputs.

The following table sets forth the fair value of our financial assets and liabilities measured on a recurring basis including those pledged as collateral, or restricted. Assets and liabilities are measured on a recurring basis if they are remeasured at least annually.

	March 31, 2008				December 31, 2007
(in millions)	Assets		Liabilities		Assets		Liabilities
Cash and cash equivalents	$	3,283	$	–	$	2,514	$	–
Restricted cash		788		–		788		–
Short-term investments		1,574		–		1,461		–
Long-term marketable debt securities		1,785		–		1,674		–
Total fixed income investment portfolio	$	7,430		–	$	6,437		–

Long-term marketable equity securities		416		–		416		–
Total derivative financial instruments		32		130		30		19
Total	$	7,878	$	130	$	6,883	$	19

The following table sets forth the fair value of our financial assets and liabilities that were measured on a recurring basis during the three months ended March 31, 2008 (in millions).

	Level 1		Level 2		Level 3		Total
Assets
Cash and cash equivalents	$	2,219	$	1,064	$	–	$	3,283
Trading securities		68		937		2		1,007
Securities available-for-sale		244		2,735		161		3,140
Equity securities		416		–		–		416
Derivative financial instruments		11		21		–		32
Total	$	2,958	$	4,757	$	163	$	7,878

Liabilities
Derivative financial instruments	$	–	$	130	$	–	$	130

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Our Level 1 assets include cash, money market instruments, U.S. Treasury securities, marketable equity securities and equity forwards. Level 2 assets include other government and agency securities, commercial paper, corporate bonds, asset-backed securities, municipal bonds, preferred securities and other derivatives. As of March 31, 2008, we held $163 million of investments, which were measured using unobservable (Level 3) inputs, representing approximately 2% of our total fair value investments portfolio. The assets include $161 million of student loan auction-rate securities and $2 million of structured investment vehicle securities for which fair value was determined based on broker-provided valuations, which approximate fair value. In February 2008, the auction-rate securities market experienced a number of failed auctions for student loan-backed securities, including those we held and continue to hold, which severely limited the liquidity for these securities. Due to market liquidity constraints related to the failed auctions, we classified the auction-rate securities as non-current assets consistent with the long-term maturity dates of the underlying student loans. As of March 31, 2008, we believe the unrealized losses in the auction-rate securities are temporary and we have the ability to hold the assets to maturity. All of our auction-rate securities are AAA/Aaa-rated and are collateralized by student loans which are guaranteed by the U.S. government to be repaid at no less than 95% of par value.

The following table sets forth a summary of the changes in the fair value of our Level 3 financial assets, which are measured at fair value on a recurring basis for the three months ended March 31, 2008 (in millions).

	Structured Investment Vehicle Securities			Auction-Rate Securities(1)
Balance at December 31, 2007	$	7		$	–
Transfer into Level 3(2)		–			174
Total unrealized losses		(1	)		(13	)
Purchases, issuances, settlement(3)		(4	)		–
Balance at March 31, 2008	$	2		$	161

___________

(1)	The unrealized loss of $13 million was included in OCI.
(2)	During the first quarter of 2008, we held $174 million of auction-rate securities that were transferred to Level 3 assets.
(3)	During the first quarter of 2008, $4 million of our structured investment vehicle was “called” or redeemed for cash.

Note 5.

Contingencies

We are a party to various legal proceedings, including licensing and contract disputes, and other matters.

On October 4, 2004, we received a subpoena from the U.S. Department of Justice requesting documents related to the promotion of Rituxan, a prescription treatment now approved for five indications. We are cooperating with the associated investigation, which is both civil and criminal in nature, and through counsel we are having discussions with government representatives about the status of their investigation and Genentech’s views on this matter, including potential resolution. The government has called, and may continue to call, former and current Genentech employees to appear before a grand jury in connection with this investigation. The outcome of this matter cannot be determined at this time.

We and the City of Hope National Medical Center (COH) are parties to a 1976 agreement related to work conducted by two COH employees, Arthur Riggs and Keiichi Itakura, and patents that resulted from that work, which are referred to as the “Riggs/Itakura Patents.” Since that time, we have entered into license agreements with various companies to manufacture, use, and sell the products covered by the Riggs/Itakura Patents. On August 13, 1999, COH filed a complaint against us in the Superior Court in Los Angeles County, California, alleging that we owe royalties to COH in connection with these license agreements, as well as product license agreements that involve the grant of licenses under the Riggs/Itakura Patents. On June 10, 2002, a jury voted to award COH approximately $300 million in compensatory damages. On June 24, 2002, a jury voted to award COH an additional $200 million in punitive damages. Such amounts were accrued as an expense in the second quarter of 2002 and are included in the accompanying Condensed Consolidated Balance Sheets in “Accrued litigation” at March 31, 2008 and December 31, 2007. We filed a notice of appeal of the verdict and damages awards with the California Court of Appeal. On

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October 21, 2004, the California Court of Appeal affirmed the verdict and damages awards in all respects. On November 22, 2004, the California Court of Appeal modified its opinion without changing the verdict and denied Genentech’s request for rehearing. On November 24, 2004, we filed a petition seeking review by the California Supreme Court. On February 2, 2005, the California Supreme Court granted that petition. The California Supreme Court heard our appeal on this matter on February 5, 2008, and on April 24, 2008 overturned the award of $200 million in punitive damages to COH but upheld the award of $300 million in compensatory damages. We expect to pay approximately $477 million to COH in the second quarter of 2008, reflecting the amount of compensatory damages awarded plus interest thereon from the date of the original decision, June 10, 2002.

As a result of the April 24, 2008 California Supreme Court decision, we recorded a net favorable litigation settlement of $301 million in the first quarter of 2008, which included $9 million of accrued interest and bond costs primarily related to the compensatory damages. In the first quarter of 2007, we recorded accrued interest and bond costs on both the compensatory and punitive damages totaling $13 million. In conjunction with the COH judgment in 2002, we posted a surety bond and were required to pledge cash and investments of $788 million to secure the bond. Our payment in the second quarter of 2008 for the compensatory damages award of approximately $477 million will be made from the restricted cash and investments, and this balance is reflected in “Restricted cash and investments” in the accompanying Condensed Consolidated Balance Sheets. We also expect approximately $313 million to be released from restricted cash and investments during the second quarter of 2008 and made available for use in our operations. Included within current liabilities in “Accrued litigation” in the accompanying Condensed Consolidated Balance Sheets at March 31, 2008 and December 31, 2007 are $473 million and $776 million, respectively, which represents our estimate of the costs for the resolution of the COH matter as of each of these reporting dates.

On April 11, 2003, MedImmune, Inc. filed a lawsuit against Genentech, COH, and Celltech R & D Ltd. in the U.S. District Court for the Central District of California (Los Angeles). The lawsuit relates to U.S. Patent No. 6,331,415 (the Cabilly patent) that we co-own with COH and under which MedImmune and other companies have been licensed and are paying royalties to us. The lawsuit includes claims for violation of anti-trust, patent, and unfair competition laws. MedImmune is seeking a ruling that the Cabilly patent is invalid and/or unenforceable, a determination that MedImmune does not owe royalties under the Cabilly patent on sales of its Synagis® antibody product, an injunction to prevent us from enforcing the Cabilly patent, an award of actual and exemplary damages, and other relief. On January 14, 2004, the U.S. District Court, amending a December 23, 2003 order, granted summary judgment in our favor on all of MedImmune’s anti-trust and unfair competition claims. On April 23, 2004, the District Court granted our motion to dismiss all remaining claims in the case. On October 18, 2005, the U.S. Court of Appeals for the Federal Circuit affirmed the judgment of the District Court in all respects. MedImmune filed a petition for certiorari with the U.S. Supreme Court on November 10, 2005, seeking review of the decision to dismiss certain of its claims. The Supreme Court granted MedImmune’s petition, and the oral argument of this case before the Supreme Court occurred on October 4, 2006. On January 9, 2007, the Supreme Court issued a decision reversing the Federal Circuit’s decision and remanding the case to the lower courts for further proceedings in connection with the patent and contract claims. On August 16, 2007, the U.S. District Court entered a Claim Construction Order defining several terms used in the Cabilly patent. On October 29, 2007, MedImmune filed a motion for partial summary judgment of non-infringement, and in connection with that motion MedImmune conceded that its Synagis product infringes claim 33 of the Cabilly patent. Genentech responded to this motion in part by granting MedImmune, with respect to the Synagis product only, a covenant not to sue for infringement under any claim of the Cabilly patent other than claim 33. The trial of this matter has been scheduled for June 23, 2008. The outcome of this matter cannot be determined at this time.

On May 13, 2005, a request was filed by a third party for reexamination of the Cabilly patent. The request sought reexamination on the basis of non-statutory double patenting over U.S. Patent No. 4,816,567. On July 7, 2005, the U.S. Patent and Trademark Office (Patent Office) ordered reexamination of the Cabilly patent. On September 13, 2005, the Patent Office mailed an initial non-final Patent Office action rejecting all 36 claims of the Cabilly patent. We filed our response to the Patent Office action on November 25, 2005. On December 23, 2005, a second request for reexamination of the Cabilly patent was filed by another third party, and on January 23, 2006, the Patent Office granted that request. On June 6, 2006, the two reexaminations were merged into one proceeding. On August 16, 2006, the Patent Office mailed a non-final Patent Office action in the merged proceeding, rejecting all the claims of the Cabilly patent based on issues raised in the two reexamination requests. We filed our response to the Patent Office action on October 30, 2006. On February 16, 2007, the Patent Office mailed a final Patent Office action

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rejecting all the claims of the Cabilly patent. We responded to the final Patent Office action on May 21, 2007 and requested continued reexamination. On May 31, 2007, the Patent Office granted the request for continued reexamination, and in doing so withdrew the finality of the February 2007 Patent Office action and agreed to treat our May 21, 2007 filing as a response to a first Patent Office action. On February 25, 2008, the Patent Office mailed a final Patent Office action rejecting all the claims of the Cabilly patent. We intend to file a response to this action and, if necessary, appeal the rejection. We requested and the Patent Office granted us an extension of time to June 6, 2008 for filing a response. The Cabilly patent, which expires in 2018, relates to methods that we and others use to make certain antibodies or antibody fragments, as well as cells and deoxyribonucleic acid (DNA) used in these methods. We have licensed the Cabilly patent to other companies and derive significant royalties from those licenses. The claims of the Cabilly patent remain valid and enforceable throughout the reexamination and appeals processes. Because the above-described proceeding is ongoing, the outcome of this matter cannot be determined at this time.

In 2006, we made development decisions involving our humanized anti-CD20 program, and our collaborator, Biogen Idec Inc., disagreed with certain of our development decisions related to humanized anti-CD20 products. Under our 2003 collaboration agreement with Biogen Idec, we believe that we are permitted to proceed with further trials of certain humanized anti-CD20 antibodies, and Biogen Idec disagreed with our position. The disputed issues have been submitted to arbitration. In the arbitration, Biogen Idec filed motions for a preliminary injunction and summary judgment seeking to stop us from proceeding with certain development activities, including planned clinical trials. On April 20, 2007, the arbitration panel denied Biogen Idec’s motion for a preliminary injunction and Biogen Idec’s motion for summary judgment. Resolution of the arbitration could require that both parties agree to certain development decisions before moving forward with humanized anti-CD20 antibody clinical trials (and possibly clinical trials of other collaboration products, including Rituxan), in which case we may have to alter or cancel planned clinical trials in order to obtain Biogen Idec’s approval. The hearing of this matter is scheduled to begin in June 2008. We expect a final decision within six months of the hearing, unless the parties are able to resolve the matter earlier through settlement discussions or otherwise. The outcome of this matter cannot be determined at this time.

On June 28, 2003, Mr. Ubaldo Bao Martinez filed a lawsuit against Porriño Town Council and Genentech España S.L. in the Contentious Administrative Court Number One of Pontevedra, Spain. The lawsuit challenges the Town Council’s decision to grant licenses to Genentech España S.L. for the construction and operation of a warehouse and biopharmaceutical manufacturing facility in Porriño, Spain. On January 16, 2008, the Administrative Court ruled in favor of Mr. Bao on one of the claims in the lawsuit and ordered the closing and demolition of the facility, subject to certain further legal proceedings. On February 12, 2008, we and the Town Council filed appeals of the Administrative Court decision at the High Court in Galicia, Spain. In addition, we are evaluating with legal counsel in Spain whether there may be other administrative remedies available to overcome the Administrative Court’s ruling. We sold the assets of Genentech España S.L., including the Porriño facility, to Lonza Group Ltd. (Lonza) in December 2006, and Lonza has operated the facility since that time. Under the terms of that sale, we retained control of the defense of this lawsuit and agreed to indemnify Lonza against certain contractually defined liabilities up to a specified limit, which is currently estimated to be approximately $100 million. The outcome of this matter, and our indemnification obligation to Lonza, if any, cannot be determined at this time.

Note 6.

Relationship with Roche Holdings, Inc. and Related Party Transactions

Roche Holdings, Inc.’s Ability to Maintain Percentage Ownership Interest in Our Stock

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for stock splits. We have repurchased shares of our Common Stock since 2001. The affiliation agreement also provides that, upon RHI’s request, we will repurchase shares of our Common Stock to increase RHI’s ownership to the Minimum Percentage. In addition, RHI will have a continuing option to buy stock from us at prevailing market prices to maintain its percentage ownership interest. Under the terms of the affiliation agreement, RHI’s Minimum Percentage is 57.7%, and RHI’s ownership percentage is to be no lower than 55.7%. As of March 31, 2008, RHI’s ownership percentage was 55.8%.

Related Party Transactions

We enter into transactions with our related parties, Roche Holding AG and affiliates (Roche) and Novartis AG and affiliates (Novartis). The accounting policies that we apply to our transactions with our related parties are consistent with those applied in transactions with independent third parties, and all related party agreements are negotiated on an arm’s-length basis.

In our royalty and supply arrangements with related parties, we are the principal, as defined under Emerging Issues Task Force (EITF) Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (EITF 99-19), because we bear the manufacturing risk, general inventory risk, and the risk to defend our intellectual property. For circumstances in which we are the principal in the transaction, we record the transaction on a gross basis in accordance with EITF 99-19; otherwise, our transactions are recorded on a net basis.

Roche

We signed two product supply agreements with Roche in July 2006, each of which was amended in November 2007. The Umbrella Manufacturing Supply Agreement (Umbrella Agreement) supersedes our previous product supply agreements with Roche. The Short-Term Supply Agreement (Short-Term Agreement) supplements the terms of the Umbrella Agreement. Under the Short-Term Agreement, Roche has agreed to purchase specified amounts of Herceptin, Avastin, and Rituxan through 2008. Under the Umbrella Agreement, Roche has agreed to purchase specified amounts of Herceptin and Avastin through 2012 and, on a perpetual basis, either party may order other collaboration products from the other party, including Herceptin and Avastin after 2012, pursuant to certain forecast terms. The Umbrella Agreement also provides that either party may terminate its obligation to purchase and/or supply Avastin and/or Herceptin with six years notice on or after December 31, 2007. To date, we have not received such notice of termination from Roche.

In December 2007, Roche opted-in to our trastuzumab drug conjugate products under terms similar to those of the existing anti-HER2 agreement. As part of the opt-in, Roche paid us $113 million and will pay 50% of subsequent development costs related to the trastuzumab drug conjugate products. In March 2008, Roche opted-in to our Avastin glioblastoma multiforme indication under the terms of our July 1999 amended and restated licensing and marketing agreement with Roche. As part of the opt-in, Roche paid us $19 million and will pay 75% of ongoing development costs related to the Avastin glioblastoma multiforme indication. We recognized the payments received from Roche as deferred revenue, which will be recognized over the expected development periods.

Late in the first quarter of 2008, Roche acquired Ventana Medical Systems, Inc. (Ventana), and as a result of the acquisition, Ventana is considered a related party. We have engaged in transactions with Ventana prior to and since the acquisition, but these transactions have not been material to our results of operations.

We currently have no active profit sharing arrangements with Roche.

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Under our existing arrangements with Roche, including our licensing and marketing agreements, we recognized the following amounts (in millions):

	Three Months Ended March 31,
	2008		2007
Product sales to Roche	$	136	$	264

Royalties earned from Roche	$	370	$	255

Contract revenue from Roche	$	20	$	30

Cost of sales on product sales to Roche	$	63	$	121

Research and development expenses incurred on joint development projects with Roche	$	70	$	58

Certain research and development (R&D) expenses are partially reimbursable to us by Roche. Amounts that Roche owes us, net of amounts reimbursable to Roche by us on these projects, are recorded as contract revenue. Conversely, R&D expenses may include the net settlement of amounts we owe Roche on R&D expenses that Roche incurred on joint development projects, less amounts reimbursable to us by Roche on these projects.

Novartis

Based on information available to us at the time of filing this Quarterly Report on Form 10-Q, we believe that the Novartis Group holds approximately 33.3% of the outstanding voting shares of Roche. As a result of this ownership, the Novartis Group is deemed to have an indirect beneficial ownership interest under FAS No. 57, “Related Party Disclosures” (FAS 57), of more than 10% of our voting stock.

We have an agreement with Novartis Pharma AG (a wholly owned subsidiary of Novartis AG; Novartis Pharma AG and affiliates are collectively referred to hereafter as Novartis) under which it has the exclusive right to develop and market Lucentis outside the U.S. for indications related to diseases or disorders of the eye. As part of this agreement, the parties will share the cost of certain of our ongoing development expenses for Lucentis.

We, along with Novartis, are co-developing and co-promoting Xolair in the U.S. We record all sales, COS, and marketing and sales expenses in the U.S.; Novartis markets the product in and records all sales, COS, and marketing and sales expenses in Europe. We and Novartis share the resulting U.S. and European operating profits according to prescribed profit sharing percentages. We record Novartis’s share of the U.S. operating profits as collaboration profit sharing expense. Our share of the European operating results was recorded as contract revenue in the first quarter of 2008 and collaboration profit sharing expense in the first quarter of 2007. Effective with our acquisition of Tanox, Inc. on August 2, 2007, Novartis also makes: (1) additional profit sharing payments to us on U.S. sales of Xolair, which reduces our profit sharing expense; (2) royalty payments to us on sales of Xolair worldwide, which we record as royalty revenue; and (3) manufacturing service payments related to Xolair, which we record as contract revenue.

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Under our existing arrangements with Novartis, we recognized the following amounts (in millions):

	Three Months Ended March 31,
	2008		2007
Product sales to Novartis	$	4	$	2

Royalties earned from Novartis	$	53	$	5

Contract revenue from Novartis	$	11	$	40

Cost of sales on product sales to Novartis	$	3	$	3

Research and development expenses incurred on joint development projects with Novartis	$	9	$	10

Collaboration profit sharing expense to Novartis	$	41	$	47

Contract revenue in the first quarter of 2007 included a $30 million milestone payment from Novartis for European Union approval of Lucentis for the treatment of neovascular (wet) age-related macular degeneration (AMD).

Certain R&D expenses are partially reimbursable to us by Novartis. Amounts that Novartis owes us, net of amounts reimbursable to Novartis by us on these projects, are recorded as contract revenue. Conversely, R&D expenses may include the net settlement of amounts we owe Novartis on R&D expenses that Novartis incurred on joint development projects, less amounts reimbursable to us by Novartis on these projects.

Note 7.

Income Taxes

Our effective income tax rate was 38% in the first quarter of 2008, an increase from 37% in the first quarter of 2007, mainly due to increased income before taxes as a result of the April 24, 2008 COH decision.

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Genentech, Inc.

We have reviewed the condensed consolidated balance sheet of Genentech, Inc. as of March 31, 2008, and the related condensed consolidated statements of income and cash flows for the three-month periods ended March 31, 2008 and 2007. These financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Genentech, Inc. as of December 31, 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended, not presented herein, and in our report dated February 5, 2008, we expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph relating to the change in method of accounting for stock-based compensation in accordance with guidance provided in Statement of Financial Accounting Standards No. 123(R), “Share-based Payment.” In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2007, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

Palo Alto, California

April 28, 2008

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENENTECH, INC.

FINANCIAL REVIEW

Overview

The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the Consolidated Financial Statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2007.

The Company

Genentech is a leading biotechnology company that discovers, develops, manufactures, and commercializes pharmaceutical products to treat patients with significant unmet medical needs. We commercialize multiple biotechnology products and also receive royalties from companies that are licensed to market products based on our technology.

Recent Major Developments

We primarily earn revenue and income and generate cash from product sales and royalty revenue. In the first quarter of 2008, our total operating revenue was $3,063 million, an increase of 8% from $2,843 million in the first quarter of 2007. Our net income for the first quarter of 2008 was $983 million, an increase of 39% from $706 million in the first quarter of 2007.

On February 12, 2008, we announced that AVADO, Roche’s study evaluating two doses of Avastin in first-line metastatic breast cancer (BC), met its primary endpoint of prolonging progression-free survival (PFS). Both doses of Avastin in combination with chemotherapy showed statistically significant improvement in the time patients lived without their disease advancing compared to chemotherapy and placebo.

On February 22, 2008, we received accelerated approval from the FDA to market Avastin in combination with paclitaxel chemotherapy for the treatment of patients who have not received prior chemotherapy for metastatic human epidermal growth factor receptor 2 (HER2)-negative BC. As a condition of the accelerated approval, we are required to make future submissions to the FDA, including the final study reports for two Phase III studies, AVADO and RIBBON-1, which are ongoing studies of Avastin in first-line metastatic HER2-negative BC. Based on the FDA’s review of our future submissions, the FDA may decide to withdraw or modify the accelerated approval, request additional post-marketing studies, or grant full approval.

On February 25, 2008, the Patent Office issued a final Patent Office action rejecting all 36 claims of the Cabilly patent. We intend to file a response to the final Patent Office action and, if necessary, appeal the rejection. We requested and the Patent Office granted us an extension of time to June 6, 2008 for filing a response. The claims of the patent remain valid and enforceable throughout the reexamination and appeals processes.

On April 14, 2008, we and Biogen Idec Inc. announced that OLYMPUS, a Phase II/III study of Rituxan for primary-progressive multiple sclerosis (PPMS), did not meet its primary endpoint as measured by the time to confirmed disease progression during the 96-week treatment period. We will continue to analyze the study results with Biogen Idec and will submit the data for presentation at an upcoming medical meeting.

On April 20, 2008, we announced an update to the previously reported Roche-sponsored international Phase III clinical study of Avastin in combination with gemcitabine and cisplatin chemotherapy in patients with advanced, non-squamous, non-small cell lung cancer (NSCLC). The update confirmed the clinically and statistically significant improvement in the primary endpoint of PFS for the two different doses of Avastin studied in the trial (15 mg/kg/every-three-weeks and 7.5 mg/kg/every-three-weeks) compared to chemotherapy alone. The study did not demonstrate a statistically significant prolongation of overall survival, a secondary endpoint, for either dose in

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combination with gemcitabine and cisplatin chemotherapy compared to chemotherapy alone. Median survival of patients in all arms of the study exceeded one year, longer than previously reported survival times in this indication.

On April 24, 2008, we announced that the California Supreme Court overturned the award of $200 million in punitive damages to COH but upheld the award of $300 million in compensatory damages resulting from a contract dispute brought by COH. The punitive damages were part of a 2004 decision of the California Court of Appeal, which upheld a 2002 Los Angeles County Superior Court jury verdict awarding these amounts. We expect to pay approximately $477 million to COH in the second quarter of 2008, reflecting the amount of compensatory damages awarded, plus interest thereon from the date of the original decision in 2002. We recorded a favorable litigation settlement of $315 million in the first quarter of 2008 as a result of the California Supreme Court decision.

On April 29, 2008, we announced that the Phase II/III study of Rituxan for systemic lupus erythematosus (SLE, commonly called lupus) did not meet its primary endpoint defined as the proportion of Rituxan treated patients who achieved a major clinical response (MCR) or partial clinical response (PCR) measured by British Isles Lupus Assessment Group (BILAG), a lupus activity response index, compared to placebo at 52 weeks. The study also did not meet any of the six secondary endpoints.

Our Strategy and Goals

As announced in 2006, our business objectives for the years 2006 through 2010 include bringing at least 20 new molecules into clinical development, bringing at least 15 major new products or indications onto the market, becoming the number one U.S. oncology company in sales, and achieving certain financial growth measures. These objectives are reflected in our revised Horizon 2010 strategy and goals summarized on our website at www.gene.com/gene/about/corporate/growthstrategy. In 2007, we announced an internal stretch goal to add a total of 30 molecules into development during the five-year period from the beginning of 2006 through the end of 2010.

Economic and Industry-wide Factors

Our strategy and goals are challenged by economic and industry-wide factors that affect our business. Key factors that affect our future growth are discussed below.

We face significant competition in the diseases of interest to us from pharmaceutical companies and biotechnology companies. The introduction of new competitive products or follow-on biologics, new information about existing products, and pricing decisions by us or our competitors may result in lost market share for us, reduced utilization of our products, lower prices, and/or reduced product sales, even for products protected by patents.

Our long-term business growth depends upon our ability to continue to successfully develop and commercialize important novel therapeutics to treat unmet medical needs, such as cancer. We recognize that the successful development of pharmaceutical products is highly difficult and uncertain, and that it will be challenging for us to continue to discover and develop innovative treatments. Our business requires significant investment in R&D over many years, often for products that fail during the R&D process. Once a product receives FDA approval, it remains subject to ongoing FDA regulation, including changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisement to physicians, and product recalls or withdrawals.

Our business model requires appropriate pricing and reimbursement for our products to offset the costs and risks of drug development. Some of the pricing and distribution of our products have received negative press coverage and public and governmental scrutiny. We will continue to meet with patient groups, payers, and other stakeholders in the healthcare system to understand their issues and concerns. The reimbursement environment for our products may change in the future and become more challenging.

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As the Medicare and Medicaid programs are the largest payers for our products, rules related to the programs’ coverage and reimbursement continue to represent an important issue for our business. New regulations related to hospital and physician payment continue to be implemented annually. As a result of the Deficit Reduction Act of 2005, new regulations became effective in the fourth quarter of 2007 that will affect the discounted price for our products paid by Medicaid and government-affiliated customers.

Intellectual property protection of our products is crucial to our business. Loss of effective intellectual property protection could result in lost sales to competing products and loss of royalty payments (for example, royalty income associated with the Cabilly patent) from licensees, and may negatively affect our sales, royalty revenue, and operating results. We are often involved in disputes over contracts and intellectual property, and we work to resolve these disputes in confidential negotiations or litigation. We expect legal challenges in this area to continue. We plan to continue to build upon and defend our intellectual property position.

Manufacturing pharmaceutical products is difficult and complex, and requires facilities specifically designed and validated to run biotechnology production processes. Difficulties or delays in product manufacturing or in obtaining materials from our suppliers, or difficulties in accurately forecasting manufacturing capacity needs or complying with regulatory requirements, could negatively affect our business. Additionally, we may have an excess of available capacity, which could lead to idling of a portion of our manufacturing facilities during which time we would incur unabsorbed or idle plant charges, or other excess capacity charges, resulting in an increase in our COS.

Our ability to attract and retain highly qualified and talented people in all areas of the company, and our ability to maintain our unique culture, will be critical to our success over the long-term. We are working diligently across the company to make sure that we successfully hire, train, and integrate new employees into the Genentech culture and environment.

Marketed Products

We commercialize the pharmaceutical products listed below in the U.S.:

Avastin (bevacizumab) is an anti-VEGF (vascular endothelial growth factor) humanized antibody approved for use in combination with intravenous 5-fluorouracil-based chemotherapy as a treatment for patients with first- or second-line metastatic cancer of the colon or rectum. It is also approved for use in combination with carboplatin and paclitaxel chemotherapy for the first-line treatment of unresectable, locally advanced, recurrent or metastatic non-squamous NSCLC. On February 22, 2008, we received accelerated approval from the FDA to market Avastin in combination with paclitaxel chemotherapy for the treatment of patients who have not received prior chemotherapy for metastatic HER2-negative BC.

Rituxan (rituximab) is an anti-CD20 antibody that we commercialize with Biogen Idec Inc. It is approved for first-line treatment of patients with follicular, CD20-positive, B-cell non-Hodgkin’s lymphoma (NHL) in combination with cyclophosphamide, vincristine, and prednisone (CVP) chemotherapy regimens or following CVP chemotherapy in patients with stable disease or who achieve a partial or complete response following first-line treatment with CVP chemotherapy. Rituxan is also approved for treatment of patients with relapsed or refractory, low-grade or follicular, CD20-positive, B-cell NHL, including retreatment and bulky diseases. Rituxan is indicated for first-line treatment of patients with diffuse large B-cell, CD20-positive, NHL in combination with cyclophosphamide, doxorubicin, vincristine, and prednisone (CHOP) or other anthracycline-based chemotherapy. Rituxan is also indicated for use in combination with methotrexate to reduce signs and symptoms and slow the progression of structural damage in adult patients with moderate-to-severe rheumatoid arthritis (RA) who have had an inadequate response to one or more tumor necrosis factor (TNF) antagonist therapies.

Herceptin (trastuzumab) is a humanized anti-HER2 antibody approved for treatment of patients with node-positive or node-negative BC as part of an adjuvant treatment regimen containing doxorubicin, cyclophosphamide, and paclitaxel (for patients who have tumors that overexpress the HER2 protein). It is also approved for use as a first-line therapy in combination with paclitaxel and as a single agent in second- and third-line therapy for patients with

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HER2-positive metastatic BC.

Lucentis (ranibizumab) is an anti-VEGF antibody fragment approved for the treatment of neovascular (wet) AMD.

Xolair (omalizumab) is a humanized anti-IgE (immunoglobulin E) antibody that we commercialize with Novartis Pharma AG. Xolair is approved for adults and adolescents (age 12 or older) with moderate-to-severe persistent asthma who have a positive skin test or in vitro reactivity to a perennial aeroallergen and whose symptoms are inadequately controlled with inhaled corticosteroids.

Tarceva (erlotinib), which we commercialize with OSI Pharmaceuticals, Inc., is a small-molecule tyrosine kinase inhibitor of the HER1/epidermal growth factor receptor signaling pathway. Tarceva is approved for the treatment of patients with locally advanced or metastatic NSCLC after failure of at least one prior chemotherapy regimen. It is also approved, in combination with gemcitabine chemotherapy, for the first-line treatment of patients with locally advanced, unresectable, or metastatic pancreatic cancer.

Nutropin (somatropin [rDNA origin] for injection) and Nutropin AQ are growth hormone products approved for the treatment of growth hormone deficiency in children and adults, growth failure associated with chronic renal insufficiency prior to kidney transplantation, short stature associated with Turner syndrome, and long-term treatment of idiopathic short stature.

Activase (alteplase, for catheter clearance) is a tissue-plasminogen activator (t-PA) approved for the treatment of acute myocardial infarction (heart attack), acute ischemic stroke (blood clots in the brain) within three hours of the onset of symptoms, and acute massive pulmonary embolism (blood clots in the lungs).

TNKase (tenecteplase) is a modified form of t-PA approved for the treatment of acute myocardial infarction (heart attack).

Cathflo Activase (alteplase, recombinant) is a t-PA approved in adult and pediatric patients for the restoration of function to central venous access devices that have become occluded due to a blood clot.

Pulmozyme (dornase alfa, recombinant) is an inhalation solution of deoxyribonuclease I, approved for the treatment of cystic fibrosis.

Raptiva (efalizumab) is a humanized anti-CD11a antibody approved for the treatment of chronic moderate-to-severe plaque psoriasis in adults age 18 or older who are candidates for systemic therapy or phototherapy.

Licensed Products

We receive royalty revenue from various licensees, including significant royalty revenue from Roche on sales of:

Ÿ	Herceptin, Pulmozyme, and Avastin outside the U.S.;

Ÿ	Rituxan outside the U.S., excluding Japan; and

Ÿ	Nutropin products, Activase, and TNKase in Canada.

See Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for information regarding certain patent-related legal proceedings.

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Available Information

The following information can be found on our website at www.gene.com, or can be obtained free of charge by contacting our Investor Relations Department at (650) 225-4150 or by sending an e-mail message to investor.relations@gene.com:

Ÿ	Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports as soon as is reasonably practicable after such material is electronically filed with the U.S. Securities and Exchange Commission;

Ÿ	Our policies related to corporate governance, including our Principles of Corporate Governance, Good Operating Principles, and Code of Ethics, which apply to our Chief Executive Officer, Chief Financial Officer, and senior financial officials; and

Ÿ	The charters of the Audit Committee and the Compensation Committee of our Board of Directors.

Critical Accounting Policies and the Use of Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based on our Condensed Consolidated Financial Statements and the related disclosures, which have been prepared in accordance with U.S. GAAP. The preparation of these Condensed Consolidated Financial Statements requires management to make estimates, assumptions, and judgments that affect the reported amounts in our Condensed Consolidated Financial Statements and accompanying notes. These estimates form the basis for the carrying values of assets and liabilities. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, and we have established internal controls related to the preparation of these estimates. Actual results and the timing of the results could differ materially from these estimates.

We believe the following policies to be critical to understanding our financial condition, results of operations, and expectations for 2008, because these policies require management to make significant estimates, assumptions, and judgments about matters that are inherently uncertain.

Loss Contingencies

We are currently, and have been, involved in certain legal proceedings, including licensing and contract disputes, and other matters. See Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on these matters. We assess the likelihood of any adverse judgments or outcomes for these legal matters as well as potential ranges of probable losses. We record an estimated loss as a charge to income if we determine that, based on information available at the time, the loss is probable and the amount of loss can be reasonably estimated. The nature of these matters is highly uncertain and subject to change; as a result, the amount of our liability for certain of these matters could exceed or be less than the amount of our current estimates, depending on the final outcome of these matters. An outcome of such matters that differs from our current estimates could have a material effect on our financial position or our results of operations in any one quarter. On April 24, 2008, we announced that the California Supreme Court overturned the award of $200 million in punitive damages to COH but upheld the award of $300 million in compensatory damages resulting from a contract dispute brought by COH. Included within current liabilities in “Accrued litigation” in the accompanying Condensed Consolidated Balance Sheet as of March 31, 2008 is $473 million, which represents our estimate of the costs for the resolution of the COH matter.

Revenue Recognition–Avastin U.S. Product Sales and Patient Assistance Program

In February 2007, we launched the Avastin Patient Assistance Program, which is a voluntary program that enables eligible patients who have received 10,000 mg of Avastin in a 12-month period to receive free Avastin in excess of the 10,000 mg during the remainder of the 12-month period. Based on the current wholesale acquisition cost, the 10,000 mg is valued at $55,000 in gross revenue. Eligible patients include those who are being treated for an FDA-approved indication and who meet the financial eligibility requirements for this program. The program is available

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for eligible patients who enroll, regardless of whether they are insured. We defer a portion of our gross Avastin product sales revenue to reflect our estimate of the commitment to supply free Avastin to patients who elect to enroll in the program.

In order to estimate the amount of free Avastin to be provided to patients under the Avastin Patient Assistance Program, we need to estimate several factors, most notably: the number of patients who are currently being treated for FDA-approved indications and the start date for their treatment regimen, the extent to which patients may elect to enroll in the program, the number of patients who will meet the financial eligibility requirements of the program, and the duration and extent of treatment for the FDA-approved indications, among other factors. We have based our enrollment assumptions on physician surveys and other information that we consider relevant. We will continue to update our estimates in each reporting period as new information becomes available. If the actual results underlying this deferred revenue accounting vary significantly from our estimates, we will need to adjust these estimates. Based on these estimates, we defer a portion of Avastin revenue on product vials sold through normal commercial channels. The deferred revenue will be recognized when free Avastin vials are delivered. In the first quarter of 2008, we deferred $1 million of Avastin product sales, resulting in a total deferred revenue liability in connection with the Avastin Patient Assistance Program of $3 million in our Condensed Consolidated Balance Sheet as of March 31, 2008. Usage of the Avastin Patient Assistance Program may increase with the approval of Avastin for the treatment of metastatic HER2-negative BC. As we continue to evaluate the amount of revenue to defer related to the Avastin Patient Assistance Program, we may recognize previously deferred revenue in Avastin U.S. product sales in future periods or increase the amount of revenue deferred.

Product Sales Allowances

Revenue from U.S. product sales is recorded net of allowances and accruals for rebates, healthcare provider contractual chargebacks, prompt-pay sales discounts, product returns, and wholesaler inventory management allowances, all of which are established at the time of sale. Sales allowances and accruals are based on estimates of the amounts earned or to be claimed on the related sales. The amounts reflected in our Condensed Consolidated Statements of Income as product sales allowances have been relatively consistent at approximately seven to eight percent of gross sales. In order to prepare our Condensed Consolidated Financial Statements, we are required to make estimates regarding the amounts earned or to be claimed on the related product sales.

Definitions for the product sales allowance types are as follows:

Rebate allowances and accruals include both direct and indirect rebates. Direct rebates are contractual price adjustments payable to direct customers, mainly to wholesalers and specialty pharmacies that purchase products directly from us. Indirect rebates are contractual price adjustments payable to healthcare providers and organizations such as clinics, hospitals, pharmacies, Medicaid, and group purchasing organizations that do not purchase products directly from us.

Ÿ	Product return allowances are established in accordance with our Product Returns Policy. Our returns policy allows product returns within the period beginning two months prior to and six months following product expiration.

Ÿ	Prompt-pay sales discounts are credits granted to wholesalers for remitting payment on their purchases within established cash payment incentive periods.

Wholesaler inventory management allowances are credits granted to wholesalers for compliance with various contractually defined inventory management programs. These programs were created to align purchases with underlying demand for our products and to maintain consistent inventory levels, typically at two to three weeks of sales depending on the product.

Ÿ	Healthcare provider contractual chargebacks are the result of our contractual commitments to provide products to healthcare providers at specified prices or discounts.

We believe that our estimates related to wholesaler inventory management payments are not material amounts, based on the historical levels of credits and allowances as a percentage of product sales. We believe that our

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estimates related to healthcare provider contractual chargebacks and prompt-pay sales discounts do not have a high degree of estimation complexity or uncertainty, as the related amounts are settled within a short period of time. We consider rebate allowances and accruals and product returns allowances to be the only estimations that involve material amounts and require a higher degree of subjectivity and judgment to account for the obligations. As a result of the uncertainties involved in estimating rebate allowances and accruals and product returns allowances, there is a possibility that materially different amounts could be reported under different conditions or using different assumptions.

Our rebates are based on definitive agreements or legal requirements (such as Medicaid). These rebates are primarily estimated using historical and other data, including patient usage, customer buying patterns, applicable contractual rebate rates, and contract performance by the benefit providers. Direct rebates are accrued at the time of sale and recorded as allowances against trade accounts receivable; indirect rebates (including Medicaid) are accrued at the time of sale and recorded as liabilities. Rebate estimates are evaluated quarterly and may require changes to better align our estimates with actual results. As part of this evaluation, we review changes to Medicaid legislation and state rebate contracts, changes in the level of discounts, and significant changes in product sales trends. Although rebates are accrued at the time of sale, rebates are typically paid out, on average, up to six months after the sale. We believe that our rebate allowances and accruals estimation process provides a high degree of confidence in the annual allowance amounts established. Based on our estimation, the changes in rebate allowances and accruals estimates related to prior years have not exceeded 3%. To further illustrate our sensitivity to changes in the rebate allowances and accruals process, a 10% change in our annualized rebate allowances and accruals provision experienced to date in 2008 (which is in excess of three times the level of variability that we reasonably expect to observe for rebates) would have an approximate $21 million unfavorable effect on our results (or approximately $0.01 per share). The total rebate allowances and accruals recorded in our Condensed Consolidated Balance Sheet were $76 million as of March 31, 2008.

At the time of sale, we record product returns allowances based on our best estimate of the portion of sales that will be returned by our customers in the future. Product returns allowances are established in accordance with our returns policy, which allows buyers to return our products with two months or less remaining prior to product expiration and up to six months following product expiration. As part of the estimating process, we compare historical return data to the related sales on a production lot basis. Historical rates of return are then determined by product and may be adjusted for known or expected changes in the marketplace. Actual annual product returns processed were less than 0.5% of gross product sales in all periods from 2005 and 2007, while annual provisions for expected future product returns were less than 1% of gross product sales in all such periods. Although product returns allowances are recorded at the time of sale, the majority of the returns are expected to occur within two years of sale. Therefore, our provisions for product returns allowances may include changes in estimate for a prior period due to the lag time. However, to date, such changes have not been material. For example, in 2007, changes in estimates related to prior years were approximately 0.3% of 2007 gross product sales. To illustrate our sensitivity to changes in the product returns allowances, if we were to experience an adjustment rate of 0.5% of 2007 gross product sales, which is nearly twice the level of annual variability that we have historically observed for product returns, that change in estimate would likely have an unfavorable effect of approximately $50 million (or approximately $0.03 per share) on our results of operations. Product returns allowances recorded in our Condensed Consolidated Balance Sheet were $75 million as of March 31, 2008.

All of the aforementioned categories of allowances and accruals are evaluated quarterly and adjusted when trends or significant events indicate that a change in estimate is appropriate. Such changes in estimate could materially affect our results of operations or financial position; however, to date they have not been material. It is possible that we may need to adjust our estimates in future periods. Our Condensed Consolidated Balance Sheet reflected estimated product sales allowance reserves and accruals totaling approximately $202 million as of March 31, 2008.

Royalties

For substantially all of our agreements with licensees, we estimate royalty revenue and royalty receivables in the period the royalties are earned, which is in advance of collection. Royalties from Roche, which are approximately 60% of our total royalty revenue, are reported based on actual sales reports from Roche. Our estimates of royalty revenue and receivables from non-Roche licensees are primarily based on communication with some licensees, historical information, forecasted sales trends, and our assessment of collectibility. Differences between actual

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royalty revenue and estimated royalty revenue are adjusted for in the period in which they become known, typically the following quarter. Since 2005, the adjustment to our royalty revenue related to prior periods has not exceeded 1% of total annual royalty revenue. To further illustrate our sensitivity to the royalty estimation process, a 1% adjustment to total annual royalty revenue, which is at the upper end of the range of our historic experience, would result in an adjustment to total 2007 annual royalty revenue of approximately $25 million (or approximately $0.01 to $0.02 per share, net of any related royalty expenses).

In cases where the collectibility of a royalty amount is doubtful, royalty revenue is not recorded in advance of payment but is recognized as cash is received. In the case of a receivable related to previously recognized royalty revenue that is subsequently determined to be uncollectible, the receivable is reserved for by reversing the previously recorded royalty revenue in the period in which the circumstances that make collectibility doubtful are determined, and future royalties from the licensee are recognized on a cash basis until it is determined that collectibility is reasonably assured.

We have confidential licensing agreements with a number of companies under which we receive royalty revenue on sales of products that are covered by the Cabilly patent. The Cabilly patent, which expires in 2018, relates to methods that we and others use to make certain antibodies or antibody fragments, as well as cells and DNA used in those methods. The Patent Office is performing a reexamination of the patent, and on February 25, 2008, issued a final Patent Office action rejecting all the claims of the Cabilly patent. We intend to file a response to the final Patent Office action and, if necessary, appeal the rejection. We requested and the Patent Office granted us an extension of time to June 6, 2008 for filing a response. The claims of the patent remain valid and enforceable throughout the reexamination and appeals processes. In addition, in April 2003, MedImmune filed a lawsuit against us challenging the Cabilly patent. See also Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on our Cabilly patent reexamination and the MedImmune lawsuit.

Cabilly patent royalties are generally due 60 days after the end of the quarter in which they are earned and recorded by us as royalty revenue. Additionally, we pay COH a percentage of our Cabilly patent royalty revenue 60 days after the quarter in which we receive payments from our licensees. As of March 31, 2008, our Condensed Consolidated Balance Sheet included Cabilly patent receivables totaling approximately $73 million and related COH payables totaling approximately $31 million.

Income Taxes

Our income tax provision is based on income before taxes and is computed using the liability method in accordance with FAS No. 109, “Accounting for Income Taxes.” Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using tax rates projected to be in effect for the year in which the differences are expected to reverse. Significant estimates are required in determining our provision for income taxes. Some of these estimates are based on interpretations of existing tax laws or regulations, or the findings or expected results from any tax examinations. Various internal and external factors may have favorable or unfavorable effects on our future effective income tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, the results of any tax examinations, changing interpretations of existing tax laws or regulations, changes in estimates of prior years’ items, past and future levels of R&D spending, acquisitions, changes in our corporate structure, and changes in overall levels of income before taxes all of which may result in periodic revisions to our effective income tax rate. Uncertain tax positions are accounted for in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.” We accrue tax related interest and penalties related to uncertain tax positions and include these with income tax expense in the Condensed Consolidated Statements of Income.

Inventories

Inventories may include currently marketed products manufactured under a new process or at facilities awaiting regulatory licensure. These inventories are capitalized based on our judgment of probable near-term regulatory licensure. Excess or idle capacity costs, based on estimated plant capabilities, are expensed in the period in which they are incurred. The valuation of inventory requires us to estimate the value of inventory that may expire prior to use or that may fail to be released for commercial sale. The determination of obsolete inventory requires us to

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estimate the future demands for our products, and in the case of pre-approval inventories, to estimate the regulatory approval date for the product or for the licensure of either the manufacturing facility or the new manufacturing process. We may be required to expense previously capitalized inventory costs upon a change in our estimate, due to, among other potential factors, the denial or delay of approval of a product or the licensure of either a manufacturing facility or a new manufacturing process by the necessary regulatory bodies, or new information that suggests that the inventory will not be saleable.

Valuation of Acquired Intangible Assets

We have acquired intangible assets in connection with our acquisition of Tanox, Inc. These intangible assets consist of developed product technology and core technologies associated with intellectual property and rights thereon, primarily related to the Xolair molecule, and assets related to the fair value write-up of Tanox’s royalty contracts, as well as goodwill. When significant identifiable intangible assets are acquired, we determine the fair value of these assets as of the acquisition date, using valuation techniques such as discounted cash flow models. These models require the use of significant estimates and assumptions including, but not limited to, determining the timing and expected costs to complete the in-process projects, projecting regulatory approvals, estimating future cash flows from product sales resulting from completed products and in-process projects, and developing appropriate discount rates and probability rates by project.

We believe that the fair value assigned to the intangible assets acquired is based on reasonable estimates and assumptions, given the available facts and circumstances as of the acquisition date. However, we may record adjustments to goodwill resulting from our acquisition of Tanox, Inc. for the resolution of pre-acquisition contingencies, our restructuring activities, tax matters, and other estimates related to the acquisition for a period of up to one year after the acquisition date. Further, we will have to continually evaluate whether the fair value of any or all intangible assets has been impaired.

Employee Stock-Based Compensation

Under the provisions of FAS 123R, employee stock-based compensation is estimated at the date of grant based on the employee stock award’s fair value using the Black-Scholes option-pricing model and is recognized as expense ratably over the requisite service period in a manner similar to other forms of compensation paid to employees. The Black-Scholes option-pricing model requires the use of certain subjective assumptions. The most significant of these assumptions are our estimates of the expected volatility of the market price of our stock and the expected term of the award. Due to the redemption of our Special Common Stock in June 1999 (Redemption) by RHI, there is limited historical information available to support our estimate of certain assumptions required to value our stock options. When establishing an estimate of the expected term of an award, we consider the vesting period for the award, our recent historical experience of employee stock option exercises (including forfeitures), the expected volatility, and a comparison to relevant peer group data. As required under GAAP, we review our valuation assumptions at each grant date, and, as a result, our valuation assumptions used to value employee stock-based awards granted in future periods may change. See Note 2, “Employee Stock-Based Compensation,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.

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Results of Operations

(In millions, except per share amounts)

	Three Months Ended March 31,
	2008			2007			% Change
Product sales	$	2,379		$	2,329			2	%
Royalties		616			419			47
Contract revenue		68			95			(28	)
Total operating revenue		3,063			2,843			8

Cost of sales		389			392			(1	)
Research and development		617			610			1
Marketing, general and administrative		517			491			5
Collaboration profit sharing		279			252			11
Recurring amortization charges related to redemption and acquisition		43			26			65
Special items: litigation-related		(301	)		13			*
Total costs and expenses		1,544			1,784			(13	)

Operating income		1,519			1,059			43

Other income (expense):
Interest and other income, net		74			74			0
Interest expense		(18	)		(18	)		0
Total other income, net		56			56			0

Income before taxes		1,575			1,115			41
Income tax provision		592			409			45
Net income	$	983		$	706			39

Earnings per share:
Basic	$	0.93		$	0.67			39
Diluted	$	0.92		$	0.66			39

Cost of sales as a % of product sales		16	%		17	%
Research and development as a % of operating revenue		20			21
Marketing, general and administrative as a % of operating revenue		17			17

Pretax operating margin		50	%		37	%

Effective income tax rate		38	%		37	%

________________________

*	Calculation not meaningful.
	Percentages in this table and throughout the discussion and analysis of our financial condition and results of operations may reflect rounding adjustments.

Total Operating Revenue

Total operating revenue increased 8% from the comparable period in 2007. This increase was primarily due to higher product sales and royalty revenue, and is discussed below.

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Total Product Sales

(In millions)

	Three Months Ended March 31,
	2008		2007		% Change
Net U.S. product sales
Avastin	$	600	$	533		13	%
Rituxan		605		535		13
Herceptin		339		311		9
Lucentis		198		211		(6	)
Xolair		117		111		5
Tarceva		111		102		9
Nutropin products		84		91		(8	)
Thrombolytics		67		68		(1	)
Pulmozyme		57		52		10
Raptiva		26		24		8
Total U.S. product sales(1)		2,205		2,037		8

Net product sales to collaborators		174		292		(40	)
Total product sales	$	2,379	$	2,329		2

______________________

(1)	The totals may not appear to equal the sum of the individual entries due to rounding.

Total product sales increased 2% in the first quarter of 2008 from the comparable period in 2007. Total U.S. product sales increased 8% from the comparable period in 2007. The increases in U.S. sales were due to higher sales across most products, in particular higher sales of our oncology products. Increased U.S. sales volume accounted for 69%, or $116 million, of the increase in U.S. net product sales in the first quarter of 2008. Changes in net U.S. sales prices across the majority of products in the portfolio accounted for most of the remainder of the increases in U.S. net product sales in the first quarter of 2008.

Our references below to market adoption and penetration, as well as patient share, are derived from our analyses of market tracking studies and surveys that we undertake with physicians. We consider these tracking studies and surveys indicative of trends and information with respect to our end users’ buying patterns. We use statistical analyses and management judgment to interpret the data that we obtain, and as such, the adoption, penetration, and patient share data presented herein represent estimates. Limitations in sample size and the timeliness in receiving and analyzing this data result in inherent margins of error; thus, where presented, we have rounded our percentage estimates to the nearest 5%.

Avastin

Net U.S. sales of Avastin increased 13% to $600 million in the first quarter of 2008 from the comparable period in 2007. Net U.S. sales in the first quarter of 2008 excluded net revenue of $1 million that was deferred in connection with our Avastin Patient Assistance Program. The increase in sales in the first quarter of 2008 was primarily a result of increased use of Avastin in first-line metastatic NSCLC and first-line metastatic BC, which received accelerated approval from the FDA in the first quarter of 2008.

Among first-line metastatic NSCLC patients, we estimate that Avastin penetration in the first quarter of 2008 was approximately 35%, which was in line with penetration in the fourth quarter of 2007 and an increase from the first quarter of 2007. Among the approximately 50%-60% of patients in first-line metastatic lung cancer who are eligible for Avastin therapy, we estimate that penetration was approximately 60%. With respect to dose, the percentage of lung cancer patients receiving the high dose of Avastin, defined as at least 5mg/kg/weekly-equivalent, was approximately 70% in the first quarter of 2008, a slight increase from the fourth quarter of 2007. The recommended dose of Avastin in lung cancer is 15mg/kg, administered intravenously every three weeks. However, we expect dose in metastatic NSCLC to continue to be a source of uncertainty for Avastin. The Roche-sponsored BO17704 study, which was presented at the American Society of Clinical Oncology (ASCO) in June 2007, evaluated a

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15mg/kg/every-three-weeks dose of Avastin (the dose approved in the U.S. for use in combination with carboplatin and paclitaxel) and a 7.5mg/kg/every-three-weeks dose of Avastin (a dose not approved for use in the U.S.) in combination with gemcitabine and cisplatin chemotherapy compared to chemotherapy alone in patients with previously untreated, advanced NSCLC. Both doses met the primary endpoint of prolonging PFS compared to chemotherapy alone. Although the study was not designed to compare the Avastin doses, a similar treatment effect in PFS was observed between the two arms. On April 20, 2008, we announced that the study did not demonstrate a statistically significant prolongation of overall survival, a secondary endpoint, for either dose in combination with gemcitabine and cisplatin chemotherapy compared to chemotherapy alone. Median survival of patients in all arms of the study exceeded one year, longer than previously reported survival times in this indication. Based on these results, additional physicians may adopt Avastin at the lower dose of 7.5mg/kg/every-three-weeks or choose not to prescribe Avastin.

On February 12, 2008, we announced that AVADO, Roche’s study evaluating two doses of Avastin in first-line metastatic BC, met its primary endpoint of prolonging PFS. Both doses of Avastin in combination with chemotherapy showed statistically significant improvement in the time patients lived without their disease advancing compared to chemotherapy and placebo, although the study was not designed to compare the Avastin doses. On February 22, 2008, the FDA notified us that Avastin received accelerated approval for use in combination with paclitaxel chemotherapy, for patients who have not received prior chemotherapy for metastatic HER2-negative BC. Based on our first quarter 2008 market research, which was conducted prior to these two announcements, Avastin adoption in first-line HER2-negative metastatic BC patients in the first quarter of 2008 was in-line with the fourth quarter of 2007. We anticipate increased use of Avastin in BC as a result of the FDA accelerated approval. With respect to dose, the percentage of BC patients receiving the high dose of Avastin, defined as 5mg/kg/weekly-equivalent, was approximately 75% in the first quarter of 2008. This is down slightly from approximately 80% in the fourth quarter of 2007. The recommended dose of Avastin in BC is 10 mg/kg, administered intravenously every two weeks. Data from the AVADO study is expected to be presented at ASCO during the second quarter of 2008 and will provide additional information regarding Avastin dosage in BC.

In first-line metastatic colorectal cancer (CRC), penetration in the first quarter of 2008 was approximately 70%, which was consistent with penetration in the first and fourth quarters of 2007. In second-line CRC, we estimate that Avastin penetration was approximately 40% in the first quarter of 2008, an increase from that seen in the first quarter of 2007.

Rituxan

Net U.S. sales of Rituxan increased 13% to $605 million in the first quarter of 2008 from the comparable period in 2007. Sales growth resulted from increased sales volume and price increases in 2007.

In the oncology setting, the increases came from Rituxan’s use following chemotherapy in indolent NHL, including areas of unapproved use, and chronic lymphocytic leukemia (CLL), an unapproved use. We estimate that Rituxan’s overall adoption rate in the combined NHL and CLL markets increased to approximately 85% in the first quarter of 2008 from approximately 80% in the first quarter of 2007.

In the RA setting, the primary drivers of growth were an increased percentage of prescribers, to approximately 85% of targeted rheumatologists, and an increased share of patients who have failed anti-TNF therapies. It remains difficult to precisely determine the sales split between Rituxan use in oncology and immunology settings since many treatment centers treat both types of patients.

On January 25, 2008, the FDA approved our supplemental biologic license application (BLA) to expand the label for Rituxan to include slowing the progression of structural damage in adult patients with moderate-to-severe RA who have failed anti-TNF therapies.

In January 2008, we announced that the Rituxan Phase III SUNRISE trial met its primary endpoint. This study was a controlled retreatment study for patients with RA who have had an inadequate response to previous treatment with one or more TNF antagonist therapies. A preliminary review of the safety data revealed no new safety signals.

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On January 24, 2008 we announced that the SERENE Phase III clinical study of Rituxan in patients who have not been previously treated with a biotherapeutic met its primary endpoint of a significantly greater proportion of Rituxan-treated patients achieving an American College of Rheumatology (ACR) 20 response at week 24, compared to placebo. In this study, patients who received a single treatment course of two infusions of either 500 mg or 1,000 mg of Rituxan in combination with a stable dose of methotrexate displayed a statistically significant improvement in ACR20 scores compared to patients who received placebo in combination with methotrexate. Although the study was not designed to compare the Rituxan doses, treatment efficacy appears to be similar between both Rituxan doses.

On April 14, 2008, we and Biogen Idec announced that OLYMPUS, a Phase II/III study of Rituxan for PPMS, did not meet its primary endpoint as measured by the time to confirmed disease progression during the 96-week treatment period. We will continue to analyze the study results with Biogen Idec and will submit the data for presentation at an upcoming medical meeting. We observed biologic activity and will continue to analyze the study results.

On April 29, 2008, we announced that the Phase II/III study of Rituxan for systemic lupus erythematosus (SLE, commonly called lupus) did not meet its primary endpoint defined as the proportion of Rituxan treated patients who achieved a MCR or PCR measured by BILAG, a lupus activity response index, compared to placebo at 52 weeks. The study also did not meet any of the six secondary endpoints. Although we do not promote off-label, our market research indicates that lupus constitutes significantly less than five percent of U.S. sales of Rituxan.

Herceptin

Net U.S. sales of Herceptin increased 9% to $339 million in the first quarter of 2008 from the comparable period in 2007. The sales growth was due to price increases in 2007 and increased use of Herceptin in the treatment of early-stage HER2-positive BC. We estimate Herceptin’s penetration in the adjuvant setting in the first quarter of 2008 was approximately 85%, an increase from the first quarter of 2007, but in-line with the fourth quarter of 2007. In first-line HER2-positive metastatic BC patients, Herceptin’s penetration was approximately 70% for the first quarter of 2008, which was consistent with the first and fourth quarters of 2007.

On January 18, 2008, the FDA expanded the Herceptin label, based on the HERA study, for the treatment of patients with early-stage HER2-positive BC to include treatment for patients with node-negative BC. Herceptin also may now be administered for one year in an every-three-week dosing schedule, instead of weekly.

Lucentis

Net U.S. sales of Lucentis decreased 6% to $198 million in the first quarter of 2008 from the comparable period in 2007. We believe that the percentage of newly diagnosed patients who were treated with Lucentis during the first quarter of 2008 was approximately 40% compared to approximately 50% during the fourth quarter of 2007 and 55% during the first quarter of 2007. We believe that the main factors affecting the decline in new patient share were the continued unapproved use of Avastin and reimbursement concerns from retinal specialists. Lucentis received a permanent J-code classification from the Centers for Medicare and Medicaid Services in January 2008, which we believe will help address some of the reimbursement concerns.

The unapproved use of Avastin and reimbursement concerns have created a difficult environment for the promotion of Lucentis. Our continuing efforts will be focused on achieving new patient share growth, however, this will be challenging based on current market conditions.

Xolair

Net U.S. sales of Xolair increased 5% to $117 million in the first quarter of 2008 from the comparable period in 2007.

On April 10, 2008, we and Novartis announced that a Phase III study evaluating Xolair in patients 6 to 11 years of age with moderate-to-severe, persistent, inadequately controlled allergic asthma met its primary endpoint,

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demonstrating a statistically significant reduction in exacerbations in Xolair-treated patients compared with placebo treated patients, with no new safety signals reported. We will work with Novartis to evaluate the complete study results, including feedback from the FDA, to determine the next steps.

Tarceva

Net U.S. sales of Tarceva increased 9% to $111 million in the first quarter of 2008 from the comparable period in 2007, primarily due to price increases in 2007 and 2008. We estimate that Tarceva’s penetration in second-line NSCLC was approximately 35%, an increase from the first quarter of 2007, but in-line with the fourth quarter of 2007. In the first-line pancreatic cancer setting, we estimate that Tarceva’s penetration was approximately 45% in the first quarter of 2008, an increase from the first quarter of 2007, but stable compared to the fourth quarter of 2007.

Nutropin Products

Combined net U.S. sales of our Nutropin products decreased 8% to $84 million in the first quarter of 2008 from the comparable period in 2007. Nutropin sales have decreased due to increased rebates in the managed care contracting environment and fewer patients being treated. The decrease in sales volume was partially offset by price increases in 2007 and 2008.

Thrombolytics

Combined net U.S. sales of our three thrombolytics products—Activase, Cathflo Activase, and TNKase—decreased 1% to $67 million in the first quarter of 2008 from the comparable period in 2007. Sales were favorably affected by increases in sales volume compared to the first quarter of 2007 and price increases in 2007 and 2008. However, these increases were offset by increased product return reserve requirements.

Pulmozyme

Net U.S. sales of Pulmozyme increased 10% to $57 million in the first quarter of 2008 from the comparable period in 2007.

Raptiva

Net U.S. sales of Raptiva increased 8% to $26 million in the first quarter of 2008 from the comparable period in 2007.

Sales to Collaborators

Product sales to collaborators, which were for non-U.S. markets, decreased 40% to $174 million in the first quarter of 2008 from the comparable period in 2007. The decrease was primarily due to the timing of Avastin and Herceptin sales to Roche. For 2008, we forecast sales to collaborators to increase by approximately 10% to 15% over 2007 with the usual quarter-to-quarter fluctuations due to the timing of the production and order plan.

Herceptin sales to Roche since the third quarter of 2006 reflect more favorable pricing terms that were part of the supply agreement with Roche signed at that time. These pricing terms will continue through the end of 2008.

Royalties

Royalty revenue increased 47% to $616 million in the first quarter of 2008 from $419 million in the comparable period in 2007. The majority of the increase was due to higher sales by Roche of our Avastin, Herceptin, and Rituxan products, and higher sales by Novartis of our Lucentis product. In addition, approximately $50 million of the increase was due to net foreign exchange-related benefits from the weaker U.S. dollar during the first quarter of 2008 compared to the first quarter of 2007. The first quarter 2008 results also included approximately $20 million of net adjustments increasing royalty revenue due to changes in estimates for amounts reported in prior periods, as compared to immaterial amounts of such net adjustments recorded in the first quarter of 2007. Of the overall

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royalties received, royalties from Roche represented approximately 60% in the first quarter of 2008 compared to approximately 61% in the first quarter of 2007. Royalties from other licensees included royalty revenue on our patent licenses, including our Cabilly patent, as discussed below.

Cash flows from royalty income include revenue denominated in foreign currencies. We currently enter into foreign currency option contracts (options) and forwards to hedge a portion of these foreign currency cash flows. These existing options and forwards are due to expire in 2008 and 2009, and we expect to continue to enter into similar contracts in accordance with our hedging policy.

We have confidential licensing agreements with a number of companies under which we receive royalty revenue on sales of products covered by the Cabilly patent. The Cabilly patent expires in December 2018, but is the subject of an ongoing reexamination and likely appeals process, and the MedImmune litigation. The net pretax contributions related to the Cabilly patent were as follows (in millions, except per share amounts):

	Three Months Ended March 31,
	2008		2007
Royalty revenue	$	84	$	62

Gross expenses(1)	$	36	$	30

Net of tax effect of Cabilly patent on diluted EPS	$	0.03	$	0.02

______________________

(1)	Gross expenses include COH’s share of royalty revenue and royalty COS on our U.S. product sales

See also Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information on our Cabilly patent reexamination and the MedImmune lawsuit related to the Cabilly patent.

Royalties are difficult to forecast because of the number of products involved, availability of licensee sales data, potential licensing and intellectual property disputes, and the volatility of foreign currency exchange rates. For 2008, we forecast royalty revenue to grow approximately 15% to 25% relative to 2007, but a number of factors could affect these results. Most notably, a continued weakness in the U.S. dollar could positively affect royalty revenue. However, royalty revenue growth could be negatively affected by a number of factors, including the strengthening of the U.S. dollar, lower than expected sales of licensees’ products, the termination of licenses, changes to the terms of contracts under which licenses have been granted, or the failure of licensees to meet their contractual payment obligations for any reason, including an adverse decision or ruling in the Cabilly patent reexamination, the MedImmune lawsuit, or appeals of these matters.

Contract Revenue

Contract revenue decreased 28% to $68 million in the first quarter of 2008 from the comparable period in 2007. The decrease was mainly due to the receipt of a milestone payment from Novartis Pharma AG in the first quarter of 2007 related to European Union approval of Lucentis. Contract revenue in the first quarter of 2008 included manufacturing service payments related to Xolair, which Novartis pays us as a result of our acquisition of Tanox, Inc., and our share of European profits related to Xolair. See “Related Party Transactions” below for more information on contract revenue from Roche and Novartis.

For 2008, we forecast contract revenue to grow by approximately 5% relative to 2007. However, contract revenue varies each quarter and is dependent on a number of factors, including the timing and level of reimbursements from ongoing development efforts, milestones, opt-in payments received, new contract arrangements, and foreign exchange rates.

Cost of Sales

Cost of sales as a percentage of product sales was 16% in the first quarter of 2008 compared to 17% in the first quarter of 2007. COS as a percentage of product sales during the first quarter of 2008 was favorably affected by a

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decreased volume of lower-margin sales to collaborators, partially offset by a charge resulting from a voluntary severance program announced in February 2008 that provided certain manufacturing employees the opportunity to voluntarily resign from the company in exchange for a severance package. Enrollment in the program closed in March 2008. We recorded compensation charges in COS associated with this program of $18 million in the first quarter of 2008, and we expect to record charges totaling approximately $10 million in the second and third quarters of 2008 related to this program.

Research and Development

Research and development expenses increased slightly to $617 million in the first quarter of 2008 from the comparable period in 2007. The higher levels of expenses in the first quarter of 2008 reflected increased development activity mainly as a result of collaboration arrangements entered into in 2007, increased spending on clinical trials, clinical manufacturing expenses, and higher research expenses. The increases in R&D expenses were offset by a reduction of in-licensing expenses of approximately $110 million in the first quarter of 2008 compared to the first quarter of 2007, due to significant new collaborations entered into during the first quarter of 2007. R&D as a percentage of operating revenue was 20% in the first quarter of 2008 compared to 21% in the first quarter of 2007.

Marketing, General and Administrative

Marketing, general and administrative (MG&A) expenses increased 5% to $517 million in the first quarter of 2008 from the comparable period in 2007. This increase was primarily due to an increase in royalty expense, primarily to Biogen Idec, resulting from higher Roche sales of Rituxan. MG&A as a percentage of operating revenue was 17% in the first quarters of 2008 and 2007.

Collaboration Profit Sharing

Collaboration profit sharing expenses increased 11% to $279 million in the first quarter of 2008 from the comparable period in 2007, primarily due to higher sales of Rituxan and Tarceva.

The following table summarizes the amounts resulting from the respective profit sharing collaborations for the periods presented (in millions):

	Three Months Ended March 31,
	2008		2007		% Change
U.S. Rituxan profit sharing expense	$	190	$	166		14	%
U.S. Tarceva profit sharing expense		48		39		23
Total Xolair profit sharing expense		41		47		(13	)
Total collaboration profit sharing expenses	$	279	$	252		11

Currently, our most significant collaboration profit sharing agreement is with Biogen Idec, with which we co-promote Rituxan in the U.S. Under the collaboration agreement, Biogen Idec granted us a worldwide license to develop, commercialize, and market Rituxan for multiple indications. In exchange for these worldwide rights, Biogen Idec has co-promotion rights in the U.S. and a contractual arrangement under which we share a portion of the pretax U.S. co-promotion profits of Rituxan and pay royalty expense based on sales of Rituxan outside the U.S. In June 2003, we amended and restated the collaboration agreement with Biogen Idec to include the development and commercialization of one or more anti-CD20 antibodies targeting B-cell disorders, in addition to Rituxan, for a broad range of indications.

Under the amended and restated collaboration agreement, our share of the current pretax U.S. co-promotion profit sharing formula is approximately 60% of operating profits, and Biogen Idec’s share is approximately 40%. For each calendar year or portion thereof following the approval date of the first new anti-CD20 product, after a period of transition, our share of the pretax U.S. co-promotion profits will change to approximately 70% of operating profits, and Biogen Idec’s share will be approximately 30%.

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Collaboration profit sharing expense, exclusive of R&D expenses, related to Biogen Idec for the periods ended March 31, 2008 and 2007 consisted of the following (in millions):

	Three Months Ended March 31,
	2008		2007		% Change
Product sales, net	$	605	$	535		13	%
Combined commercial and expenses		144		130		11
Combined co-promotion profits	$	461	$	405		14
Amount due to Biogen Idec for its share of co-promotion profits–included in collaboration profit sharing expense	$	190	$	166		14

In addition to Biogen Idec’s share of the combined co-promotion profits for Rituxan, collaboration profit sharing expense includes the quarterly settlement of Biogen Idec’s portion of the combined commercial costs. Since we and Biogen Idec each individually incur commercial costs related to Rituxan and the spending mix between the parties can vary, collaboration profit sharing expense as a percentage of sales can also vary accordingly.

Total revenue and expenses related to our collaboration with Biogen Idec included the following (in millions):

	Three Months Ended March 31,
	2008		2007		% Change
Contract revenue from Biogen Idec (R&D reimbursement)	$	33	$	21		57	%

Co-promotion profit sharing expense	$	190	$	166		14	%

Royalty expense on sales of Rituxan outside the U.S. and other patent costs–included in MG&A expenses	$	68	$	56		21	%

Recurring Amortization Charges Related to Redemption and Acquisition

On June 30, 1999, RHI exercised its option to cause us to redeem all of our Special Common Stock held by stockholders other than RHI. The Redemption was reflected as the purchase of a business, which under GAAP required push-down accounting to reflect in our financial statements the amounts paid for our stock in excess of our net book value.

On August 2, 2007, we acquired Tanox, Inc. In connection with the acquisition, we recorded approximately $814 million of intangible assets, representing developed product technology and core technology, which are being amortized over 12 years.

We recorded recurring charges related to the amortization of intangibles associated with the Redemption and push-down accounting and our acquisition of Tanox, Inc. These charges were $43 million in the first quarter of 2008 and $26 million in the first quarter of 2007.

Special Items: Litigation-Related

The California Supreme Court heard our appeal on the COH matter on February 5, 2008, and on April 24, 2008 overturned the award of $200 million in punitive damages to COH but upheld the award of $300 million in compensatory damages. As a result of the California Supreme Court decision, we recorded a net favorable litigation settlement of $301 million in the first quarter of 2008, which included $9 million of accrued interest and bond costs primarily related to the compensatory damages. In the first quarter of 2007, we recorded accrued interest and bond costs on both the compensatory and punitive damages totaling $13 million. Because the California Supreme Court decision occurred after we furnished our financial results for the quarter ended March 31, 2008 on Form 8-K, the net $301 million favorable litigation-related amount presented in our Condensed Consolidated Statement of Income for the three months ended March 31, 2008 is updated from the amount previously furnished

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with the Form 8-K dated April 10, 2008. See Note 5, “Contingencies,” in the Notes to the Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information regarding the COH litigation.

Operating Income

Operating income was $1,519 million in the first quarter of 2008, a 43% increase from the first quarter of 2007. Our operating income as a percentage of operating revenue (pretax operating margin) was 50% in the first quarter of 2008 and 37% in the first quarter of 2007.

Other Income (Expense)

The components of “Other income (expense)” were as follows (in millions):

	Three Months Ended March 31,
	2008			2007			% Change
Gains on sales of biotechnology equity securities, net	$	1		$	8			(88	) %
Write-downs of biotechnology debt and equity securities		–			(3	)		(100	)
Interest income(1)		69			69			0
Interest expense		(18	)		(18	)		0
Other miscellaneous income		4			–			–
Total other income, net	$	56		$	56			0

______________________

(1)	Interest income includes interest and dividend income, bond-related amortization, realized gains and losses on available-for-sale securities and trading securities, and changes in unrealized gains and losses on trading securities.

Other income, net for the first quarter of 2008 remained flat compared to the first quarter of 2007, as increased interest income in the first quarter of 2008 due to higher cash balances was offset by decreases in interest rates and losses on the sales of certain securities.

In 2008, we forecast “Other income, net” to decrease by more than 20% relative to 2007.

Income Tax Provision

Our effective income tax rate was 38% in the first quarter of 2008, an increase from 37% from the first quarter of 2007, mainly due to increased income before taxes as a result of the April 24, 2008 COH decision.

Financial Assets and Liabilities

On January 1, 2008, we adopted FAS 157, which established a framework for measuring fair value in GAAP and clarified the definition of fair value within that framework. FAS 157 does not require assets and liabilities that were previously recorded at cost to be recorded at fair value. For assets and liabilities that are already required to be disclosed at fair value, FAS 157 introduced, or reiterated, a number of key concepts which form the foundation of the fair value measurement approach to be used for financial reporting purposes. The fair value of our financial instruments reflects the amounts that would be received in connection with the sale of an asset or paid in connection with the transfer a liability in an orderly transaction between market participants at the measurement date (exit price). FAS 157 also established a fair value hierarchy that prioritizes the use of inputs used in valuation techniques into the following three levels:

Level 1—quoted prices in active markets for identical assets and liabilities.

Level 2—observable inputs other than quoted prices in active markets for identical assets and liabilities.

Level 3—unobservable inputs.

The adoption of FAS 157 did not have an effect on our financial condition or results of operations but FAS 157 introduced new disclosures about how we value certain assets and liabilities. Much of the disclosure is focused on the inputs used to measure fair value, particularly in instances where the measurement uses significant unobservable

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(Level 3) inputs. The substantial majority of our financial instruments are valued using quoted prices in active markets or based on other observable inputs. Our Level 1 assets include cash, money market instruments, U.S. Treasury securities, marketable equity securities and equity forwards. Level 2 assets include other government and agency securities, commercial paper, corporate bonds, asset-backed securities, municipal bonds, preferred securities and other derivatives. As of March 31, 2008, we held $163 million of investments, which were measured using unobservable (Level 3) inputs representing approximately 2% of our total fair value investments portfolio. The assets include $161 million of student loan auction-rate securities and $2 million of structured investment vehicle securities, for which fair value was determined based on broker-provided valuations, which approximate fair value. In February 2008, the auction-rate securities market experienced a number of failed auctions for student loan-backed securities, such as those held by us, which severely limited the liquidity for these securities. Due to market liquidity constraints related to the failed auctions, we classified the auction-rate securities as non-current assets consistent with the long-term maturity dates of the underlying student loans. As of March 31, 2008, we believe the unrealized losses in the auction rate securities are temporary and we have the ability to hold the assets to maturity. All of our auction-rate securities are AAA/Aaa-rated and are collateralized by student loans which are guaranteed by the U.S. government to be repaid at no less than 95% of par value. We held no auction rate securities as of December 31, 2007.

The following table sets forth the fair value of our financial assets and liabilities reported on a recurring basis including those pledged as collateral, or restricted (in millions).

	March 31, 2008				December 31, 2007
	Assets		Liabilities		Assets		Liabilities
Cash and cash equivalents	$	3,283	$	–	$	2,514	$	–
Restricted cash		788		–		788		–
Short-term investments		1,574		–		1,461		–
Long-term marketable debt securities		1,785		–		1,674		–
Total fixed income investment portfolio	$	7,430		–	$	6,437		–

Long-term marketable equity securities		416		–		416		–
Total derivative financial instruments		32		130		30		19
Total	$	7,878	$	130	$	6,883	$	19

Liquidity and Capital Resources

(In millions)

	March 31, 2008		December 31, 2007
Unrestricted cash, cash equivalents, short-term investments, and long-term marketable debt and equity securities	$	7,058	$	6,065
Net receivable—equity hedge instruments		11		24
Total unrestricted cash, cash equivalents, short-term investments, long-term marketable debt and equity securities, and equity hedge instruments	$	7,069	$	6,089
Working capital	$	5,920	$	4,835
Current ratio	2.6:1		2.2:1

Total unrestricted cash, cash equivalents, short-term investments, and long-term marketable securities, including the fair value of the equity hedge instruments, was $7,069 million as of March 31, 2008, an increase of $980 million from December 31, 2007. This increase primarily reflects cash generated from operations and increases from stock option exercises, partially offset by cash used for capital expenditures. To mitigate the risk of market value fluctuations, certain of our biotechnology equity securities are hedged with forward contracts, which are carried at estimated fair value. See Note 4, “Investment Securities and Financial Instruments,” in the Notes to the Consolidated Financial Statements in Part II, Item 8 of the Form 10-K for the year ended December 31, 2007 for further information regarding activity in our marketable investment portfolio and derivative instruments.

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Cash Provided by Operating Activities

Cash provided by operating activities is primarily driven by increases in our net income. However, operating cash flows differ from net income as a result of non-cash charges or differences in the timing of cash flows and earnings recognition. Significant components of cash provided by operating activities are as follows:

Accounts payable, other accrued liabilities, and other long-term liabilities increased $12 million in the first quarter of 2008, mainly due to an increase in taxes payable, accrued clinical expenses, and accrued royalties related to growth in the business and timing of payments. These were partially offset by decreases in accrued compensation and other accrued liabilities due to the timing of payments.

Inventories decreased $22 million in the first quarter of 2008, as more products were sold than produced during the quarter.

Accounts receivable—product sales increased $42 million from December 31, 2007, primarily due to increased product sales and a decrease in outstanding credit notes applied to certain accounts receivable balances as of March 31, 2008 compared to December 31, 2007, mainly due to the timing of their application. The average collection period of our accounts receivable—product sales as measured in days sales outstanding (DSO) was 34 days as of March 31, 2008, compared to 33 days as of December 31, 2007 and 42 days as of March 31, 2007. The decrease in DSO from the first quarter of 2007 was primarily due to the reduction in the extended payment terms that we offered to certain wholesalers in conjunction with the launch of Lucentis on June 30, 2006. Accounts receivable related to royalties increased $82 million from December 31, 2007, due to increased royalty revenue. These increases in accounts receivable were partially offset by the receipt of payment from Roche of $113 million in the first quarter of 2008 related to their opt-in to our trastuzumab drug conjugate products. See “Related Party Transactions” below for further information on our relationship with Roche.

Cash Used in Investing Activities

Cash used in investing activities was primarily due to capital expenditures, and purchases, sales, and maturities of investments. Capital expenditures were $200 million in the first quarter of 2008. During the first quarter of 2008, capital expenditures were related to construction of our fill-finish facility in Hillsboro, Oregon and our E. coli production facility in Singapore; leasehold improvements for newly constructed buildings on our South San Francisco, California campus; and purchases of equipment and information systems.

We forecast that our 2008 capital expenditures will be approximately $900 million, excluding capitalized costs related to construction costs for which we are considered to be the owner during the construction period.

Cash Used in or Provided by Financing Activities

Cash used in or provided by financing activities includes activity under our employee stock plans. We received $147 million in the first quarter of 2008 related to stock option exercises and stock issuances under our employee stock purchase plan.

Under a stock repurchase program approved by our Board of Directors in December 2003 and most recently extended in April 2008, we are authorized to repurchase up to 150 million shares of our Common Stock for an aggregate amount of up to $10.0 billion through June 30, 2009. In this program, as in previous stock repurchase programs, purchases may be made in the open market or in privately negotiated transactions from time to time at management’s discretion. We also may engage in transactions in other Genentech securities in conjunction with the repurchase program, including certain derivative securities, although as of March 31, 2008, we have not engaged in any such transactions. We intend to use the repurchased stock to offset dilution caused by the issuance of shares in connection with our employee stock purchase plan. Although there are currently no specific plans for the shares that may be purchased under the program, our goals for the program are (1) to address provisions of our affiliation agreement with RHI related to maintaining RHI’s minimum ownership percentage, (2) to make prudent investments of our cash resources, and (3) to allow for an effective mechanism to provide stock for our employee stock purchase

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plans. See “Relationship with Roche Holdings, Inc.” below for more information on RHI’s minimum ownership percentage.

We enter into Rule 10b5-1 trading plans to repurchase shares in the open market during those periods when trading in our stock is restricted under our insider trading policy.

In November 2007, we entered into a prepaid share repurchase arrangement with an investment bank pursuant to which we delivered $300 million to the investment bank. Pursuant to this arrangement, the investment bank delivered approximately four million shares to us on March 31, 2008. The prepaid amount was reflected as a reduction of our stockholders’ equity as of December 31, 2007.

As of March 31, 2008, 79 million cumulative shares had been purchased under our stock repurchase program for $5.7 billion, and a maximum of 71 million additional shares for amounts totaling up to $4.3 billion may be purchased under the program through June 30, 2009.

The par value method of accounting is used for Common Stock repurchases. The excess of the cost of shares acquired over the par value is allocated to additional paid-in capital, with the amounts in excess of the estimated original sales price charged to retained earnings.

Off-Balance Sheet Arrangements

We have certain contractual arrangements that create potential risk for us and are not recognized in our Condensed Consolidated Balance Sheets. We believe that there have been no significant changes in the off-balance sheet arrangements disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007 that have, or are reasonably likely to have, a material current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Contractual Obligations

During the first quarter of 2008, we believe that there have been no significant changes in our payments due under contractual obligations, as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.

Contingencies

We are party to various legal proceedings, licensing and contract disputes, and other matters. See Note 5, “Contingencies,” in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.

Relationship with Roche Holdings, Inc.

We issue shares of Common Stock in connection with our stock option and stock purchase plans, and we may issue additional shares for other purposes. Our affiliation agreement with RHI provides, among other things, that with respect to any issuance of our Common Stock in the future, we will repurchase a sufficient number of shares so that immediately after such issuance, the percentage of our Common Stock owned by RHI will be no lower than 2% below the “Minimum Percentage” (subject to certain conditions). The Minimum Percentage equals the lowest number of shares of Genentech Common Stock owned by RHI since the July 1999 offering (to be adjusted in the future for dispositions of shares of Genentech Common Stock by RHI as well as for stock splits or stock combinations) divided by 1,018,388,704 (to be adjusted in the future for stock splits or stock combinations), which is the number of shares of Genentech Common Stock outstanding at the time of the July 1999 offering, as adjusted for stock splits. We have repurchased shares of our Common Stock since 2001 (see discussion above in “Liquidity and Capital Resources”). The affiliation agreement also provides that, upon RHI’s request, we will repurchase shares of our Common Stock to increase RHI’s ownership to the Minimum Percentage. In addition, RHI will have a continuing option to buy stock from us at prevailing market prices to maintain its percentage ownership interest. Under the terms of the affiliation agreement, RHI’s Minimum Percentage is 57.7% and RHI’s ownership percentage is to be no lower than 55.7%. As of March 31, 2008, RHI’s ownership percentage was 55.8%.

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Related Party Transactions

We enter into transactions with our related parties, Roche and Novartis. The accounting policies that we apply to our transactions with our related parties are consistent with those applied in transactions with independent third parties, and all related party agreements are negotiated on an arm’s-length basis.

In our royalty and supply arrangements with related parties, we are the principal, as defined under EITF 99-19, because we bear the manufacturing risk, general inventory risk, and the risk to defend our intellectual property. For circumstances in which we are the principal in the transaction, we record the transaction on a gross basis in accordance with EITF 99-19; otherwise our transactions are recorded on a net basis.

Roche

We signed two product supply agreements with Roche in July 2006, each of which was amended in November 2007. The Umbrella Agreement supersedes our previous product supply agreements with Roche. The Short-Term Agreement supplements the terms of the Umbrella Agreement. Under the Short-Term Agreement, Roche has agreed to purchase specified amounts of Herceptin, Avastin, and Rituxan through 2008. Under the Umbrella Agreement, Roche has agreed to purchase specified amounts of Herceptin and Avastin through 2012 and, on a perpetual basis, either party may order other collaboration products from the other party, including Herceptin and Avastin after 2012, pursuant to certain forecast terms. The Umbrella Agreement also provides that either party may terminate its obligation to purchase and/or supply Avastin and/or Herceptin with six years notice on or after December 31, 2007. To date, we have not received such notice of termination from Roche.

Late in the first quarter of 2008, Roche acquired Ventana Medical Systems, Inc., and as a result of the acquisition, Ventana is considered a related party. We have engaged in transactions with Ventana prior to and since the acquisition, but these transactions have not been material to our results of operations.

We currently have no active profit sharing arrangements with Roche.

Under our existing arrangements with Roche, including our licensing and marketing agreement, we recognized the following amounts (in millions):

	Three Months Ended March 31,
	2008		2007
Product sales to Roche	$	136	$	264

Royalties earned from Roche	$	370	$	255

Contract revenue from Roche	$	20	$	30

Cost of sales on product sales to Roche	$	63	$	121

Research and development expenses incurred on joint development projects with Roche	$	70	$	58

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Certain R&D expenses are partially reimbursable to us by Roche. Amounts that Roche owes us, net of amounts reimbursable to Roche by us on these projects, are recorded as contract revenue. Conversely, R&D expenses may include the net settlement of amounts that we owe Roche for R&D expenses that Roche incurred on joint development projects, less amounts reimbursable to us by Roche on these projects.

Novartis

We have an agreement with Novartis Pharma AG under which Novartis Pharma AG has the exclusive right to develop and market Lucentis outside the U.S. for indications related to diseases or disorders of the eye. As part of this agreement, the parties share the cost of certain of our ongoing development expenses for Lucentis.

We, along with Novartis, are co-developing and are co-promoting Xolair in the U.S. We record all sales, COS, and marketing and sales expenses in the U.S.; Novartis markets the product in and records all sales, COS, and marketing and sales expenses in Europe. We and Novartis share the resulting U.S. and European operating profits according to prescribed profit sharing percentages. We record Novartis’s share of the U.S. operating profits as collaboration profit sharing expense. Our share of the European operating results was recorded as contract revenue in the first quarter of 2008 and collaboration profit sharing expense in the first quarter of 2007. Effective with our acquisition of Tanox, Inc. on August 2, 2007, Novartis also makes: (1) additional profit sharing payments to us on U.S. sales of Xolair, which reduces our profit sharing expense; (2) royalty payments to us on sales of Xolair worldwide, which we record as royalty revenue; and (3) manufacturing service payments related to Xolair, which we record as contract revenue.

Under our existing arrangements with Novartis, we recognized the following amounts (in millions):

	Three Months Ended March 31,
	2008		2007
Product sales to Novartis	$	4	$	2

Royalties earned from Novartis	$	53	$	5

Contract revenue from Novartis	$	11	$	40

Cost of sales on product sales to Novartis	$	3	$	3

Research and development expenses incurred on joint development projects with Novartis	$	9	$	10

Collaboration profit sharing expense to Novartis	$	41	$	47

Contract revenue in the first quarter of 2007 included a $30 million milestone payment from Novartis for European Union approval of Lucentis for the treatment of AMD.

Certain R&D expenses are partially reimbursable to us by Novartis. Amounts that Novartis owes us, net of amounts reimbursable to Novartis by us on these projects, are recorded as contract revenue. Conversely, R&D expenses may include the net settlement of amounts that we owe Novartis for R&D expenses that Novartis incurred on joint development projects, less amounts reimbursable to us by Novartis on these projects.

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Stock Options

Option Program Description

Our employee stock option program is a broad-based, long-term retention program that is intended to attract and retain talented employees and to align stockholder and employee interests. Our program primarily consists of our 2004 Equity Incentive Plan (the Plan), a broad-based plan under which stock options, restricted stock, stock appreciation rights, and performance shares and units may be granted to employees, directors, and other service providers. Substantially all of our employees participate in our stock option program. In the past, we granted options under our amended and restated 1999 Stock Plan, 1996 Stock Option/Stock Incentive Plan, our amended and restated 1994 Stock Option Plan, and our amended and restated 1990 Stock Option/Stock Incentive Plan. Although we no longer grant options under these plans, exercisable options granted under almost all of these plans are still outstanding.

All stock option grants are made with the approval of the Compensation Committee of the Board of Directors or an authorized delegate. See “Compensation Discussion and Analysis” in our 2008 Proxy Statement for further information concerning the policies and procedures of the Compensation Committee regarding the use of stock options.

General Option Information

Summary of Option Activity

(Shares in millions)

				Options Outstanding
	Shares Available for Grant			Number of Shares			Weighted-Average Exercise Price
December 31, 2006		68.7			88.3		$	54.43
Grants		(17.8	)		17.8			79.40
Exercises		–			(10.4	)		32.76
Cancellations		3.5			(3.5	)		76.45
December 31, 2007		54.4			92.2		$	60.94
Grants		(0.3	)		0.3			72.17
Exercises		–			(3.5	)		35.05
Cancellations		1.2			(1.2	)		79.96
March 31, 2008 (Year to Date)		55.3			87.8		$	61.76

In-the-Money and Out-of-the-Money Option Information

(Shares in millions)

	Exercisable				Unexercisable				Total
As of March 31, 2008	Shares		Weighted-Average Exercise Price		Shares		Weighted-Average Exercise Price		Shares		Weighted-Average Exercise Price
In-the-Money		43	$	41.70		28	$	77.20		71	$	55.78
Out-of-the-Money(1)		10		86.05		7		85.84		17		85.97
Total Options Outstanding		53				35				88

___________

(1)	Out-of-the-money options are those options with an exercise price equal to or greater than the fair market value of Genentech Common Stock, $81.18, at the close of business on March 31, 2008.

Dilutive Effect of Options

Grants, net of cancellations, as a percentage of outstanding shares were (0.08)% for the first quarter of 2008, 1.36% for the year ended December 31, 2007, and 1.43% for the year ended December 31, 2006.

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Equity Compensation Plan Information

Our stockholders have approved all of our equity compensation plans under which options are outstanding.

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This report contains forward-looking statements regarding our Horizon 2010 strategy of bringing new molecules into clinical development, bringing major new products or indications onto the market, becoming the number one U.S. oncology company in sales, and achieving certain financial growth measures; our internal stretch goal to add a total of 30 molecules into development; the evaluation of data from clinical studies; Avastin sales growth; reimbursement for Lucentis; sales to collaborators; Herceptin pricing terms; foreign currency option contracts and forwards; royalty and contract revenue; other income, net; auction rate securities; payments related to the City of Hope litigation; our rights and liabilities under collaboration agreements; compensation charges associated with voluntary severance; and capital expenditures.

These forward-looking statements involve risks and uncertainties, and the cautionary statements set forth below and those contained in “Risk Factors” in this Quarterly Report on Form 10-Q identify important factors that could cause actual results to differ materially from those predicted in any such forward-looking statements. Such factors include, but are not limited to, difficulty in enrolling patients in clinical trials; the need for additional data, data analysis or clinical studies; BLA preparation and decision making; FDA actions or delays; failure to obtain or maintain FDA approval; difficulty in obtaining materials from suppliers; unexpected safety, efficacy or manufacturing issues for us or our contract/collaborator manufacturers; increased capital expenditures including greater than expected construction and validation costs; product withdrawals; competition; efficacy data concerning any of our products which shows or is perceived to show similar or improved treatment benefit at a lower dose or shorter duration of therapy; pricing decisions by us or our competitors; our ability to protect our proprietary rights; the outcome of, and expenses associated with, litigation or legal settlements; increased R&D, MG&A, stock-based compensation, environmental and other expenses, and increased COS; variations in collaborator sales and expenses; our indebtedness and ability to pay our indebtedness; actions by Roche that are adverse to our interests; decreases in third party reimbursement rates; and greater than expected income tax rate. We disclaim and do not undertake any obligation to update or revise any forward-looking statement in this Quarterly Report on Form 10-Q.

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