Subpoena May Spoil Genentech's Earnings Party

The company has high hopes for two new drugs, but a probe into Rituxan may divert investors' attention.
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Updated from 6:58 a.m. EDT

The drugs Avastin and Tarceva might be the keys to

Genentech's

(DNA)

future, but company executives may have to dwell on the past a little bit more than they would like to Wednesday afternoon when they discuss third-quarter results with analysts and investors.

That's because Genentech disclosed late Monday that the U.S. attorney in eastern Pennsylvania had subpoenaed documents about Rituxan, its treatment for non-Hodgkin's lymphoma, which is sold in the U.S. through a joint venture between Genentech and

Biogen Idec

(BIIB) - Get Report

. Genentech said the "inquiry is both civil and criminal in nature," adding that the subpoena is related to the promotion of the drug. The company offered no other details.

After the markets closed and ahead of its earnings conference call Wednesday, the company said it earned 230.9 million, or 21 cents a share. That compares with earnings of $143.9 million, or 14 cents a share on a split-adjusted basis, for the same period last year. Non a non-GAAP basis, the company earned 24 cents a share.

The consensus view on Wall Street was net income of $228.9 million, or 21 cents a share, on sales of $1.2 billion for the three months ended Sept. 30, according to Thomson First Call.

For Genentech earnings, it's a tale of three money-spinners: past, present and future.

Rituxan, which is also being considered for other treatments, is currently Genentech's top drug. For the first six months of this year, the drug produced $825 million in sales, or 39% of corporate revenue. Rituxan, which reached the market in late 1997, recorded revenue of $1.49 billion last year.

Avastin, an advanced colon cancer drug, is viewed as the key sales and earnings propellant in the near term, while the experimental Tarceva, whose late-stage clinical tests have shown promising results in lung cancer and advanced pancreatic cancer, is looked upon as an integral part of Genentech's long-term financial vision.

Fast Start for Avastin

"Avastin is the most important driver of Genentech's future revenue growth, and should contribute more than 42% of total top-line growth and 50% of EPS growth through 2008," said Geoffrey C. Porges of Sanford C. Bernstein & Co., in a late September report to clients. He has a market perform rating on the stock. (He doesn't own shares; his firm doesn't have an investment banking relationship.)

Avastin was approved by the Food and Drug Administration in late February, adding to the company's anticancer drug arsenal that includes Herceptin, for advanced breast cancer, and Rituxan.

Avastin produced $133 million in sales for the second quarter, and Porges said he was raising his third-quarter estimate by $28 million to $169 million and his fourth-quarter revenue prediction by $24 million to $183 million.

Illustrating the what-have-you-done-for-me-lately approach on Wall Street, Porges noted that "the focus for Genentech and its investors recently shifted" from Avastin to Tarceva, because of the recent release of

clinical test results on Tarceva's treatment of patients with non-small-cell lung cancer and the

company's application to the Food and Drug Administration for that treatment.

High Hopes for Tarceva

The FDA recently announced that Tarceva would be evaluated under an accelerated review program. Genentech's partners in developing and marketing Tarceva are

OSI Pharmaceuticals

(OSIP)

and Switzerland's

Roche

, which owns 58.3% of Genentech's common shares.

Two weeks ago, the companies unveiled results of a late-stage clinical test showing that Tarceva, plus a standard chemotherapy drug, provided a small but statistically significant benefit in

treating patients with advanced pancreatic cancer. These patients were compared with patients who had received chemotherapy plus placebo.

Despite the promise of Tarceva and the momentum of Avastin, Porges pointed out potential risks for Genentech's financial progress, most notably the recent company warning of "serious thromboembolic adverse events" linked to taking Avastin. Those events include stroke, heart attacks, heart-related chest pains and death caused by blood clots. In tests involving patients with advanced colon cancer, the warning says, the risk of a dangerous side effect was approximately twice as great for patients receiving Avastin.

Warning Signs

Although Genentech sent a "Dear Doctor" letter in mid-August informing physicians of potential side effects, Porges said the warning "should not surprise well-informed physicians, but may alarm patients and less expert practitioners."

A recent report by the SG Cowen brokerage said the "Dear Doctor" letter "appears to have had some impact already on Avastin sales in August." Cowen, which doesn't provide stock ratings, added that "although Avastin appears to be tracking ahead of expectations, we believe the potential for future sales revisions to spark upside in Genentech shares is modest."

A Cowen survey of physicians showed that 50% used Avastin as a first-line therapy in August, down from 54% in July, suggesting that the "Dear Doctor" letter had some effect. However, the percentage of doctors using the drug as a second-line therapy grew to 25% in August from 16% in July, and the percentage of physicians using the drug as a third-line therapy advanced to 10% from 7%.

The survey found that physicians concerned about these side effects cut their use of Avastin by 18% and that physicians less concerned about the side effects increased their usage. The Cowen report acknowledged that extrapolating the views of 27 oncologists to the total market "holds much potential for error." The firm added that it still believes Avastin will continue to grab more market share in the colorectal cancer market, and "could provide further upside" to Wall Street estimates. (None of Cowen's health care analysts owns shares of Genentech; the firm says it seeks to do business with companies featured in its research reports.)