________________________

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 [x]  No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes [x]  No [ ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

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. 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); Herceptin® (trastuzumab) anti-HER2 antibody; Lucentis™ (ranibizumab, rhuFab V2) 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; Nutropin Depot® (somatropin (rDNA origin) for injectable suspension) encapsulated sustained-release growth hormone; Omnitarg™ (pertuzumab) HER dimerization inhibitor; Protropin® (somatrem for injection) 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 HC1) is a trademark of OSI Pharmaceuticals, Inc.; and Xolair® (omalizumab) anti-IgE antibody is a trademark of Novartis AG. This report also includes other trademarks, service marks and trade names of other companies.

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We prepared the condensed consolidated financial statements following the requirements of the Securities and Exchange Commission for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by accounting principles generally accepted in the United States of America (or "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, 2004. In the opinion of management, the financial statements include all normal and recurring adjustments that are considered necessary for the fair presentation of our financial position and operating results.

Revenues, 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.

The condensed consolidated financial statements include the accounts of Genentech and all subsidiaries. Genentech also consolidated a variable interest entity (or "VIE") in which Genentech is the primary beneficiary pursuant to Financial Accounting Standards Board (or "FASB") Interpretation No. 46 (or "FIN 46") "Consolidation of Variable Interest Entities," as amended, and recorded the noncontrolling interest in the consolidated balance sheet. Material intercompany accounts and transactions have been eliminated.

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 from those estimates.

Certain reclassifications of prior period amounts have been made to our condensed consolidated financial statements to conform to the current year presentation.

In December 2004, the FASB issued a revision of Statement of Financial Accounting Standards (or "FAS") No. 123, "Accounting for Stock-Based Compensation." The revision is referred to as "FAS 123R -- Share-Based Payment", effective for reporting periods beginning after June 15, 2005. On April 14, 2005, the Securities and Exchange Commission (or the "SEC") adopted a rule amendment that delayed the compliance dates for FAS 123R such that we are now allowed to adopt the new standard no later than January 1, 2006. FAS 123R supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," (or "APB 25") and will require companies to recognize compensation expense, using a fair-value based method, for costs related to share-based payments including stock options and stock issued under our employee stock purchase plans. We expect to adopt FAS 123R using the modified prospective basis measured and recognized on January 1, 2006. We expect that our adoption of FAS 123R will result in compensation expense comparable to those disclosed below, before the effect of capitalization of manufacturing related compensation expenses. We are currently evaluating option valuation methodologies and assumptions in light of FAS 123R; the methodologies and assumptions we ultimately use to adopt FAS 123R may be different than those currently used as discussed below in "Accounting for Stock-Based Compensation" section of this

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note. We currently expect that our adoption of FAS 123R will have a material impact on our consolidated results of operations.

Until we adopt FAS 123R, we will continue to follow APB 25 to account for employee stock options, because the alternative fair value method of accounting prescribed by FAS No. 123 requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, the intrinsic value method of accounting, no compensation expense is recognized because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant. We apply FAS 123 for disclosure purposes only.

The following proforma net income and earnings per share were determined as if we had accounted for our employee stock options and employee stock plan under the fair value method prescribed by FAS 123. The resulting effect on net income and earnings per share pursuant to FAS 123 is not likely to be representative of the effects in future periods, due to subsequent additional option grants and periods of vesting.

The Black-Scholes option valuation model was developed for use in estimating the fair value of publicly traded options, which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions and these assumptions can vary over time. Because our employee stock options and stock plan shares have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing valuation models do not provide a reliable measure of the fair value of our employee stock options.

The fair value of options was estimated at the date of grant using a Black-Scholes option valuation model with the following weighted-average assumptions:

Due to the redemption of our special common stock in June 1999 (or "Redemption"), there is limited historical information available to determine the necessary inputs to value employee stock options and the stock issued under the employee stock plan. In 2004, having completed our first full four-year option vesting cycle on options issued after the Redemption, and having further analyzed economic data from marketable instruments and comparable

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companies, the assumptions for volatility and expected lives were further refined to reflect what management believes to be a better measure of fair value. However, changes in these assumptions did not materially impact compensation expense presented above.

The following is a reconciliation of the denominator used in basic and diluted earnings per share (or "EPS") computations (in thousands):

The following is a summary of the outstanding options to purchase common stock that were excluded from the computation of diluted EPS because such options were anti-dilutive (in thousands, except for exercise prices):

Comprehensive income is comprised of net income and other comprehensive income (or "OCI"). OCI includes certain changes in stockholders' equity that are excluded from net income. Specifically, we include in OCI changes in the fair value of derivatives designated as effective cash flow hedges and unrealized gains and losses on our available-for-sale securities.

The activity in comprehensive income, net of income taxes, during the first quarters of 2005 and 2004 was as follows (in millions):

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

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The activity in OCI, net of income taxes, related to our available-for-sale securities and cash flow hedges was as follows (in millions):

At March 31, 2005, net losses on derivative instruments expected to be reclassified from accumulated other comprehensive income to "other income, net" during the next twelve months are $5.2 million. These net losses are primarily due to the recognition of premiums related to maturing foreign currency exchange options.

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

The components of our other intangible assets, including those that are acquisition-related and arising from the Redemption and push-down accounting were as follows (in millions):

Amortization expense of our other intangible assets was $39.5 million and $43.0 million for the first quarters of 2005 and 2004, respectively.

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The expected future annual amortization expense of our other intangible assets is as follows (in millions):

During the quarter ended March 31, 2005, there were no significant changes to our synthetic lease arrangements, or our assessment of those arrangements under the provisions of FIN 46R, a revision of Interpretation 46, as discussed in Note 6, "Leases, Commitments and Contingencies" of our Annual Report on Form 10-K for the year ended December 31, 2004.

In December 2004, we entered into a Master Lease Agreement with Slough SSF, LLC for the lease of property adjacent to the Company's South San Francisco campus. The property will be developed into eight buildings and two parking structures. The lease of the property will take place in two phases pursuant to separate lease agreements for each building as contemplated by the Master Lease Agreement. Phase I building leases will begin throughout 2006 and Phase II building leases may begin as early as 2008. For accounting purposes, due to the nature of our involvement with the construction of the buildings subject to the Master Lease Agreement, we are considered to be the owner of the assets during the construction period through the lease commencement date, even though the funds to construct the building shell and some infrastructure costs are paid by the lessor. As such, in the first quarter 2005, we have capitalized $44.0 million of construction costs in property, plant and equipment, and have also recognized a corresponding amount as a construction financing obligation in long-term debt in the accompanying condensed consolidated balance sheet. We expect at the time of completion of the project, if all the buildings and infrastructure were completed by the lessor, our construction asset and related obligation will be in excess of $365.0 million. Our aggregate lease payments as contemplated by the Master Lease Agreement through 2020 (if there is no acceleration or delay in the rent commencement date for the second phase of the buildings) will be approximately $540.1 million.

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

On October 4, 2004, we received a subpoena from the United States (or "U.S.") Department of Justice, requesting documents related to the promotion of Rituxan, a prescription treatment approved for the treatment of relapsed or refractory, low-grade or follicular, CD20 positive, B-cell non-Hodgkin's lymphoma. We are cooperating with the associated investigation, which we have been advised is both civil and criminal in nature. The outcome of this matter cannot be determined at this time.

We and the City of Hope National Medical Center (or "COH") are parties to a 1976 agreement relating 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, Genentech has entered into license agreements with various companies to make, use and sell the products covered by the Riggs/Itakura Patents. On August 13, 1999, the COH filed a complaint against us in the Superior Court in Los Angeles County, California, alleging that we owe

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royalties to the 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 the COH approximately $300 million in compensatory damages. On June 24, 2002, a jury voted to award the COH an additional $200 million in punitive damages. Such amounts were accrued as an expense in the second quarter of 2002 and were included in the condensed consolidated balance sheets in "litigation-related and other long-term liabilities" at March 31, 2005 and December 31, 2004. Genentech filed a notice of appeal of the verdict and damages awards with the California Court of Appeal. On 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, Genentech filed a petition seeking review by the California Supreme Court. On February 2, 2005, the California Supreme Court granted that petition. The amount of cash paid, if any, or the timing of such payment in connection with the COH matter will depend on the outcome of the California Supreme Court's review of the matter; however, we expect that it will take longer than one year to further resolve the matter.

On August 12, 2002, the U.S. Patent and Trademark Office (or "Patent Office") declared an interference between U.S. Patent No. 6,054,561, owned by Chiron Corporation (or "Chiron"), and a patent application exclusively licensed by Genentech from a university relating to anti-HER2 antibodies. On October 24, 2002, the Patent Office redeclared the interference to include, in addition to the above-referenced Chiron patent and university patent application, a number of patents and patent applications owned by either Chiron or Genentech, including Chiron's U.S. Patent No. 4,753,894 that is also at issue in the separate patent infringement lawsuit described below. On November 30, 2004, the Patent Office's Board of Patent Appeals and Interferences issued rulings on several preliminary motions. These rulings terminated both interferences involving the patent application referenced above that Genentech licensed from a university, redeclared interferences between the Genentech and Chiron patents and patent applications, and made several determinations which could affect the validity of the Genentech and Chiron patents and patent applications involved in the remaining interferences. On January 28, 2005, Genentech filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit. Because the appeal process and further interference proceedings are ongoing, the outcome of this matter cannot be determined at this time.

On March 13, 2001, Chiron filed a patent infringement lawsuit against us in the U.S. District Court in the Eastern District of California, alleging that the manufacture, use, sale and/or offer for sale of our Herceptin antibody product infringes Chiron's U.S. Patent No. 4,753,894. Chiron is seeking compensatory damages for the alleged infringement, additional damages, and attorneys' fees and costs. Genentech filed a motion to dismiss this lawsuit, which was denied. On November 1, 2002, the parties filed a proposed stipulation to stay all proceedings in this lawsuit until (1) the interference involving U.S. Patent No. 4,753,894 is resolved or two years from entry of the proposed stipulation, whichever is sooner. On or about November 13, 2002, the Court entered the stipulation, staying the proceedings as requested by the parties. On November 10, 2004, the Court extended the stay until the resolution of all proceedings before the United States Supreme Court in a separate Chiron suit that has now been concluded. This lawsuit is separate from and in addition to the Chiron interference mentioned above. The final outcome of this matter cannot be determined at this time.

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 '415 patent") that is co-owned by Genentech and COH and under which MedImmune and other companies have been licensed and are paying royalties to Genentech. The lawsuit includes claims for violation of antitrust, patent, and unfair competition laws. MedImmune is seeking to have the '415 patent declared invalid and/or unenforceable, a determination that MedImmune does not owe royalties under the '415 patent on sales of its Synagis® antibody product, an injunction to prevent Genentech from enforcing the '415 patent, an award of actual and exemplary damages, and other relief. On January 14, 2004 (amending a December 23, 2003 Order), the U.S. District Court granted summary judgment in Genentech's favor on all of MedImmune's antitrust and unfair competition claims. MedImmune sought to amend its complaint to reallege certain claims for antitrust and unfair competition. On February 19, 2004, the Court denied this motion in its entirety and final judgment was entered in favor of Genentech and Celltech and against MedImmune on March 15, 2004 on all antitrust and unfair competition claims. MedImmune filed a notice of appeal of this judgment with the U.S. Court of Appeals for the Federal Circuit.

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Concurrently, in the District Court litigation, Genentech filed a motion to dismiss all remaining claims in the case. On April 23, 2004, the District Court granted Genentech's motion and dismissed all remaining claims. Final judgment was entered in Genentech's favor on May 3, 2004, thus concluding proceedings in the District Court. MedImmune filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit. Oral argument of MedImmune's appeal was held on February 10, 2005. Because the appeal process is ongoing, the final outcome of this matter cannot be determined at this time.

We recorded $13.5 million and $13.4 million for the three months ended March 31, 2005 and 2004, respectively, for accrued interest and bond costs related to the COH trial judgment. In conjunction with the City of Hope judgment, we posted a surety bond and were required to pledge cash and investments of $682.0 million at March 31, 2005 and December 31, 2004 to secure the bond. These amounts are reflected in the condensed consolidated balance sheets in "restricted cash and investments." We expect that we will continue to incur interest charges on the judgment and service fees on the surety bond each quarter through the process of appealing the COH trial results.

We expect from time to time to issue additional 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 Roche provides, among other things, that we establish a stock repurchase program designed to maintain Roche's percentage ownership interest in our common stock. The affiliation agreement provides that we will repurchase a sufficient number of shares pursuant to this program such that, with respect to any issuance of common stock by Genentech in the future, the percentage of Genentech common stock owned by Roche immediately after such issuance will be no lower than Roche's lowest percentage ownership of Genentech common stock at any time after the offering of common stock occurring in July 1999 and prior to the time of such issuance, except that Genentech may issue shares up to an amount that would cause Roche's lowest percentage ownership to be no more than 2% below the "Minimum Percentage." The Minimum Percentage equals the lowest number of shares of Genentech common stock owned by Roche since the July 1999 offering (to be adjusted in the future for dispositions of shares of Genentech common stock by Roche 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 the two-for-one splits of Genentech common stock in November 1999, October 2000 and May 2004. We repurchased shares of our common stock in 2005 and 2004 (see discussion below in "Liquidity and Capital Resources -- Cash Provided by or Used in Financing Activities" in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 of this Form 10-Q). As long as Roche's percentage ownership is greater than 50%, prior to issuing any shares, the affiliation agreement provides that we will repurchase a sufficient number of shares of our common stock such that, immediately after our issuance of shares, Roche's percentage ownership will be greater than 50%. The affiliation agreement also provides that, upon Roche's request, we will repurchase shares of our common stock to increase Roche's ownership to the Minimum Percentage. In addition, Roche will have a continuing option to buy stock from us at prevailing market prices to maintain its percentage ownership interest. At March 31, 2005, Roche's ownership percentage was 56.0%. The Minimum Percentage at March 31, 2005 was 57.7% and, under the terms of the affiliation agreement, Roche's lowest ownership percentage is to be 55.7%. At April 26, 2005, Roche's ownership percentage was 0.1% below the lowest ownership percentage. Genentech and Roche are in discussion concerning this matter.

We enter into transactions with our related parties, Roche Holdings, Inc. (including F. Hoffmann-La Roche (or "Hoffmann-La Roche") and other affiliates) and Novartis Pharma AG (or "Novartis"), in the ordinary course of business. The accounting policies we apply to our transactions with our related parties are consistent with those

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applied in transactions with independent third-parties and all related party agreements are negotiated on an arm's-length basis.

Under our existing arrangements with Hoffmann-La Roche, including our licensing and marketing agreement, we recognized contract revenue from Hoffmann-La Roche, including amounts earned related to ongoing development activities, of $16.5 million and $25.8 million in the first quarters of 2005 and 2004, respectively. All other revenues from Hoffmann-La Roche and their affiliates, principally royalties and product sales, were $155.9 million and $98.9 million in the first quarters of 2005 and 2004, respectively. Cost of sales included amounts related to Hoffmann-La Roche of $47.2 million and $22.4 million in the first quarters of 2005 and 2004, respectively. R&D expenses included amounts related to Hoffmann-La Roche of $32.4 million and $31.2 million in the first quarters of 2005 and 2004, respectively.

We understand that The Novartis Group holds approximately 33.3% of the outstanding voting shares of Roche Holding Ltd. As a result of this ownership, The Novartis Group is deemed to have an indirect beneficial ownership interest under FAS 57 "Related Party Disclosures" of more than 10% of Genentech's voting stock.

Under an arrangement with Novartis, a holding company of The Novartis Group, and Tanox, Inc., we currently supply Xolair and receive cost plus a mark-up similar to other supply arrangements. Novartis is expected to undertake primary bulk manufacturing responsibility in late 2005 or early 2006. Future production costs of Xolair may initially be higher than those currently reflected in our cost of sales as a result of any production shift from Genentech to Novartis, or to any other party, until production economies of scale can be achieved by that manufacturing party.

Collaboration profit sharing expenses were $23.6 million in the first quarter of 2005 and $11.8 million in the first quarter of 2004. R&D expenses include amounts related to Novartis of $9.7 million in the first quarters of 2005 and 2004. Revenue from Novartis related to product sales and the associated cost of sales were $3.3 million and $2.8 million, respectively, in the first quarter of 2005. Revenue from Novartis related to product sales and the associated cost of sales was not material in the first quarter of 2004. Contract revenue from Novartis related to manufacturing, commercial and ongoing development activities, was $10.0 million in the first quarter of 2005 and $10.8 million in the first quarter of 2004.

The effective income tax rate was 36% in the first quarter of 2005 compared to 34% in the first quarter of 2004. The increase in the income tax rate primarily reflects increased income before taxes and reduced benefits from R&D tax credits. The income tax provision for the first quarter of 2004 included a benefit of $6.5 million related to a favorable change in estimates of research credits.

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We have reviewed the accompanying condensed consolidated balance sheet of Genentech, Inc. as of March 31, 2005, and the related condensed consolidated statements of income and cash flows for the three-month periods ended March 31, 2005 and 2004. These financial statements are the responsibility of Genentech's management.

We conducted our reviews 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 to financial data, 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 reviews, we are not aware of any material modifications that should be made to the accompanying 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, 2004, 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 18, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Palo Alto, California
April 11, 2005

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GENENTECH, INC.
FINANCIAL REVIEW

Genentech is a leading biotechnology company that discovers, develops, manufactures, and commercializes biotherapeutics for significant unmet medical needs. Genentech manufactures and commercializes multiple biotechnology products directly in the United States (or "U.S."), and receives royalties from companies that are licensed to market products based on our technology.

In the first quarter of 2005, our total operating revenues were $1,461.6 million and our net income was $284.2 million. For the remainder of 2005, we expect the growth of our business to continue to be driven by sales of our new products, Tarceva, Avastin, Xolair and Raptiva and continued sales of our established oncology products, Rituxan and Herceptin. We also expect sales of our other products, contract revenues and royalties to continue to contribute to the bottom-line.

We are in the final year of our 5x5 plan. We expect to exceed our most important goal of average annual non-GAAP EPS growth, while we do not expect to meet our non-GAAP net income as a percentage of total operating revenues goal, due primarily to the success of Rituxan and the associated profit split. We are well positioned to exceed our goal of five significant products/indications in late stage development and have already exceeded our goal of five new products or indications approved through 2005. We expect to have substantive progress against our goal of $500 million in new revenue from alliances and/or acquisitions, but we are uncertain if we will meet this goal due in part to the fact that we have changed our strategic focus to pursue earlier stage opportunities. Information on our 5x5 plan can be found on our website at http://www.gene.com.

Our long-term business objectives are reflected in our Horizon 2010 strategy and goals summarized below and on our website at http://www.gene.com.

• To aim to become the number one U.S. oncology company (measured by U.S. sales) by 2010.

• To position ourselves for continued leadership in our oncology business by bringing five new oncology products or indications for existing products into clinical development and into the market by 2010.

• To build a leading immunology business by expanding the fundamental understanding of immune disorders, bringing at least five new immunology products or indications into clinical development, and obtaining U.S. Food and Drug Administration (or "FDA") approval of at least five new indications or products by 2010.

• To increase our leadership in developing biotherapeutics for disorders of tissue growth and repair, with a major focus on angiogenic disorders, and to move at least three new projects into late-stage research or developmental research and three or more new projects into clinical development by 2010.

• To achieve average annual non-GAAP EPS growth rates through 2010 sufficient to be considered a growth company.

Achieving these goals depends on our ability to make and capitalize on advances in basic research, to rapidly complete clinical development while designing high-quality trials, to shape the markets for our products, to increase our manufacturing capabilities and to maintain our unique corporate culture. These goals and objectives are further challenged by economic and industry-wide factors that affect our business. Some of the most important factors are discussed below:

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• Successful development of biotherapeutics is highly difficult and uncertain. Our long-term business growth depends upon our ability to commercialize important new therapeutics to treat unmet medical needs such as cancer. Since the underlying biology of these diseases is not completely understood, it is very challenging to discover and develop safe and effective treatments, and the majority of potential new therapeutics fail to generate the safety and efficacy data required to obtain regulatory approval. In addition, there is tremendous competition in the diseases of interest to us. Our business requires significant investments in research and development over many years, often for products that fail during the R&D process. In addition, after our products receive FDA approval, they remain subject to ongoing FDA regulation, including changes to the product label, new or revised regulatory requirements for manufacturing practices, written advisement to physicians, or product recalls. We believe that our continued focus on excellent science, compelling biological mechanisms, and designing high quality clinical trials to address significant medical needs positions us well to deliver sustainable growth.

• Intellectual property protection of our products is crucial to our business. Loss of effective intellectual property protection on one or more products could result in lost sales to competing products and negatively affect our sales, royalty revenues 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 biotherapeutics is difficult and complex, and requires facilities specifically designed and validated to run biotechnology production processes where protein biotherapeutics are involved. The manufacture of a biotherapeutic requires proper formulation of the product involved, executing on and scaling the manufacturing process used for that product, obtaining regulatory approval to manufacture the product, and is subject to changes in regulatory requirements or standards that may require modifications to the involved manufacturing process or to a manufacturing process used by our contract-manufacturers. In connection with our manufacturing efforts, we may need to record period charges associated with manufacturing failures or inefficiencies or other production-related costs that are not absorbed into inventory. In addition, we may experience delays in the shipment of our products. We may also have inadequate manufacturing capacity to meet future demands. We anticipate that we may face a significant business challenge to increase bulk supply to keep pace with growing demand for our products. We are currently assessing our demand forecasts and our manufacturing plans in light of the recent successful clinical trial results for Avastin, Herceptin and Rituxan. If our forecasted demand significantly increases, or if actual demand exceeds our forecasts, or if our efforts to increase production (as described below) are unsuccessful and we are not able to find alternate sources of capacity, we may not have sufficient available bulk capacity to meet demand for some of our products. In order to maximize production output, we will need to successfully execute an aggressive production plan at all of our facilities and we will need to successfully implement all of our capacity enhancement projects, including start-up and licensure of our contract manufacturing facilities at Lonza Biologics and Wyeth Pharmaceuticals, licensure of our Porriño, Spain plant for commercial production, successful construction, qualification and licensure of our new plant in Vacaville, as well as qualification and licensure of yield improvements for the Avastin and Rituxan production processes. In addition, we are undertaking efforts to secure additional licensed filling capacity in order to mitigate the current risk associated with having a single licensed filling facility for many of our products. As part of this effort, we expect to begin constructing a new aseptic fill line in our South San Francisco plant in the third quarter of 2005. Further, we may incur period charges associated with securing alternate sources of capacity.

• The Medicare Modernization Act was enacted into law in December 2003. On November 3, 2004, the 2005 Physician Fee Schedule and Hospital Outpatient Prospective Payment System Final Rules were announced and were in-line with our expectations. As Centers for Medicare and Medicaid Services is our single largest payer, the new rules represent an important area of focus in 2005. We will be monitoring the situation closely and, in 2005, we continue to anticipate minimal impact to our revenues. To date, we have not seen any detectable effects of the new rules on our product sales.

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• With respect to follow-on biologics, we believe that current technology cannot prove a follow-on biotechnology product to be safe and effective outside the New Drug Application (or "NDA") and Biologics License Application (or "BLA") process. We filed a Citizen Petition with the FDA in April 2004 requesting that the agency re-assess its approach to approvals of follow-on biologics and put processes in place to protect trade secrets and confidential commercial data and information from use and disclosure by others. The FDA initiated a public process to discuss the complex scientific issues surrounding follow-on biologics and we participated in the FDA Stakeholder meeting in September 2004. Following this meeting, the FDA and Drug Information Association held a scientific workshop in February 2005, which we hope will be followed by a similar public discussion of the critical legal issues involved with establishing an approval pathway for follow-on biologics.

• The success of our company is predicated on its ability to recruit and retain highly qualified and talented people in all areas of the company. In 2004 we experienced a 23% growth in the number of employees. This significant growth in employees is challenging to manage, especially given our work environment where our culture is important for our success. 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.

We commercialize in the U.S. the biotechnology products listed below.

Rituxan (rituximab) anti-CD20 antibody, which we commercialize with Biogen Idec Inc. (or "Biogen Idec"), is approved for the treatment of patients with relapsed or refractory, low-grade or follicular, CD20-positive, B-cell non-Hodgkin's lymphoma.

Avastin (bevacizumab) is a humanized antibody that binds to vascular endothelial growth factor (or "VEGF") approved for use in combination with intravenous 5-fluorouracil-based chemotherapy as a treatment for patients with first-line (or previously untreated) metastatic cancer of the colon or rectum.

Herceptin (trastuzumab) anti-HER2 antibody is a humanized antibody for the treatment of certain patients with metastatic breast cancer. Herceptin is approved for use as a first-line therapy in combination with Taxol® (paclitaxel), a product made by Bristol-Myers Squibb Company, and as a single agent in second- and third-line therapy in patients with metastatic breast cancer who have tumors that overexpress the HER2 protein.

Tarceva (erlotinib), which we commercialize with OSI Pharmaceuticals, Inc. (or "OSI"), is a small molecule designed to block tumor cell growth by inhibiting the tyrosine kinase activity of HER1/epidermal growth factor receptor (or "EGFR") signaling pathway, approved for the treatment of patients with locally advanced or metastatic non-small cell lung cancer (or "NSCLC") after failure of at least one prior chemotherapy regimen.

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

Nutropin AQ [somatropin (rDNA origin) for injection] is a liquid formulation growth hormone approved for the same indications as Nutropin.

Nutropin Depot [somatropin (rDNA origin) for injectable suspension] is a long-acting growth hormone for the treatment of growth failure associated with pediatric growth hormone deficiency. On June 1, 2004, we and our collaborator Alkermes, Inc. made a decision to discontinue commercialization of Nutropin Depot. We expect sales of Nutropin Depot to cease in 2005.

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Activase (alteplase, recombinant) is a tissue plasminogen activator (or "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).

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.

TNKase (tenecteplase) is a single-bolus thrombolytic agent approved for the treatment of acute myocardial infarction (heart attack).

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

Xolair (omalizumab) is a humanized anti-IgE antibody, which we commercialize with Novartis Pharma AG (or "Novartis") in the United States, approved for the treatment of moderate-to-severe persistent asthma in adults and adolescents.

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.

We receive royalties from F. Hoffmann-La Roche (or "Hoffmann-La Roche") on sales of:

• Herceptin, Pulmozyme, and Avastin outside of the U.S.,

• Rituxan outside of the U.S., excluding Japan, and

• growth hormone products, Activase, Cathflo Activase and TNKase in Canada.

We also receive royalties on additional licensed products that are marketed by other companies. In January 2005, we entered into a patent license agreement with ImClone Systems Inc. (or "ImClone") under which we will receive certain royalties from ImClone on sales of ERBITUX® by ImClone and its commercialization partners.

The following information can be found on our website at http://www.gene.com or can be obtained free of charge by contacting our Investor Relations Department at (650) 225-1599 or by sending an e-mail message to investor.relations@gene.com:

• 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 reasonably practicable after such material is electronically filed with the Securities and Exchange Commission;

• our policies related to corporate governance, including Genentech's Principles of Corporate Governance, Good Operating Principles (Genentech's code of ethics applying to Genentech's directors, officers and employees) as well as Genentech's Code of Ethics applying to our Chief Executive Officer, Chief Financial Officer and senior financial officials; and

• the charter of the Audit Committee of our Board of Directors.

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The accompanying discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States (or "GAAP"). The preparation of these condensed consolidated financial statements requires us 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 making judgments about 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. Actual results could differ materially from these estimates.

We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates, assumptions and judgments about matters that are inherently uncertain.

We are currently involved in certain legal proceedings as discussed in Note 3, "Leases and Contingencies," in the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Form 10-Q. We assess the likelihood of any adverse judgments or outcomes to these legal matters as well as potential ranges of probable losses. As of March 31, 2005, we have accrued $638.5 million in "litigation-related and other long-term liabilities," which represents our estimate of the costs for the current resolution of these matters. 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 different than previously estimated could materially impact our financial position or our results of operations in any one quarter.

We recognize revenue from the sale of our products, royalties earned and contract arrangements. Our revenue arrangements with 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 applied to each of the separate units. Advance payments received in excess of amounts earned are classified as deferred revenue until earned.

• We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, title passes, the price is fixed and determinable, and collectibility is reasonably assured. Allowances are established for estimated discounts, product returns, bad debts, and rebates.

• We recognize revenue from royalties based on licensees' sales of our products or technologies. Royalties are recognized as earned in accordance with the contract terms when royalties from licensees can be reliably measured and collectibility is reasonably assured. Royalty estimates are made in advance of amounts collected using historical and forecasted trends.

• Contract revenue generally includes upfront and continuing licensing fees, manufacturing fees, milestone payments and reimbursements of development, post-marketing and certain commercial costs.

• Nonrefundable upfront fees, including product opt-ins, for which no further performance obligations exist are recognized as revenue on the earlier of when payments are received or collection is assured.

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• Nonrefundable upfront licensing fees, including product opt-ins, and certain guaranteed, time-based payments that require continuing involvement in the form of development, manufacturing or other commercialization efforts by us are recognized as revenue:

• ratably over the development period if development risk is significant, or

• ratably over the manufacturing period or estimated product useful life if development risk has been substantially eliminated.

• Upfront manufacturing fees are recognized as revenue as the related manufacturing services are rendered, generally on a straight-line basis over the longer of the manufacturing obligation period or the expected product life. Manufacturing profit is recognized when the product is shipped and title passes.

• Milestone payments are recognized as revenue when milestones, as defined in the contract, are achieved.

• Reimbursements of development, post-marketing and certain commercial costs are recognized as revenue as the related costs are incurred.

Income tax expense is based on pretax financial accounting income under the liability method. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates 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. We believe that our estimates are reasonable and that our reserves for income tax related uncertainties are adequate. Various internal and external factors may have favorable or unfavorable effects on our future effective tax rate. These factors include, but are not limited to, changes in tax laws, regulations and/or rates, changing interpretations of existing tax laws or regulations, future levels of R&D spending, and changes in overall levels of pretax earnings.

Inventories consist of currently marketed products, products manufactured under contract and product candidates awaiting regulatory approval, which are capitalized based on management's judgment of probable near term commercialization. The valuation of inventory requires us to estimate obsolete or excess inventory. The determination of obsolete or excess inventory requires us to estimate the future demands for our products, and in the case of pre-approval inventories, an estimate of the regulatory approval date for the product. We may be required to expense previously capitalized costs related to pre-approval inventory upon a change in such judgment, due to, among other potential factors, a denial or delay of approval by the necessary regulatory bodies. In the event that a pre-approval product candidate receives regulatory approval, subsequent sales of previously reserved inventory will result in increased gross margins.

Under Financial Accounting Standards Board Interpretation No. 46R (or "FIN 46R"), a revision to Interpretation 46, "Consolidation of Variable Interest Entities," we are required to assess new business development collaborations as well as to reassess, upon certain events, some of which are outside our control, the accounting treatment of our existing business development collaborations based on the nature and extent of our variable interests in the entities as well as the extent of our ability to exercise influence in the entities with which we have such collaborations. Our continuing compliance with FIN 46R may result in our consolidation of companies or related entities with which we have a collaborative arrangement and this may have a material impact on our financial condition and/or results of operations in future periods.

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___________

Total operating revenues increased 50% in the first quarter of 2005 from the comparable period in 2004. This increase was primarily due to higher product sales and royalty income. This increase is further discussed below.

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Total product sales increased 55% to $1,186.0 million in the first quarter of 2005 from the comparable period in 2004. Net U.S. sales increased 53% to $1,087.0 million in the first quarter of 2005 from the comparable period in 2004. The increase in net U.S. sales was due to higher sales across all products, in particular sales of our new products, Avastin and Tarceva, and higher sales of Rituxan, Xolair and Herceptin. Avastin was launched in February 2004 and Tarceva was launched in November 2004. Net U.S. oncology sales accounted for 75% of net U.S. product sales compared to 72% in the first quarter of 2004. Increased U.S. sales volume, including new product shipments, accounted for 92%, or $346.0 million, of the increase in U.S. net product sales in the first quarter of 2005. Changes in net U.S. sales prices across the portfolio accounted for an increase of 8%, or $30.0 million, of the increase in U.S. net product sales in the first quarter of 2005.

In the first quarter of 2005, net U.S. sales of Rituxan increased 22% to $440.5 million from the comparable period in 2004. Net U.S. sales in the first quarter of 2005 included $9.6 million for a reorder to replace a shipment that was destroyed while in transit to a wholesaler. Total demand driven net U.S. sales in the first quarter of 2005 were $430.9 million, a 19% growth over the first quarter of 2004. Net U.S. sales growth was primarily driven by increased sales volumes resulting from greater penetration in the non-Hodgkin's lymphoma (or "NHL") and chronic lymphocytic leukemia (or "CLL") markets, specifically front line indolent NHL, front line CLL, and indolent maintenance, which are all unapproved uses. Also impacting our year-over-year first quarter increase, to a lesser extent, was a price increase that was effective on September 9, 2004.

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While penetration in the main hematological uses of Rituxan may be approaching peak levels, we believe there is still growth potential for use of Rituxan in the maintenance setting (an unapproved use) in treating NHL, Additional opportunities for long-term Rituxan sales growth lie in other potential new indications, particularly in immunologic diseases such as rheumatoid arthritis.

In the recently published 2005 Centers for Medicare and Medicaid Services Final Rules for Medicare Reimbursement, there is minimal change in the overall reimbursement for Rituxan in 2005 when compared to that in 2004. To date, we have not seen any detectable effects of the new rules on our product sales, but we are closely monitoring the situation. Therefore, we anticipate that this change will have a limited impact on Rituxan sales in 2005.

Net U.S. sales of Avastin increased to $202.9 million in the first quarter of 2005 compared to $38.1 million in the first quarter of 2004 driven by increased use in colorectal cancer, which continues to represent approximately 95% of current Avastin use. In both the first-line (our approved indication) and relapsed/refractory (an unapproved indication) settings, Avastin is being combined with a wide range of 5FU-based chemotherapies. Net U.S. sales of Avastin increased 7% from $190.5 million in the fourth quarter of 2004. While we have had rapid uptake in the colorectal market, there remains potential growth in this indication driven mainly by increased time on therapy. We also anticipate longer-term growth to be driven by use in potential new indications, including non-small-cell lung and breast cancers.

On January 28, 2005, the Centers for Medicare and Medicaid Services published its final National Coverage Decision which had a positive outcome for Avastin. Specifically, the final decision provides Medicare coverage of drugs used in nine specified clinical trials, seven of which include Avastin. At present, all Medicare carriers and all of our targeted commercial payers are covering Avastin and reimbursement has proceeded as expected.

On March 14, 2005, we and our collaborator, Hoffmann-La Roche, announced that an interim analysis of a Phase III study of Avastin plus paclitaxel and carboplatin chemotherapies in first-line non-squamous, non-small cell lung cancer met its primary efficacy endpoint of improving overall survival, or a reduction in the risk of death, compared to chemotherapy alone. On April 14, 2005, we and our collaborator, Hoffmann-La Roche, announced that an interim analysis of a Phase III study of Avastin plus paclitaxel chemotherapy in first-line metastatic breast cancer met its primary efficacy endpoint of showing a statistically significant improvement in progression-free survival, compared to chemotherapy alone. Progression-free survival is an efficacy endpoint that measures the amount of time a therapy is able to delay the growth and spread of a patient's tumors. These trials were sponsored by the National Cancer Institute (or "NCI"), part of the National Institutes of Health, under a Cooperative Research and Development Agreement between NCI and us, and conducted by a network of researchers led by the Eastern Cooperative Oncology Group (or "ECOG"). According to ECOG, data from these studies will be submitted and presented at the annual meeting of the American Society of Clinical Oncology (ASCO), May 13 - 17, 2005.

Net U.S. sales of Herceptin increased 19% to $129.6 million in the first quarter of 2005 from the first quarter of 2004. This growth was driven by multiple factors including physicians' extending the average treatment duration and increased first-line penetration. Also contributing to our first quarter increase and our future sales growth was a price increase that was effective on February 22, 2005. We currently believe there will be limited impact on Herceptin's usage under the new Medicare Act. We believe there is an opportunity for long-term Herceptin sales growth in the adjuvant setting, an unapproved use. In other unapproved uses, there continues to be growing adoption by physicians in the combination of Herceptin, carboplatin and taxane, a combination otherwise known as TCH. The TCH regimen has demonstrated an improved time to disease progression and may therefore lead to a longer treatment duration.

On April 25, 2005, we announced that two Phase III trials of Herceptin were stopped early after a preliminary joint interim analysis demonstrated an improvement in the primary endpoint of disease-free survival and in the secondary

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endpoint of overall survival. The trials compared Herceptin plus chemotherapy to chemotherapy alone as adjuvant therapy following initial treatment with surgery for women with early-stage (or cancer that has not spread beyond the breast and associated lymph nodes) human epidermal growth factor receptor 2 (HER2) positive breast cancer. The two studies were sponsored by the NCI and conducted by a network of researchers led by the National Surgical Adjuvant Breast and Bowel Project (NSABP) and the North Central Cancer Treatment Group (NCCTG), who conducted this prospectively-designed joint interim analysis. The joint interim analysis plan was developed following discussion with the FDA. According to the NCI, the cooperative groups will present results from these studies at the 2005 ASCO annual meeting.

Net U.S. sales of Tarceva were $47.6 million in the first quarter of 2005, as compared to $13.3 million in the fourth quarter of 2004. Tarceva was approved by the FDA on November 18, 2004. The increase in net U.S. product sales was driven primarily by rapid growth in patient market share in second- and third-line NSCLC.

Combined net U.S. sales of Nutropin products increased 7% in the first quarter of 2005 from the comparable period in 2004, primarily as a result of price increases.

Combined net U.S. sales of our three thrombolytics products, Activase, Cathflo Activase, and TNKase, increased 14% to $50.6 million in the first quarter of 2005 from the comparable period in 2004. This increase was primarily driven by growth in our catheter clearance and stroke markets, as well as price increases on certain of our thrombolytic products. Sales of our thrombolytic products used to treat acute myocardial infarction continue to be impacted by the adoption by physicians of mechanical reperfusion strategies; however, the decline in the use of thrombolytics in the acute myocardial infarction market has been offset by growth in our other markets.

Our sales in the first quarters of 2005 and 2004 were impacted by continued competition from Retavase® (reteplase), a competing product, and its aggressive price discounting. In March 2005, Protein Design Labs purchased Retavase® from Centocor through their acquisition of ESP Pharma.

On January 4, 2005, Cathflo Activase received approval from the FDA for catheter clearance in pediatric patients. With this new indication, Cathflo Activase is the only thrombolytic approved for use in pediatric patients with dysfunctional central venous access devices.

Net U.S. sales of Pulmozyme increased 16% to $44.0 million in the first quarter of 2005 from the comparable period in 2004. This increase primarily reflects an increased focus on aggressive treatment of cystic fibrosis early in the course of the disease and, to a lesser extent, a price increase in July 2004.

Net U.S. sales of Xolair increased to $65.3 million in the first quarter of 2005 compared to $29.8 million in the first quarter of 2004. This overall growth was driven by growth in our prescriber base combined with strong payer coverage and a high perceived clinical response.

Net U.S. sales of Raptiva were $16.6 million in the first quarter of 2005, compared to $6.3 million in the first quarter of 2004 and $16.4 million in the fourth quarter of 2004. This growth rate was due to continued acceptance of the

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product and effective reimbursement processing. Raptiva also had a price increase effective on September 3, 2004. However, the rate of growth in prescriptions and resulting revenue for Raptiva has been negatively impacted by the approval of ENBREL® for psoriasis. In addition, we recently analyzed data results of the exploratory study in patients with alopecia areata, an autoimmune disorder, and we did not observe evidence of benefit in this population of patients.

During the first quarter of 2005, product sales to collaborators, the majority of which were in non-U.S. markets, were $99.0 million compared with $52.7 million for the first quarter in 2004. This increase was primarily due to sales of product manufactured under a contract with a third party and sales of Avastin to Hoffman-La Roche.

Novartis Pharma AG, our collaborator on Xolair, launched Xolair in Canada on March 21, 2005.

Serono S.A. (or "Serono"), which has rights to market Raptiva in certain areas of the world outside the U.S., announced that Raptiva is available commercially in 18 countries as of March 31, 2005.

For the year 2005, we expect sales to collaborators to increase by approximately 50% relative to sales of $197.7 million in 2004.

Royalty revenues increased 50% to $231.9 million in the first quarter of 2005 from the comparable period in 2004. The increase was due to higher international sales by Hoffmann-La Roche primarily on our Herceptin and Rituxan products, a new license arrangement with ImClone under which we receive royalties on sales of ERBITUX®, and to higher sales by various other licensees on other products. The ERBITUX® arrangement included a one-time payment to us, which was recognized in the first quarter of 2005, relating to ERBITUX® sales from the period between launch of the product last year and the signing of the agreement in January 2005. For the full year 2005, we continue to expect the royalty line to increase by approximately 30% over $641.1 million for 2004. See "Related Party Transactions" below for more information on royalties from Hoffmann-La Roche.

Cash flows from royalty income include revenues denominated in foreign currencies. We currently purchase simple foreign currency put option contracts (or "options") and forwards to hedge these foreign royalty cash flows. The terms of these options and forwards are generally one to five years. See also Note 1, "Summary of Significant Accounting Policies -- Derivative Financial Instruments" section in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q.

Contract revenues decreased 24% to $43.7 million in the first quarter of 2005 from $57.3 million in the comparable period in 2004. The decrease was primarily due to lower revenues from our collaborators, including Hoffmann-La Roche. See "Related Party Transactions" below for more information on contract revenue from Hoffmann-La Roche.

Contract revenues vary each quarter and are dependent on a myriad of factors, including the timing and level of reimbursements from ongoing development efforts, milestones and opt-in payments received, and new contract arrangements. In 2005, we currently expect contract revenues to decrease by approximately 10% as compared to $231.2 million in 2004.

Cost of sales (or "COS") as a percentage of product sales were 21% in the first quarter of 2005 compared to 15% in the first quarter 2004. This increase from the prior year was primarily due to changes in product sales mix, including significantly higher sales to collaborators which have a higher cost as a percentage of sales, and also due to slightly

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higher production costs and inventory reserves for several products. COS in the first quarter of 2004 were unusually low due to the low COS associated with the Avastin and Raptiva launch inventories and other favorable sales mix conditions.

For the full year 2005, we continue to expect COS to be approximately 18% of product sales, with continued quarter-to-quarter variability based on product mix changes and production results, acknowledging that there is always potential for an increase in COS if we have unforeseen manufacturing, contract manufacturing, or inventory related issues.

R&D expenses increased 28% to $243.2 million in the first quarter of 2005 from the comparable period in 2004. This increase reflects the ongoing clinical development of our pipeline products, higher expenses for early-stage projects, and increased post-marketing studies and in-licensing expense. R&D as a percentage of revenues was 17% in the first quarter of 2005 compared to 20% in the first quarter of 2004, primarily due to higher revenues. We anticipate a significant increase in R&D expenses in the upcoming quarters of 2005; in particular, expenses related to: (i) in-licensing, (ii) development research on advance oncology, immunology and angiogenic disorders, and (iii) our clinical development pipeline and clinical production costs for products including Avastin, Rituxan Immunology, Lucentis, BR3-Fc, anti-NGF, topical Hedgehog Antagonist and topical VEGF for diabetic foot ulcers. In 2005, we expect R&D expenses as a percentage of revenue to be comparable to 21% in 2004.

The major components of R&D expenses were as follows (in millions):