e10vq

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended June 30, 2007.


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: 0-19222

GENELABS TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)


California		94-3010150

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

505 Penobscot Drive, Redwood City, California		94063

(Address of principal executive offices)		(Zip Code)

(650) 369-9500

(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. þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o Accelerated Filer o Non-accelerated Filer þ

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

There were 30,184,000 shares of the Registrant’s Common Stock issued and outstanding on July 31, 2007.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4T. Controls and Procedures
PART II — OTHER INFORMATION
	Item 1A. Risk Factors
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits
SIGNATURES
EXHIBIT INDEX
EXHIBIT 10.04
EXHIBIT 31.01
EXHIBIT 32.01

FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, referred to as the Exchange Act, which are subject to the “safe harbor” created therein, including those statements which use any of the words “may,” “will,” “anticipates,” “estimates,” “intends,” “believes,” “expects,” “plans,” “potential,” “seeks,” “goal,” “objective,” and similar expressions. These forward-looking statements include, among others, statements regarding:

	•		our ability to secure sufficient funds as a going concern;

	•		estimates that existing cash resources will be adequate to provide liquidity for our regular operations into fiscal year 2009;

	•		our future cash resources, expenditures and our ability to obtain additional funding for our business plans;

	•		plans, programs, progress, and potential success regarding our research efforts, including our ability to identify components for preclinical development and the success of any such preclinical development efforts in our hepatitis C and other research programs;

	•		plans, programs, progress, and potential success regarding our collaborators and licensees, including Gilead Sciences, Inc. for nucleoside compounds targeting hepatitis C virus, Novartis for non-nucleoside compounds against hepatitis C virus, GlaxoSmithKline for hepatitis E vaccine, and, for Prestaraä, Watson Pharmaceuticals, Inc., Genovate Biotechnology Co., Ltd., and Tanabe Seiyaku Co., Ltd.;

	•		our ability, or our collaborators’ ability, to achieve any of the milestones contained in our agreements;

	•		plans, programs, progress, and potential success regarding our research efforts, including our ability to identify compounds for preclinical development and the success of any such preclinical development efforts in our hepatitis C and other research programs, and our efforts in hiring additional personnel;

	•		further actions or developments relating to Prestaraä (prasterone), our investigational drug for lupus, and its New Drug Application; and

	•		the securing and defense of intellectual property rights important to our business.

All statements in this quarterly report on Form 10-Q that are not historical are forward-looking statements and are subject to risks and uncertainties, including those set forth in the Risk Factors section in Item 1A of Part II. These as well as other factors may also cause actual results to differ materially from those projected and expressed or implied in these statements. We assume no obligation to update any such forward-looking statement for subsequent events. The risks and uncertainties under the captions “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained herein, among other things, should be considered in evaluating our prospects and future financial performance. All forward-looking statements included in this quarterly report on Form 10-Q are made as of the date hereof.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

GENELABS TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)


	June 30,			December 31,
	2007			2006
	(Unaudited)			(Note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	23,854		$	18,560
Accounts receivable		825			931
Prepaid expenses and other current assets		152			348

Total current assets		24,831			19,839
Property and equipment, net		1,684			1,011
Long-term investment		—			960
Long-term deposit		112			112
Restricted cash		150			150

Total assets	$	26,777		$	22,072


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable and other accrued liabilities	$	971		$	769
Accrued compensation and related expenses		1,345			1,293
Unearned contract revenue		7,446			7,946

Total current liabilities		9,762			10,008
Accrued compensation		216			427
Other accrued liabilities		60			60
Unearned contract revenue		4,893			8,571

Total liabilities		14,931			19,066

Commitments and contingencies
Shareholders’ equity:
Common stock		250,164			240,401
Accumulated deficit		(238,318	)		(237,395	)

Total shareholders’ equity		11,846			3,006

Total liabilities and shareholders’ equity	$	26,777		$	22,072

See notes to condensed consolidated financial statements.

GENELABS TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	For the six months ended
	June 30,
	2007			2006
Cash flows from operating activities:
Net loss	$	(923	)	$	(7,687	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		253			204
Share-based compensation		394			537
Gain on sale of long-term investment		(1,189	)		—
Changes in assets and liabilities:
Accounts receivable		106			(326	)
Other current assets		196			108
Accounts payable, accrued liabilities and accrued compensation		43			397
Unearned contract revenue		(4,178	)		11,755

Net cash provided by (used in) operating activities		(5,298	)		4,988

Cash flows from investing activities:
Purchases of property and equipment		(926	)		(41	)
Proceeds from sale of long-term investment, net		2,149			—

Net cash provided by (used in) investing activities		1,223			(41	)

Cash flows from financing activities:
Proceeds from issuance of common stock and warrants, net of issuance costs:
Private placement arrangements and exercise of warrants		9,124			8,280
Employee stock plans and exercise of stock options		245			129

Net cash provided by financing activities		9,369			8,409

Net increase in cash and cash equivalents		5,294			13,356
Cash and cash equivalents, beginning of the period		18,560			10,061

Cash and cash equivalents, end of the period	$	23,854		$	23,417

See notes to condensed consolidated financial statements.

GENELABS TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2007

1. Significant Accounting Policies

Business Description

Genelabs Technologies, Inc., referred to as Genelabs or the Company, is a biopharmaceutical company focused on the discovery and development of pharmaceutical products to improve human health. The Company has built drug discovery capabilities that can support various research and development projects. The Company is currently concentrating these capabilities on discovering novel compounds that selectively inhibit replication of the hepatitis C virus and advancing preclinical development of compounds from this hepatitis C virus drug discovery program, while also developing a late-stage product for lupus.

Basis of Presentation

The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Accelerated Clinical Research Organization, Inc., Genelabs Diagnostic, Inc. and Genelabs Europe B.V. All intercompany accounts and transactions have been eliminated. Genelabs operates in one business segment, the discovery and development of pharmaceutical products.

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual amounts may differ from those estimates.

These financial statements have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three- and six-month periods ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. These unaudited condensed consolidated financial statements are meant to be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The comparative balance sheet as of December 31, 2006 has been derived from the audited financial statements at that date.

Revenue Recognition

Contract revenue for research and development is recorded as earned based on the performance requirements of the contract. Revenue from non-refundable upfront license fees where the Company continues involvement, such as through a collaboration, is recognized ratably over the research and development period. The Company bases the amortization period for each agreement on its estimate of the potential period over which the Company has significant obligations under the contract. Advance payments received in excess of amounts earned are classified as deferred revenue. During the second quarter of 2007 the Company revised its estimate of the potential period over which it has significant obligations under the agreement with Gilead Sciences, Inc. (Gilead). The agreement with Gilead provides terms which allow Gilead to extend the term of the collaboration for one additional year to September 30,

2008. Accordingly, prior to the second quarter of 2007, the Company recognized the up-front payment received from Gilead into revenue on a straight-line basis over a period ending September 30, 2008. During the second quarter, Gilead advised the Company that it did not intend to exercise the option to extend the term because it is satisfied that the Company has identified a lead compound series that fulfills certain criteria. As a result, during the second quarter of 2007 the Company shortened the revenue recognition period for the Gilead up-front payment to September 30, 2007.

New Accounting Standards Not Yet Adopted

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 establishes a common definition and framework for measuring fair value under GAAP and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 157 but does not expect it to have a significant impact on its consolidated financial position and results of operations.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 expands opportunities to use fair value measurement in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 159 but does not expect it to have a significant impact on its consolidated financial position and results of operations.

2. Stock-Based Compensation

Stock-Based Compensation Plans

The Company currently provides stock-based compensation under two plans:

Stock Option Plan. The Company’s 2007 Omnibus Stock Incentive Plan (the “2007 Plan”) provides for the issuance of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, deferred stock and performance shares to employees, officers, directors, consultants or advisors to the Company. The number of awards granted under the plan is determined by the Board of Directors or a committee designated by the Board of Directors. Stock options generally are not granted at prices lower than fair market value on the date of grant and vest over periods ranging up to four years, with expiration no later than ten years from the date of grant. The 2007 Plan was approved by the Company’s shareholders at the June 15, 2007 annual meeting and is a successor to the 2001 Stock Option Plan (the “2001 Plan”). No additional grants will be made under the 2001 Plan. The 2007 Plan provided for the reservation of all available shares for grant under the 2001 Plan as of the date of the annual meeting and any and all shares that would otherwise be returned to the 2001 Plan by reason of expiration of its term or cancellation upon termination of employment or service for issuance. As of June 30, 2007, the number of shares of common stock available for future grants under the 2007 Plan is approximately 3,871,000.

Employee Stock Purchase Plan. Employees who meet certain minimum requirements are eligible to participate in the Company’s Employee Stock Purchase Plan (the “ESPP”). Eligible employees are entitled to purchase stock at 85% of the market value at the beginning of the then effective offering period or the ending of the then effective six-month purchase period, whichever is lower. Stock may be purchased at the same price for up to four purchase periods comprising an offering period. Employees can contribute up to 15% of total compensation, but purchases are limited to a maximum of $25,000 per year. As of June 30, 2007, approximately 980,000 shares were available for future purchases.

Stock-Based Compensation Expense

SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), requires that stock-based compensation awards be accounted for using a fair-value based method and, accordingly, the Company recognizes share-based compensation expense based on the estimates of the value of awards as measured at the grant date. The portion of the expense related to awards that are ultimately expected to vest is recognized on a straight line basis over the related employees’ requisite service periods in the Company’s Condensed Statement of Operations.

The Company adopted SFAS 123R effective January 1, 2006 using the modified prospective transition method. Under the modified prospective application, prior periods are not restated to reflect the impact of SFAS123R for comparative purposes. The valuation provisions of SFAS 123R apply to new awards and to awards that are outstanding on the effective date and subsequently modified or cancelled. Estimated compensation expense for awards outstanding at the effective date will be recognized over the remaining service period using the compensation cost calculated for pro forma disclosure purposes under the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) which the Company applied prior to January 1, 2006.

The Company uses the Black-Scholes option-pricing model (Black-Scholes model) as its method of valuation for share-based payment awards.

Because the Company’s historical data demonstrated different patterns of stock option exercise behavior for officers, including directors, as compared to non-officers, upon adoption of SFAS 123R the Company has elected to value its options separately for these two groups. The fair value of shares granted under our stock option plan for the three and six months ended June 30, 2007 and 2006 was estimated using the following weighted-average assumptions:


	For the three and six months ended
	June 30,
	2007			2006
	Non-						Non-
	Officers			Officers			Officers
Risk-free interest rate		4.5	%		4.5	%		4.5	%
Dividend yield		0.0	%		0.0	%		0.0	%
Expected volatility		100.0	%		100.0	%		100.0	%
Expected term (years)		5.75			6.75			5.75

There were no options grants to officers during the three and six months ended June 30, 2007.

Subsequent to June 30, 2007, on July 27, 2007, the Company issued 666,000 and 847,000 stock options to officers and non-officers, respectively, under the 2007 Plan.

The fair value of shares assumed to be purchased under our stock purchase plan for purposes of determining the related stock-based compensation expense for the three and six months ended June 30, 2007 and 2006 was estimated using the following weighted-average assumptions:


	For the three and six months
	ended June 30,
	2007			2006
Risk-free interest rate		4.9	%		4.4	%
Dividend yield		0.0	%		0.0	%
Expected volatility		100.0	%		100.0	%
Expected term (years)		1.6			1.2

The expected dividend yield, volatility and term used in valuing the Company’s share-based payment awards were determined by the Company based upon the historical behavior of option holders, historical fluctuations in the market price of the Company’s stock over a period similar to the expected terms of the awards, historical dividend payments and the expectations of Company management regarding these factors. The risk-fee interest rate assumption is based upon observed interest rates appropriate for the expected life of the Company’s employee stock options.

As share-based compensation expense for stock options recognized in the Condensed Consolidated Statement of Operations is based on awards ultimately expected to vest, the share-based compensation expense related to stock options has been reduced for estimated forfeitures. SFAS 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.

All assumptions used in determining the weighted-average estimated fair value of share-based payment awards and the related share-based compensation expense for the periods presented are subject to substantial change in the future.

Total share-based compensation expense related to the Company’s share based awards was included in the statement of operations as follows (amounts in thousands, except per share data):


	For the three months						For the six months ended
	ended June 30,						June 30,
	2007			2006			2007			2006
Research and development	$	150		$	217		$	293		$	419
General and administrative		44			60			101			118

Total share-based compensation expense	$	194		$	277		$	394		$	537


Effect on net loss per common share, basic and diluted	$	(0.01	)	$	(0.02	)	$	(0.02	)	$	(0.03	)

On December 29, 2006, a purchase date under our ESPP, our closing stock price was lower than the stock price at the beginning of the respective purchase period. As a result, 38 participants were withdrawn from the then effective offering period and reenrolled into a new twenty-four-month offering period beginning January 1, 2007. In accordance with SFAS 123R, this is considered a modification and incremental compensation cost of approximately $71,000 associated with this modification is being recognized during the new offering period.

3. Income Taxes

In June 2006, the FASB issued FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109” (“FIN 48”). FIN 48 establishes a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted FIN 48 as of January 1, 2007, as required. The adoption of FIN 48 did not have an impact on our financial results or financial position for the three or six months ended June 30, 2007.

At December 31, 2006, the Company had net operating loss (NOL) carryforwards for federal income tax purposes of approximately $185 million which expire in the years 2007 through 2026 and

federal research and development tax credits of approximately $4.6 million which expire in the years 2007 through 2026. The Company also had federal capital loss carryforwards of $2.4 million which will expire in 2009. In addition, the Company had net operating loss carryforwards for state income tax purposes of approximately $46 million which expire in the years 2012 through 2016 and state research and development (R&D) tax credits of approximately $5.5 million which do not expire. The realization of these tax benefits is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, any deferred tax assets arising from these benefits have been fully offset by a valuation allowance as of December 31, 2006 and June 30, 2007. Additionally, the utilization of the NOL and R&D credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred previously or that could occur in the future provided by Sections 382 and 383 of the Internal Revenue Code of 1986, as well as similar state and foreign provisions. These ownership changes may limit the amount of NOL and R&D credit carryforwards than can be utilized annually to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. Since the Company’s formation, the Company has raised capital through the issuance of capital stock on several occasions which, combined with the purchasing shareholders’ subsequent disposition of those shares, may have resulted in a change of control, as defined by Section 382, or could result in a change of control in the future upon subsequent disposition. The Company has not currently completed a study to assess whether a change in control has occurred or whether there have been multiple changes of control since the Company’s formation due to the significant complexity and cost associated with such study and that there could be additional changes in the future. If we have experienced a change of control at any time since Company formation, utilization of our NOL or R&D credit carryforwards would be subject to an annual limitation under Sections 382 and 383 which is determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization. Further, until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48. Interest and penalties related to uncertain tax positions will be reflected in income tax expense. Tax years 1992 to 2006 remain subject to future examination by the major tax jurisdictions in which we are subject to tax.

4. Comprehensive Loss

During the three and six month periods ending June 30, 2007 and 2006, the Company’s comprehensive loss was the same as its net loss.

5. Net Loss per Share

Net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period. Had the Company been in a net income position, diluted earnings per share for the three months ended June 30, 2007 and 2006 would have included an additional 1,307,000 and 1,000 shares, respectively, and for the six months ended June 30, 2007 and 2006 would have included an additional 776,000 and 2,000 shares, respectively, related to the Company’s outstanding stock options and warrants as determined under the treasury stock method.

6. Private Placement Financing

On February 14, 2007, Genelabs completed the sale of approximately 5,814,000 shares of its common stock and warrants to purchase approximately 1,744,000 shares of its common stock for gross proceeds of $10 million. Genelabs sold the shares and warrants for $1.72 per share (which includes the warrant purchase price of $0.125 per share underlying the warrants). The warrants have an exercise price of $1.85 per share and a term of five years. Net proceeds from the placement were approximately $9.1 million.

7. Disposition of Long-Term Investment

On January 11, 2007, Genelabs disposed of its remaining investment in Genovate Biotechnology Co., Ltd. Genelabs received approximately $2.2 million in exchange for the shares and recorded a $1.2 million gain. Net proceeds from the sale were approximately $2.1 million.

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

All statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations that are not historical are forward-looking statements. All estimates for periods later than June 30, 2007 of costs, expenses, revenue, savings, future amortization periods and other items are forward-looking statements. Statements regarding possible actions or decisions in periods ending after June 30, 2007 by Genelabs and other parties, including collaborators and regulatory authorities, are forward-looking statements. Actual results may differ from the forward-looking statements due to a number of risks and uncertainties that are discussed under “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Shareholders and prospective investors in the Company should carefully consider these risk factors. We disclaim any obligation to update these statements for subsequent events.

Genelabs Technologies, Inc., referred to as Genelabs or the Company, is a biopharmaceutical company focused on the discovery and development of pharmaceutical products to improve human health. The Company has built drug discovery capabilities that can support various research and development projects. The Company is currently concentrating these capabilities on discovering novel compounds that selectively inhibit replication of the hepatitis C virus, or HCV, and advancing preclinical development of compounds from this hepatitis C virus drug discovery program, while also exploring options for development of a late-stage product for lupus.

On February 14, 2007, Genelabs completed the sale of approximately 5,814,000 shares of its common stock and warrants to purchase approximately 1,744,000 shares of its common stock for gross proceeds of $10 million. The warrants have an exercise price of $1.85 per share and a term of five years. Net proceeds from the placement were approximately $9.1 million.

Results of Operations – Second Quarter 2007 compared to Second Quarter 2006

Summary

Genelabs’ net loss was $0.4 million in the second quarter of 2007 compared to a net loss of $4.3 million for the second quarter of 2006. The lower net loss in the 2007 period compared to the 2006 period is primarily due to:

	•		higher revenue from our collaboration with the Novartis Institutes for BioMedical Research (Novartis);

	•		higher revenue from our collaboration with Gilead Sciences, Inc. (Gilead) after we shortened the revenue recognition period for the up-front payment we received under the program;

	•		lower general and administrative expenses due to the effect of financial advisory and other fees related to the collaboration with Novartis in 2006; and

	•		lower expenses for our employee incentive bonus compensation program.

Partially offsetting the above decreases in our net loss were increased expenses for our HCV drug discovery programs.

Revenue

Contract revenue was $4.4 million in the second quarter of 2007 compared to $2.2 million in the second quarter of 2006. The $2.2 million increase in contract revenue in the second quarter of 2007 was primarily the result of a $1.3 million increase in revenue recognized under our collaboration with Novartis which began in June 2006. In the second quarters of 2007 and 2006, we also recognized $2.5 million and $1.4 million in revenue, respectively, under our collaboration with Gilead. The collaborations with both Novartis and Gilead included non-refundable up-front payments to Genelabs, which are being

recognized into revenue over the term of our estimated potential obligations under the respective agreements. The $1.1 million increase in contract revenue under our collaboration with Gilead resulted from a change in the period over which we estimate that we have significant obligations to Gilead. The Gilead agreement provides terms which allow Gilead to extend the term of the collaboration for one additional year to September 30, 2008. Accordingly, prior to the second quarter of 2007, we recognized the Gilead up-front payment into revenue on a straight-line basis over a period which would have ended on September 30, 2008. During the second quarter, Gilead advised us that it did not intend to exercise the option to extend the term because it is satisfied that we identified a nucleoside lead compound series that fulfills certain criteria. As a result, during the second quarter of 2007 we shortened the period over which we are recognizing the Gilead up-front payment to September 30, 2007. We are currently evaluating certain derivatives of our nucleoside lead compound series with Gilead. The objective of these efforts is to select the most suitable among these compounds for further development.

The collaborations with Novartis and Gilead also include quarterly payments to Genelabs for research activities during the term or our research obligations to our collaborators, which we recognize into revenue as earned. Quarterly payments under the Gilead collaboration will not be made after September 30, 2007.

Royalty revenue was $0.3 million and $0.2 million in the second quarters of 2007 and 2006, respectively.

Research and Development Expenses

Because we are in the business of drug discovery and development and have not developed any products that have been approved for sale, the majority of our resources are devoted to drug discovery and development efforts, and accordingly, most of our costs are classified as research and development and expensed as incurred. Research and development expenses include related salaries and benefits, supplies and chemicals used in laboratories, preclinical and clinical trials, product manufacturing costs, contract and outside service fees, and allocated facilities and overhead costs. The majority of Genelabs’ research and development is directed toward discovery of new drugs targeting HCV, although we are also continuing work on the design of a new Phase III clinical study of Prestara™ as an investigational new drug for lupus. The following table shows our research and development expenses by major category (dollars in thousands):


	For the three months ended
	June 30,
	2007		2006		Change
Drug discovery (HCV)	$	2,376	$	1,908		+25	%
Drug development (Prestara™)		217		358		-39	%
Support costs and other research and development		1,192		1,792		-33	%

Total research and development	$	3,785	$	4,058		-7	%

Expenses for drug discovery comprise the largest category of our research and development expenses. Drug discovery costs increased by $0.5 million in the second quarter of 2007 compared to the second quarter of 2006 primarily as a result of continued growth in our HCV drug discovery programs; including an increase in the number of scientists we have working on our programs. Drug development costs for Prestara™, our investigational drug for lupus, were $0.1 million lower in the second quarter of 2007 than in the second quarter of 2006 as a result of a lower number of employees working on the program in 2007. Support costs and other research and development costs decreased by $0.6 million in the second quarter of 2007 compared to the second quarter of 2006. These costs are primarily those associated with maintaining our research and development facility such as rent, insurance, depreciation, utilities, maintenance and security as well as the cost of support staff, the Company bonus and stock-based compensation. These costs are allocated based on relative headcount between research and development and general and administrative employees. These and other research and development

expenses decreased in the second quarter of 2007 compared to the second quarter of 2006 primarily due to employee incentive bonus compensation expenses recorded after we met board-specified criteria resulting in the removal of payment contingencies in the 2006 period.

Since initiating our first drug discovery program in 1993, Genelabs has built medicinal chemistry, combinatorial chemistry, computational modeling, molecular biology, assay development and high-throughput screening, drug metabolism, pharmacokinetics and toxicology capabilities. Genelabs has incurred direct drug discovery costs of approximately $57 million through June 30, 2007. Of this amount, approximately $28 million relates to our HCV drug discovery programs which began in early 2002. During 2007, substantially all of our drug discovery efforts were directed toward three separate HCV research programs, which are concentrated on identifying a new drug to combat infection with HCV. Two of these programs target the HCV NS5b RNA-dependent RNA polymerase (the enzyme directly responsible for replication of the HCV genome), although through different mechanisms. We refer to one of these programs as our nucleoside program and we refer to the other as our non-nucleoside program. We are simultaneously pursuing several additional HCV programs utilizing chemical and mechanistic approaches that are distinct from the nucleoside and non-nucleoside polymerase programs. Among these, one is targeted at the NS5a protein, a different viral protein than NS5b, but which is also required for viral replication. Part of our drug discovery process includes continued testing of our preclinical drug candidates and identification of additional potential lead compounds.

Genelabs also began developing Prestara™ for systemic lupus erythematosus in 1993 when we licensed exclusive rights to patents related to Prestara™ from Stanford University. In April 2007 we announced that we had reached agreement with the FDA on a Special Protocol Assessment (SPA) for a Phase III clinical trial of Prestara™. The SPA documents the FDA’s agreement that the design and planned analyses of the study adequately address objectives in support of a New Drug Application (NDA) submission. The FDA indicated to Genelabs that a positive outcome to the proposed new Phase III study in addition to evidence of efficacy from previous trials of Prestara™ and an overall positive risk/benefit assessment would, in principle, meet FDA standards for NDA approval. We are evaluating possible methods of financing the new clinical trial and currently do not plan to initiate the trial unless we obtain satisfactory financing to do so. Unless we are successful in securing satisfactory financing, we expect that we will continue to have lower spending on Prestara™ as demonstrated by the costs incurred under the program during the second quarter of 2007 as compared to the second quarter of 2006. In the course of our development efforts for this investigational new drug we have incurred direct costs of approximately $51 million through June 30, 2007.

Due to the nature of drug discovery research and drug development, we cannot reliably estimate the outcome of scientific experiments, many of which will impact the design and conduct of subsequent scientific experiments, and all of which provide additional information on both the direction of the research program and likelihood of its success. As such, the potential timing for key future events that may occur in our drug discovery and development programs cannot reliably be estimated and we cannot estimate whether a compound will advance to a later stage of development or when we may determine that a program is no longer viable for potentially producing a drug candidate. We also cannot reasonably predict the costs to reach these stages, and cannot predict whether any of our compounds will result in commercial products or lead to revenue for the Company. Management continually evaluates the status of our drug discovery research and our drug development programs and expects to continue to devote resources toward these efforts, while at the same time managing the level of expenditures to balance limited cash resources and the various drug discovery and development opportunities. We expect to hire a limited number of additional staff for each of our primary HCV polymerase-targeted programs to address our current objectives for the programs. We believe that our costs will increase as we hire additional scientists. However, the outcomes of current and planned scientific experiments and outcomes of corporate partnering discussions may cause us to revise these expectations and estimates.

General and Administrative Expenses

General and administrative expenses were $1.6 million in the second quarter of 2007 compared to $2.7 million in the second quarter of 2006. Our general and administrative expenses consist primarily of personnel costs for executive management, finance, business development, human resources and legal departments, as well as professional expenses, such as legal and audit, and allocated facilities costs such as rent, insurance, depreciation, utilities, maintenance and security as well as the cost of support staff, the Company bonus and stock-based compensation. The decrease in general and administrative expenses in the second quarter of 2007 compared to the second quarter of 2006 is primarily due to expenses for financial advisory and other fees related to the collaboration with Novartis recorded in the 2006 period for which there was no comparable expense in the 2007 period.

Other Income

Interest income was $0.3 million in the second quarter of 2007 compared to $0.1 million in the second quarter of 2006. The increase in interest income, net, was primarily due to the higher average cash balance in the second quarter of 2007 compared to the second quarter of 2006.

Results of Operations – First Six Months of 2007 compared to First Six Months of 2006

Summary

Genelabs’ net loss was $0.9 million for the first six months of 2007, compared to a net loss of $7.7 million for the first six months of 2006. The higher net loss in the 2007 period compared to the 2006 period is primarily due to:

	•		higher revenue from our collaboration with the Novartis Institutes for BioMedical Research (Novartis);

	•		higher revenue from our collaboration with Gilead Sciences, Inc. (Gilead) after we shortened the revenue recognition period for the up-front payment we received under the program;

	•		lower general and administrative expenses due to the effect of financial advisory and other fees related to the collaboration with Novartis in 2006

	•		lower expenses for our employee incentive bonus compensation program; and

	•		gain on the disposition of our investment in Genovate Biotechnology Co., Ltd.

Partially offsetting the above decreases in our net loss were increased expenses for our HCV drug discovery programs.

Revenue

Contract revenue was $7.8 million in the first half of 2007 compared to $3.7 million in the first half of 2006. The $4.1 million increase in contract revenue in the second quarter of 2007 was primarily the result of a $3.1 million increase in revenue recognized under our collaboration with Novartis which began in June 2006. In the first half of 2007 and 2006, we also recognized $4.0 million and $2.8 million in revenue, respectively, under our collaboration with Gilead. The collaborations with both Novartis and Gilead included non-refundable up-front payments to Genelabs, which are being recognized into revenue over the term of our estimated potential obligations under the respective agreements. The $1.2 million increase in contract revenue under our collaboration with Gilead resulted from a change in the period over which we estimate that we have significant obligations to Gilead.

Royalty revenue was $0.5 million and $0.3 million in the first half of 2007 and 2006, respectively.

Research and Development Expenses

The following table shows our research and development expenses by major category (in thousands):


	For the six months ended June 30,
	2007		2006		Change
Drug discovery (HCV)	$	4,800	$	3,814		+26	%
Drug development (Prestara™)		407		791		-49	%
Support costs and other research and development		2,474		3,042		-19	%

Total research and development	$	7,681	$	7,647		+1	%

Research and development expenses increased modestly in the first half of 2007 compared to the first half of 2006. Expenses for drug discovery comprise the largest category of our research and development expenses. Drug discovery costs increased by $1.0 million in the first half of 2007 compared to the first half of 2006 primarily as a result of an increase in the number of scientists working on our HCV programs. Drug development costs for Prestara™, our investigational drug for lupus, were $0.4 million lower in the first half of 2007 than in the second quarter of 2006 as a result of a lower number of employees working on the program in 2007. Support costs and other research and development costs decreased by $0.6 million in the first half of 2007 compared to the first half of 2006 primarily due to employee incentive bonus compensation expenses recorded after we met board-specified criteria resulting in the removal of payment contingencies in the 2006 period.

General and Administrative Expenses

General and administrative expenses were $3.3 million in the first half of 2007 compared to $4.3 million in the first half of 2006. The decrease in general and administrative expenses in the first half of 2007 compared to the same period in 2006 is primarily due to expenses for financial advisory and other fees related to the collaboration with Novartis recorded in the 2006 period for which there was no comparable expense in the 2007 period.

Other Income

During the first half of 2007 we recorded a $1.2 million gain on the disposition of our investment in Genovate Biotechnology Co., Ltd. The Company received approximately $2.2 million in exchange for the shares. Net proceeds from the sale were approximately $2.1 million.

Interest income was $0.6 million in the first half of 2007 compared to $0.2 million in the first half of 2006. The increase in interest income, net, was primarily due to the higher average cash balance in the first half of 2007 compared to the first half of 2006.

Liquidity and Capital Resources

We assess liquidity primarily by the cash and cash equivalents available to fund our operations. Genelabs had cash and cash equivalents of $23.9 million at June 30, 2007.

We presently estimate that our current cash resources are adequate to fund our operations into fiscal year 2009, however, we believe this estimate and our future liquidity and capital resources will be materially impacted by our success or failure or the success or failure of our collaborators in reaching milestones under corporate collaborations, the progress of our unpartnered drug discovery programs, our ability to enter into or modify existing corporate collaborations, clinical development and regulatory actions regarding our investigational drugs and financing activities.

Since Genelabs’ inception, we have operated at a loss and have funded operations primarily through public and private offerings of equity securities and, to a lesser extent, contract revenues. We expect to incur substantial additional costs, including research costs for drug discovery and development costs for investigational drugs. The amount of additional costs in our business plans will depend on numerous factors including the progress of our research and development programs and the actions of corporate collaborators. To meet our capital needs through the end of 2009 and beyond we will require additional funding, but additional funds may not be available on acceptable terms, if at all. The unavailability of additional funds could delay or prevent the development, approval or marketing of some or all of our products and technologies, which would have a material adverse effect on our business, financial condition and results of operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Genelabs’ exposure to market risk for changes in foreign currency exchange rates relates primarily to the Company’s investment in a Taiwan-based biopharmaceutical company, Genovate Biotechnology Co., Ltd., which the Company disposed of in January 2007. Genelabs has not yet paid income taxes which may be due to the Ministry of Finance in Taiwan related to the disposition. To the extent that we are required to pay taxes on the transaction, they will need to be settled in Taiwan dollars and, as a result, changes in foreign currency exchange rates would potentially have an impact on the amount due.

Item 4T. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

The Company’s management, with the participation of the Company’s Chief Executive Officer and acting Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and acting Chief Financial Officer has concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and acting Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.

Changes in Internal Control Over Financial Reporting.

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15 and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1A. Risk Factors

There are a number of risk factors that should be considered by Genelabs shareholders and prospective investors. It is not possible to comprehensively address all risks that exist, but the following risks in particular should be considered, in addition to other information in this Quarterly Report on Form 10-Q.

Risks Related to Genelabs

We may not be profitable in the near future or at all and in order to carry out our business plans we will require additional funds which may not be available.

We have incurred losses each year since our inception and have accumulated approximately $238 million in net losses through June 30, 2007, including a net loss of $0.9 million for the six months ended June 30, 2007 and a net loss of $8.7 million for the year ended December 31, 2006. We may never be profitable and our revenues may never be sufficient to fund operations. We presently estimate that our current cash resources are adequate to fund our operations into 2009. Thereafter, we will require additional capital to carry out our business plans.

Additional funds for our research and development activities may not be available on acceptable terms, if at all. The unavailability of additional funds could delay or prevent the development of some or all of our products and technologies, which would have a material adverse effect on our business, financial condition and results of operations.

Our collaborations may fail, which may result in costs and delays that may impair our ability to successfully develop and commercialize our products and product candidates.

Given our financial position and the broad range of resources required for drug development, we have in the past and will likely continue to enter into collaborations with pharmaceutical and larger biotechnology companies. We have received no revenue from the sale of drugs. To date, almost all of our revenue has come from collaboration agreements. We have entered into collaborations with Novartis, Gilead, GlaxoSmithKline, Watson, Tanabe and other companies and we may enter into future collaborations with these or other companies. Our collaborators may breach their contracts, or our collaborators may not diligently and successfully develop and commercialize the results of the research. Alternatively, our collaborators may elect not to extend or augment the collaborations which may result in a decrease in revenue, an increase in research costs or cause us to terminate the research program. Recently, Gilead advised us that it does not intend to exercise an option that it has under our license and research collaboration agreement to extend the term of our collaboration beyond its September 30, 2007 expiration as Gilead is satisfied that we have identified a nucleoside lead compound series that fulfills certain criteria. We are currently evaluating certain derivatives of this nucleoside lead compound series with Gilead. The objective of these efforts is to select the most suitable among these compounds for further development. There can be no assurance that any compound from this series will eventually be developed. Novartis may not continue to fund our research beyond its obligations in the research contract, and GlaxoSmithKline may choose not to continue developing the hepatitis E vaccine which it has been developing under a license from us.

We are dependent on our collaborators to successfully carry out preclinical and clinical development, to obtain regulatory approvals, and/or to market and sell any products arising from the research and/or development conducted by us or the collaborator. Factors which may cause our collaborators to fail in these efforts include: problems with toxicity, bioavailability or efficacy of the product candidate, difficulties in manufacture, problems in satisfying regulatory requirements, emergence

of competitive product candidates developed by the collaborator or by others, insufficient commercial opportunity, problems the collaborators may have with their own contractors, lack of patent protection for our product candidates or claims by others that it infringes their patents or other intellectual property rights.

Collaboration on a project also may result in disputes with the collaborator over the efforts by us and/or the collaborator, the achievement of milestones or rights to intellectual property. If we fail to perform all of our obligations, our collaborators may withhold further funding, seek to seize control over our intellectual property and other assets, and/or assert claims for damages against us. In the course of the collaboration our collaborator may obtain know-how which enables it to compete with us in the same area of research and/or development. Because research and development results are unpredictable, we and our collaborators may not achieve any of the milestones in the collaboration agreements. We may also find it difficult to advance to the development stage with some of our newer drug candidates if we are unable to find a suitable collaborator and we may not be able to negotiate new collaboration agreements on favorable terms or at all.

Our research programs are in an early stage and may not successfully produce commercial products.

Pharmaceutical discovery research is inherently high-risk because of the high failure rate of projects. To date, our pharmaceutical research has been focused on a limited number of targets for which no or few commercial drugs have been successfully developed. Our projects may fail if, among other reasons, the compounds being developed fail to meet criteria for potency, toxicity, pharmacokinetics, manufacturability, intellectual property protection and freedom from infringement, or other criteria; or if we fail to make progress due to lack of resources or access to enabling technologies. Genelabs’ product candidates, other than Prestara™, are in an early stage of research. All of our research projects may fail to produce commercial products.

We face substantial competition which may result in others discovering, developing or commercializing drugs before or more successfully than us.

The biotechnology industry is highly competitive and characterized by rapid and significant technological change. Creation of the type of compounds we seek to discover requires sophisticated and expensive lab equipment and facilities, a team of scientists with advanced scientific knowledge in many disciplines such as chemistry, biochemistry and biology, and time and effort. We face, and will continue to face, intense competition from organizations such as pharmaceutical and biotechnology companies, as well as academic and research institutions and government agencies. Many of these organizations are also pursuing the discovery and development of new drugs to treat infection with the hepatitis C virus, and some are at a more advanced stage of development. Any of these organizations may discover, develop or commercialize products that are more effective, safer or less costly than those that we are developing. Our competitors may also obtain U.S. Food and Drug Administration, or FDA, or other regulatory approval for their products more rapidly than we may obtain approval for ours.

Many of our competitors are substantially larger than we are and have greater capital resources, larger research and development staffs and better facilities than we have. Many of our competitors are more experienced in drug discovery, development and commercialization, in obtaining regulatory approvals and in drug manufacturing and marketing. In addition, if Genelabs discovers compounds that have the potential to be drugs, public information about our research success may lead other companies with greater resources to focus more efforts in areas similar to ours. Because large pharmaceutical companies have access to the latest equipment and have many more personnel available to focus on solving particular research problems, even if our research programs are successful we may have a competitive disadvantage.

If third parties on whom we rely do not perform as contractually required or expected, we may not be able to obtain regulatory approval for or commercialize our product candidates.

As part of our process of conducting drug discovery research and clinical trials we rely on third parties such as medical institutions, pre-clinical and clinical investigators, contract laboratories and contract research organizations to participate in the conduct of our clinical trials. We also rely on contract manufacturers for supply of active ingredients and formulated material for use in preclinical and clinical development. We depend on Novartis, Gilead and GlaxoSmithKline to conduct preclinical and clinical development, to obtain regulatory approval and to manufacture and commercialize our product candidates. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if the third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised due to their failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our preclinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for or successfully commercialize our product candidates. Additionally, our collaboration partners may have alternative product candidates which they elect to favor over our product candidates. If they do not elect our product candidates for further development, our ability to advance in the pre-clinical and clinical development may be impaired or precluded

The results of our most recent clinical trial of Prestara™, Genelabs’ drug candidate for systemic lupus erythematosus, were not positive, substantially decreasing the probability that Prestara will ever be approved for marketing or at least substantially delaying the timing for such potential approval and thus diminishing our business prospects.

In order to satisfy conditions set by the FDA, we conducted a Phase III clinical trial of Prestara™ on women with lupus taking glucocorticoids using bone mineral density as the trial’s primary endpoint. Prestara™ is a pharmaceutical formulation containing highly purified prasterone, the synthetic equivalent of dehydroepiandrosterone or DHEA, a naturally occurring hormone. This clinical trial did not demonstrate a statistically significant difference between the bone mineral density of the group of patients taking Prestara™ and the group taking placebo. Additionally, the trial was not specifically designed to demonstrate, and in fact did not demonstrate, a statistically significant benefit in secondary endpoints such as amelioration of lupus symptoms.

A separate clinical trial of prasterone (the active ingredient in Prestara™) was conducted by Genovate Biotechnology Co., Ltd., or Genovate, a Taiwan-based company that has a license from us for Prestara™ in most Asian countries. In April 2005, we announced that this clinical trial, did not meet its primary endpoint, bone mineral density at the lumbar spine. While a prior Phase III clinical trial conducted on lupus disease activity was determined by the FDA to be positive, adequate and well-controlled, the FDA has advised us that it will require two positive Phase III clinical trials in order to review and potentially approve the Prestara™ New Drug Application because both our most recent Phase III and Genovate’s clinical trails did not meet their primary endpoints, the FDA will not approve Prestara™ without another positive Phase III clinical trial. In April 2007 we announced that we had received agreement from the FDA under a Special Protocol Assessment (SPA) for a new Phase III clinical trial of Prestara™. This new clinical trial is of different design and has a different endpoint than our prior clinical trials. However, Genelabs does not presently have the funds to conduct this trial and may not be able to raise such funds at all or in a form or price that would be acceptable to us or our existing shareholders.

Our outside suppliers and manufacturers for Prestara™ are subject to regulation, including by the FDA, and if they do not meet their commitments, we would have to find substitute suppliers or manufacturers which could delay supply of product to the market.

Regulatory requirements applicable to pharmaceutical products tend to make the substitution of suppliers and manufacturers costly and time consuming. We rely on a single supplier of prasterone, the active ingredient in Prestara™, and we rely on a single finished product manufacturer, Patheon Inc., for production of Prestara™ capsules and for packaging. The disqualification of a supplier or manufacturer through their failure to comply with regulatory requirements could negatively impact our business because of delays and costs in obtaining and qualifying alternate suppliers. We have no internal manufacturing capabilities for pharmaceutical products and are entirely dependent on contract

manufacturers and suppliers for the manufacture of our drug candidates. Genelabs and our North American collaborator, Watson, previously arranged for the manufacture of quantities of Prestara™ and prasterone, its active ingredient, in anticipation of possible marketing approval. This inventory has exceeded its initial retest date, although the active ingredient may still be used if it successfully passes re-testing. Watson has informed us that they wish to have the portion of prasterone inventory owned by them destroyed which we are currently in the process of doing.

The following could harm our ability to manufacture Prestara™:

	•		The unavailability at reasonable prices of adequate quantities of the active ingredient or intermediates;

	•		The loss of a supplier’s or manufacturer’s regulatory approval;

	•		The failure of a supplier or manufacturer to meet regulatory agency pre-approval inspection requirements;

	•		The failure of a supplier or manufacturer to maintain compliance with ongoing regulatory agency requirements;

	•		The inability to develop alternative sources in a timely manner or at all;

	•		The inability or refusal of the manufacturers to meet our needs for any reason, such as loss or damage to facilities or labor disputes;

	•		The manufacture of product that is defective in any manner; and

	•		The competing demands on the contract manufacturer’s capacity, for example, shifting manufacturing priorities to their own products or more profitable products for other customers;

We may be unable to obtain patents or protect our intellectual property rights, or others could assert their patents against us.

Agency or court proceedings could invalidate our current patents, or patents that issue on pending applications. Our business would suffer if we do not successfully defend or enforce our patents, which would result in loss of proprietary protection for our technologies and products. Patent litigation may be necessary to enforce patents to determine the scope and validity of our proprietary rights or the proprietary rights of another.

The active ingredient in Prestara™ is prasterone, more commonly known as dehydroepiandrosterone, or DHEA. DHEA is a compound that has been in the public domain for many years. Although we have an issued U.S. patent on the specific polymorphic form of DHEA we have used in our formulation of prasterone, we do not believe it is possible to obtain patent protection for the base chemical compound anywhere in the world. Genelabs licensed two United States patents covering uses of DHEA in treating lupus from Stanford University in 1993. The Stanford patents expire in 2012 and 2013, and the license expires when the patents expire. In addition, we have filed patent applications covering additional uses for Prestara™ and various pharmaceutical formulations and intend to file additional applications as appropriate. We have filed patent applications covering compounds from our HCV drug discovery programs; however, not all of these HCV applications have issued. A number of patents have issued to Genelabs covering our drug discovery technologies and methods related to selective regulation of gene expression and the control of viral infections. A number of patent applications are pending.

If another company successfully brings legal action against us claiming our activities violate, or infringe, their patents, a court may require us to pay significant damages and prevent us from

using or selling products or technologies covered by those patents. Others could independently develop the same or similar discoveries and may have priority over any patent applications Genelabs has filed on these discoveries. Prosecuting patent priority proceedings and defending litigation claims can be very expensive and time-consuming for management. In addition, intellectual property that is important for advancing our drug discovery efforts or for uses for the active ingredient in Prestara™ owned by others might exist now or in the future. We might not be able to obtain licenses to a necessary product or technology on commercially reasonable terms, or at all, and therefore, we may not pursue research, development or commercialization of promising products.

We may be unable to attract or retain key personnel, which could delay our drug discovery and development and compromise our ability to develop successfully or commercialize our drug candidates.

Our ability to develop our business depends in part upon our attracting and retaining qualified management and scientific personnel. The loss of our key personnel, significant salary increases to retain our key personnel or the failure to recruit additional key personnel could significantly impede attainment of our objectives and harm our financial condition and operating results. Additionally, recent and proposed laws, rules and regulations increasing the liability of directors and officers may make it more difficult to retain incumbents and to recruit for these positions.

In June 2006, we entered into a collaboration with Novartis which will require us to dedicate a specified level of scientific personnel to the work plan established with Novartis. Because we have obligations to dedicate a specified number of scientists to the collaborations, we may not have sufficient personnel to continue to advance our unpartnered NS5a drug discovery program. As the number of qualified personnel is limited, competition for such staff is intense. Further, our collaboration with Novartis specifies the funding rates for Genelabs’ scientific personnel working on the collaboration, which means we bear the risk of any personnel cost increases. We may not be able to continue to attract or retain such people on acceptable terms, given the competition for those with similar qualifications among biotechnology, pharmaceutical and healthcare companies, universities and nonprofit research institutions.

On August 25, 2006 we announced the resignation of Matthew Loar as Chief Financial Officer, effective September 1, 2006. We are currently searching for his replacement, and our Chief Executive Officer, James A.D. Smith, has assumed Mr. Loar’s duties on an interim basis.

Although we currently meet the standards for continued listing on the Nasdaq Capital Market, there is no guarantee that we will continue to meet these standards in the future and if we are delisted the value of your investment in Genelabs may substantially decrease.

To remain listed on the Nasdaq Capital Market we must have a market value of at least $35 million or at least $2.5 million in shareholders’ equity. In 2006, our market value fluctuated between approximately $13 million and approximately $44 million. In the first half of 2007, our market value fluctuated between approximately $35 million and approximately $80 million. In the past, we received a delisting notice from the Nasdaq Stock Market and although we successfully appealed that delisting and are currently in compliance with listing requirements, any future delisting from the Nasdaq Capital Market would adversely affect the trading price of our common stock, significantly limit the liquidity of our common stock and impair our ability to raise additional funds.

Our facilities are located near an earthquake fault, and an earthquake could disrupt our operations and adversely effect results.

All of our operations are conducted in a single facility built on landfill in an area of California near active geologic faults which historically have caused major earthquakes from time to time. The office park where the facility is located is approximately at sea level behind levees sheltering the buildings from the San Francisco Bay. In the event of a significant earthquake, we could experience significant damage and business interruption for which we are not insured.

Industry Risks

Our activities involve hazardous materials and improper handling of these materials by our employees or agents could expose us to significant legal and financial penalties.

Our research and development activities involve the controlled use of hazardous materials, including infectious agents, chemicals and various radioactive compounds. Our organic chemists use solvents, such as chloroform, isopropyl alcohol and ethanol, corrosives such as hydrochloric acid and highly flammable materials, some of which are pressurized, such as hydrogen. We use radioactive compounds in small quantities under license from the State of California, including Carbon(14), Cesium(137), Chromium(51), Hydrogen(3), Iodine(125), Phosphorus(32), Phosphorus(33) and Sulfur(35). Our biologists use biohazardous materials, such as bacteria, fungi, parasites, viruses and blood and tissue products. We also handle chemical, medical and radioactive waste, byproducts of our research, through licensed contractors. As a consequence, we are subject to numerous environmental and safety laws and regulations, including those governing laboratory procedures, exposure to blood-borne pathogens and the handling of biohazardous materials. Federal, state and local governments may adopt additional laws and regulations affecting us in the future. We may incur substantial costs to comply with, and substantial fines or penalties if we violate current or future laws or regulations.

Although we believe that our safety procedures for using, handling, storing and disposing of hazardous materials comply with the standards prescribed by state and federal regulations, we cannot eliminate the risk of accidental contamination or injury from these materials. In the event of an accident, state or federal authorities may curtail our use of these materials and we could be liable for any civil damages that result, the cost of which could be substantial. Further, any failure by us to control the use, disposal, removal or storage of, or to adequately restrict the discharge of, or assist in the cleanup of, hazardous chemicals or hazardous, infectious or toxic substances could subject us to significant liabilities, including joint and several liability under state or federal statutes. We do not specifically insure against environmental liabilities or risks regarding our handling of hazardous materials. Additionally, an accident could damage, or force us to shut down, our research facilities and operations.

We may not be able to obtain or maintain sufficient insurance on commercially reasonable terms or with adequate coverage against potential liabilities in order to protect ourselves against product liability claims.

Our business exposes us to potential product liability risks that are inherent in the testing, manufacturing and marketing of human therapeutic products. We may become subject to product liability claims if someone alleges that the use of our products injured subjects or patients. This risk exists for products tested in human clinical trials as well as products that are sold commercially. Although we currently have product liability insurance coverage in amounts that we believe are customary for companies of our size and in our industry and sufficient for risks we typically face, we may not be able to maintain this type of insurance in a sufficient amount. There is no assurance that product liability insurance will continue to be available in the future at a cost or on acceptable terms or with adequate coverage against potential liabilities which could harm our business by requiring us to use our resources to pay potential claims.

Risks Relating to Owning Our Stock

Because our stock is volatile, the value of your investment in Genelabs may substantially decrease.

The market price of our common stock, like the stock prices of many publicly traded biopharmaceutical companies, has been and will probably continue to be highly volatile. Between January 1, 2006 and December 31, 2006, the price of our common stock fluctuated between $2.55 and $0.70 per

share. Between January 1, 2007 and June 30, 2007, the price of our common stock fluctuated between $1.43 and $2.67 per share. In addition to the factors discussed in this Risk Factors section, a variety of events can impact the stock price. For example, the availability of a large block of stock for sale in relation to our normal trading volume could result in a decline in the market price of our common stock.

In addition, numerous events occurring outside of our control may also impact the price of our common stock, including:

	•		progress of our products through the regulatory process;

	•		results of preclinical studies and clinical trials;

	•		announcements of technological innovations or new products by us, our competitors or others;

	•		publicity regarding actual or potential results with respect to compounds or drugs we or our collaborators are developing;

	•		government regulatory actions affecting our products or our competitors’ products in the United States and foreign countries;

	•		developments or disputes concerning patent or proprietary rights;

	•		actual or anticipated fluctuations in our operating results;

	•		changes in our financial estimates by securities analysts;

	•		general market conditions for emerging growth, biotechnology and pharmaceutical companies;

	•		broad market fluctuations; and

	•		economic conditions in the United States or abroad.

Because the average daily trading volume of our common stock is low, your ability to sell your shares in the secondary trading market may be limited.

Because the average daily trading volume of our common stock is low, the liquidity of our common stock may be impaired. As a result, prices for shares of our common stock may be lower than might otherwise prevail if the average daily trading volume of our common stock was higher. The average daily trading volume of our common stock may be low relative to the stocks of exchange-listed companies, which could limit your ability to sell your shares in the secondary trading market.

We may incur significant costs from class action litigation.

In the past, following periods of large price declines in the public market price of a company’s stock, holders of that stock occasionally have instituted securities class action litigation against the company that issued the stock. If any of our shareholders were to bring this type of lawsuit against us, even if the lawsuit is without merit, we could incur substantial costs defending the lawsuit. The lawsuit also could divert the time and attention of our management, which would hurt our business. Any adverse determination in litigation could also subject us to significant liabilities.

Exercise of outstanding options and warrants will dilute shareholders and could decrease the market price of our Common Stock.

As of June 30, 2007, we had issued and outstanding 30,184,000 shares of common stock, and outstanding options and warrants to purchase 7,639,000 additional shares of common stock. At our 2007 annual meeting, our stockholders authorized an additional 4,400,000 shares of common stock for issuance under our equity incentive plans. As of July 31, 2007, 3,458,000 shares of common stock remain available for issuance under our equity incentive plans. The existence of the outstanding options and warrants may adversely affect the market price of our common stock due to sales of a large number of shares or the perception that such sales could occur. These factors also could make it more difficult to raise funds through future offerings of common stock, and could adversely impact the terms under which we could obtain additional equity capital. Exercise of outstanding options and warrants, or any future issuance of additional shares of common stock or other equity securities, including but not limited to options, warrants or other derivative securities convertible into our common stock, may result in significant dilution to our shareholders and may decrease the market price of our common stock.

Changes in securities laws and regulations may increase our costs.

The Sarbanes-Oxley Act of 2002 has previously required us to make changes to some of our corporate governance practices. Because we are currently a non-accelerated filer we presently only comply with the Section 404(a) of the Sarbanes-Oxley Act which requires annual management assessments of the effectiveness of our internal controls over financial reporting. We currently do not have to comply with the portion of Section 404 which requires a report by our independent registered public accounting firm addressing our assessments. Beginning with calendar year 2008, our auditors will again be required to issue a report addressing our assessments. The implementation of these compliance matters will likely result in an increase in our general and administrative expenses. We also may determine that we do not have effective controls over financial reporting. There may be other accounting or regulatory changes enacted in the future which would have a disproportionate impact on us compared to other companies because of our small size and our lack of product revenue to provide a source of funds to pay for compliance with the changes, among other reasons.

Item 4. Submission of Matters to a Vote of Security Holders

Genelabs held its Annual Meeting of Shareholders on June 15, 2007.

At the meeting, the shareholders elected the following nominees to serve as directors of the Company until the next annual meeting and until a successor is elected and qualified, or until their earlier resignation or removal:


Director Name	Shares Voted For		Shares Withheld
Leslie J. Browne, Ph.D.		23,478,985		1,000,498
Irene A. Chow, Ph.D.		23,466,722		1,012,753
H. H. Haight		23,477,429		1,002,046
Alan Y. Kwan		23,478,092		1,001,383
Matthew J. Pfeffer		23,477,471		1,002,004
James A. D. Smith		23,474,026		1,005,449

The shareholders also approved the Company’s 2007 Omnibus Stock Incentive Plan (with 13,675,582 shares voting for, 1,976,104 against, 66,567 abstaining and 8,778,254 broker non-votes).

The shareholders also approved the amendment to the Company’s 2001 Employee Stock Purchase Plan (with 13,758,527 shares voting for, 1,876,732 against, 82,994 abstaining and 8,778,254 broker non-votes).

Additionally, the shareholders ratified the selection of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2007 (with 23,856,864 shares voting for, 568,030 against and 71,613 abstaining).

Item 6. Exhibits


Exhibit
No.		Exhibit Title
3.01		Registrant’s Amended and Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.01 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001).

3.02		Registrant’s Certificate of Amendment of Articles of Incorporation (incorporated herein by reference to Exhibit 3.2 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).

3.03		Registrant’s Certificate of Amendment of Articles of Incorporation dated December 14, 2005 (incorporated herein by reference to Exhibit 3.03 of Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).

3.04		Registrant’s Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.01 to Registrant’s Current Report on Form 8-K filed on January 29, 2007).

4.01		Specimen Certificate for Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.01 of Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).

10.02*		Registrant’s 2007 Omnibus Stock Incentive Plan (incorporated herein by reference to Exhibit A of Registrant’s Definitive Proxy Statement on Form DEF 14A filed on April 27, 2007).

10.03*		Registrant’s 2001 Employee Stock Purchase Plan (incorporated herein by reference to Exhibit B of Registrant’s Definitive Proxy Statement on Form DEF 14A filed on April 27, 2007).

10.04*		Registrant’s Annual Bonus Plan dated August 10, 2007.

31.01		Certification of Chief Executive Officer and acting Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

32.01		Certification of Chief Executive Officer and acting Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Indicates management contract or compensatory plan, contract or arrangement.

EXHIBIT INDEX


Exhibit
No.		Exhibit Title
3.01		Registrant’s Amended and Restated Articles of Incorporation (incorporated herein by reference to Exhibit 3.01 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001).

3.02		Registrant’s Certificate of Amendment of Articles of Incorporation (incorporated herein by reference to Exhibit 3.2 to Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2003).

3.03		Registrant’s Certificate of Amendment of Articles of Incorporation dated December 14, 2005 (incorporated herein by reference to Exhibit 3.03 of Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).

3.04		Registrant’s Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.01 to Registrant’s Current Report on Form 8-K filed on January 29, 2007).

4.01		Specimen Certificate for Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.01 of Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).

10.02*		Registrant’s 2007 Omnibus Stock Incentive Plan (incorporated herein by reference to Exhibit A of Registrant’s Definitive Proxy Statement on Form DEF 14A filed on April 27, 2007).

10.03*		Registrant’s 2001 Employee Stock Purchase Plan (incorporated herein by reference to Exhibit B of Registrant’s Definitive Proxy Statement on Form DEF 14A filed on April 27, 2007).

10.04*		Registrant’s Annual Bonus Plan dated August 10, 2007.

31.01		Certification of Chief Executive Officer and acting Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.

32.01		Certification of Chief Executive Officer and acting Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Indicates management contract or compensatory plan, contract or arrangement.


	For the three months ended						For the six months ended
	June 30,						June 30,
	2007			2006			2007			2006
Revenue:
Contract	$	4,404		$	2,156		$	7,808		$	3,711
Royalty		301			163			482			313

Total Revenue		4,705			2,319			8,290			4,024


Operating expenses:
Research and development		3,785			4,058			7,681			7,647
General and administrative		1,640			2,656			3,318			4,253

Total operating expenses		5,425			6,714			10,999			11,900


Operating loss		(720	)		(4,395	)		(2,709	)		(7,876	)
Gain on sale of long-term investment		—			—			1,189			—
Interest income		312			98			597			189


Net loss	$	(408	)	$	(4,297	)	$	(923	)	$	(7,687	)


Net loss per common share – basic and diluted	$	(0.01	)	$	(0.24	)	$	(0.03	)	$	(0.43	)


Weighted average shares outstanding to calculate basic and diluted net loss per common share		29,986			17,886			28,562			17,852


		GENELABS TECHNOLOGIES, INC. (Registrant)

		Principal Executive Officer and acting Principal Financial and Chief Accounting Officer:

Date: August 14, 2007		/s/ James A.D. Smith

		James A.D. Smith
		President and Chief Executive Officer



Date: August 14, 2007	/s/ James A.D. Smith
	James A.D. Smith
	President, Chief Executive Officer and acting Chief Financial Officer

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