-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V06ZyeZv1swjvXOeSvQJS2EySGMvDBxAI5ZQV0qqsJLtC6FdZPglugJuCjoKOTE2 8KqPEeMPBDxykHGEB0d5Ww== 0001341004-06-001438.txt : 20060515 0001341004-06-001438.hdr.sgml : 20060515 20060515134311 ACCESSION NUMBER: 0001341004-06-001438 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060515 DATE AS OF CHANGE: 20060515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENELABS TECHNOLOGIES INC /CA CENTRAL INDEX KEY: 0000874443 STANDARD INDUSTRIAL CLASSIFICATION: PHARMACEUTICAL PREPARATIONS [2834] IRS NUMBER: 943010150 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-19222 FILM NUMBER: 06839094 BUSINESS ADDRESS: STREET 1: 505 PENOBSCOT DR CITY: REDWOOD CITY STATE: CA ZIP: 94063 BUSINESS PHONE: 6503969500 MAIL ADDRESS: STREET 1: 505 PENOBSCOT DR CITY: REDWOOD CITY STATE: CA ZIP: 94063 10-Q 1 gene10q.txt FORM 10-Q =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q |X| Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended March 31, 2006. or |_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ____________ to ______________. Commission File No. 0-19222 GENELABS TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) California 94-3010150 (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification number) 505 Penobscot Drive, 94063 Redwood City, California (Zip code) (Address of principal executive offices) Registrant's telephone number, including area code: (650) 369-9500 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 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 [ ] Accelerated Filer [ ] Non-accelerated Filer [x] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x] There were 17,817,649 shares of the Registrant's Common Stock issued and outstanding on April 21, 2006. =============================================================================== 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: o our ability to secure sufficient funds to continue as a going concern; o our ability to remain listed on the Nasdaq Capital Market; o estimates that existing cash resources will be adequate to provide liquidity for our regular operations only to approximately the beginning of the fourth quarter of 2006; o our future cash resources, expenditures and our ability to obtain additional funding for our business plans; and o 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; o plans, programs, progress, and potential success regarding our collaborators and licensees, including Gilead Sciences, Inc. for nucleoside compounds against hepatitis C virus, GlaxoSmithKline for hepatitis E vaccine, and, for Prestara, Watson Pharmaceuticals, Inc., Genovate Biotechnology Co., Ltd., and Tanabe Seiyaku Co., Ltd.; o our ability, or our collaborators' ability, to achieve any of the milestones contained in our agreements; o further actions or developments relating to Prestara(TM) (prasterone), our investigational drug for lupus, and its New Drug Application; o 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 at the end of Item 2. Among these are the risks that we may not be able to raise sufficient funds to continue operations, that we may be delisted from the Nasdaq Capital Market, that problems with our manufacturers or collaborators may negatively impact their or our research, clinical trials or product manufacture, development or marketing, that our research programs may fail, that our attempts to license our technologies to others may fail and that clinical trials of Prestara(TM) or similar formulations of prasterone are abandoned, delayed, or have results that are negative, inconclusive or not usable to support regulatory approval, that the U.S. Food and Drug Administration, or FDA, and foreign authorities may delay or deny approval of Prestara(TM). 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)
March 31, December 31, 2006 2005 ------------ ------------- (Unaudited) (Note 1) ASSETS Current assets: Cash and cash equivalents $ 7,415 $ 10,061 Restricted cash 150 150 Other current assets 414 539 ------------------ ------------------- Total current assets 7,979 10,750 Property and equipment, net 888 951 Long-term investment 960 960 ------------------ ------------------- $ 9,827 $ 12,661 ================== =================== LIABILITIES AND SHAREHOLDERS' EQUITY/(DEFICIT) Current liabilities: Accounts payable and other accrued liabilities $ 810 $ 608 Accrued compensation and related expenses 828 789 Accrued manufacturing costs 675 675 Unearned contract revenue 4,120 3,220 ------------------ ------------------- Total current liabilities 6,433 5,292 Accrued compensation 94 284 Unearned contract revenue 4,083 4,738 ------------------ ------------------- Total liabilities 10,610 10,314 ------------------ ------------------- Commitments and contingencies Shareholders' equity/(deficit): Common stock 231,317 231,057 Accumulated deficit (232,100) (228,710) ------------------ ------------------- Total shareholders' equity/(deficit) (783) 2,347 ------------------ ------------------- $ 9,827 $ 12,661 ================== =================== See notes to condensed consolidated financial statements.
GENELABS TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share amounts) (Unaudited)
For the three months ended March 31, --------------------------------------------- 2006 2005 ------------------- ------------------- Revenue: Contract $ 1,555 $ 1,555 Royalty 150 167 ------------------- ------------------- Total revenue 1,705 1,722 ------------------- ------------------- Operating expenses: Research and development 3,589 3,262 General and administrative 1,597 1,421 ------------------- ------------------- Total operating expenses 5,186 4,683 ------------------- ------------------- Operating loss (3,481) (2,961) Interest income, net 91 120 ------------------- ------------------- Net loss $ (3,390) $ (2,841) =================== =================== Net loss per common share - basic and diluted $ (0.19) $ (0.16) =================== =================== Weighted average shares outstanding to calculate basic and diluted net loss per common share 17,818 17,700 =================== =================== See notes to condensed consolidated financial statements.
GENELABS TECHNOLOGIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW (In thousands) (Unaudited)
For the three months ended March 31, --------------------------------------------- 2006 2005 ------------------- ------------------- Cash flows from operating activities: Net loss $ (3,390) $ (2,841) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization expense 104 105 Share-based compensation expense 260 6 Changes in assets and liabilities: Other current assets 125 318 Accounts payable, accrued liabilities and accrued compensation 51 (1,834) Unearned contract revenue 245 (655) ------------------- ------------------- Net cash used in operating activities (2,605) (4,901) Cash flows from investing activities: Purchase of property and equipment (41) (11) Cash flows from financing activities: Proceeds from issuance of common stock, net - 3 ------------------- ------------------- Net decrease in cash and cash equivalents (2,646) (4,909) Cash and cash equivalents, beginning of the period 10,061 26,358 ------------------- ------------------- Cash and cash equivalents, end of the period $ 7,415 $ 21,449 =================== =================== See notes to condensed consolidated financial statements.
GENELABS TECHNOLOGIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular amounts in thousands, except per share data) (Unaudited) March 31, 2006 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 unaudited 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 Company's consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business for the foreseeable future. The Company has incurred recurring operating losses and negative cash flows from operations, including a net loss of $3,390,000 and cash used in operations of $2,605,000 for the quarter ended March 31, 2006. As of March 31, 2006, the Company had cash and cash equivalents of $7,415,000, working capital of $1,546,000 and an accumulated deficit of $232,100,000. The Company expects its cash and cash equivalents would sustain existing operations only to approximately the beginning of the fourth quarter of 2006. These factors raise substantial doubt about the Company's ability to continue as a going concern. The ability of the Company to continue as a going concern is dependent upon its ability to obtain additional capital from a collaboration, equity financing or other means. In order to satisfy its projected cash needs for at least the next twelve months, Genelabs is pursuing various alternatives, including licensing its non-nucleoside HCV polymerase program, renegotiating the terms of a collaboration and pursuing investments from third-parties. If any of these transactions are completed Genelabs expects they would provide additional cash to the Company, although the amounts are not determinable. Genelabs may be unable to complete any of these transactions as currently contemplated or at all, and the outcome of these matters cannot be predicted at this time. Further, assuming the Company successfully raises additional funds, the Company may never achieve positive cash flow. If the Company is not able to secure additional funding the Company will be required to scale back its research and development programs and general and administrative activities and may not be able to continue in business. These consolidated financial statements do not include any adjustments to the specific amounts and classifications of assets and liabilities, which might be necessary should the Company be unable to continue in business. 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 ("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-month period ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. 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, 2005. The comparative balance sheet as of December 31, 2005 has been derived from the audited financial statements at that date. 2. Stock-Based Compensation In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" (SFAS 123R), which changes the accounting for share-based payment awards under our stock option and stock purchase plans, eliminating the ability to account for awards using the intrinsic value method, which had been used by the Company through December 31, 2005. Instead, SFAS 123R requires that awards be accounted for using a fair-value based method, and the Company is now required to recognize a share-based compensation expense based on estimates of the value of the awards. Under SFAS 123R, share-based compensation expense is measured at the grant date, based on the estimated fair value of the award. 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 our Condensed Statement of Operations. The Company has no awards with market or performance conditions. 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 FAS123R 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 FASB Statement No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). Employee Stock Plans -------------------- Employee Stock Purchase Plan. Employees who meet certain minimum requirements are eligible to participate in the Company's Employee Stock Purchase Plan. Eligible employees are entitled to purchase stock at 85% of the market value at the beginning or ending of six-month purchase periods, whichever is lower, and stock may be purchased at the same price for up to four periods. Employees can contribute up to 15% of total compensation, but purchases are limited to a maximum of $25,000 per year. At March 31, 2006 408,000 shares were available for future purchases. Stock Option Plan. The Company's stock option plan provides for the issuance of incentive stock options and nonqualified stock options to employees, officers, directors and independent contractors. The number of stock options granted is determined by the Board of Directors or a committee designated by the Board of Directors, except for grants to directors, who receive options based on a formula. 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. At March 31, 2006, 354,000 shares were available for future grants. Share-Based Compensation Information under FAS 123R (beginning January 1, 2006) -------------------------------------------------------------- Under the provisions of SFAS 123R, the Company has elected to continue using 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 exercise behavior for officers as compared to non-officer employees, upon adoption of SFAS 123R the Company has elected to value its options separately for officers and non-officers. The weighted-average estimated fair value of employee stock options granted during the three months ended March 31, 2006 was $1.51 and $1.44 per share for officers and non-officers, respectively, using the Black-Scholes model with the following weighted-average assumptions (annualized percentages) for the three months ended March 31, 2006: Employees who are not Officers Officers -------------------------- Risk-free interest rate 4.5% 4.5% Dividend yield 0.0% 0.0% Expected volatility 90.0% 90.0% Expected term (years) 6.75 5.75 The expected dividend yield, volatility and term above 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 options, 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 recognized in the Consolidated Statement of Operations for the three months ended March 31, 2006 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. Future forfeitures of vested and unvested employee stock options outstanding are estimated by the Company to be approximately 4.1% and 10.6% per year for officers and non-officers, respectively. The estimated fair value of each share expected to be purchased under our stock purchase plan was $0.74 for the three months ended March 31, 2006 based upon the following assumptions (annualized percentages) for all participating employees: Risk-free interest rate 4.5% Dividend yield 0.0% Expected volatility 90.0% Expected term (years) 0.50 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 period presented are subject to substantial change in the future. Share-based compensation expense is recognized on a straight-line basis over the related employee's requisite service periods. Total share-based compensation expense related to all of the Company's share based awards recognized for the three months ended March 31, 2006 was included in the statement of operations as follows: Research and development $ 202 General and administrative 58 -------------- Total share-based compensation expense $ 260 ============== Effect on net loss per common share, basic and diluted $ (0.01) ============== Share-based compensation expense for the three months ended March 31, 2006 includes $60,000 related to share-based awards granted during the three months ended March 31, 2006. As of March 31, 2006, total compensation cost related to non-vested stock options not yet recognized was $1.4 million, which will be expensed over a weighted average period of 1.4 years. Stock Option Activity --------------------- Stock option transactions for the first quarter of 2006 are summarized as follows: Weighted Weighted Average Average Aggregate Number Exercise Remaining Intrinsic of Shares Price Term Value ----------------------------------------------------------
Outstanding at December 31, 2005 1,746 $ 9.73 Granted 542 $ 1.91 Exercised - $ - Canceled (51) $ 21.41 ----------- Outstanding at March 31, 2006 2,237 $ 7.57 7.6 years $ - =========== Exercisable at March 31, 2006 1,156 $ 11.86 5.7 years $ -
The fair value of options that vested during the three months ended March 31, 2006 was $200,000. Pro-Forma Information under SFAS 123 (for periods prior to January 1, 2006) -------------------------------------------------------------------- Prior to adopting the provisions of SFAS 123R, the Company applied APB Opinion No. 25 "Accounting for Stock Issued to Employees" in accounting for its share based payment awards. The Company grants employee stock options at an exercise price equal to the fair market value of the shares at the date of grant and, accordingly, recognized no compensation expense for awards to employees. The Company followed the disclosure only provisions of SFAS 123, as amended by SFAS No. 148. The following table presents information showing the effects to the reported net loss and net loss per share if Genelabs had accounted for employee awards using the fair-value method: For the three months ended March 31, 2005 -------------- Net loss as reported $ (2,841) Stock-based employee compensation cost: Included in net loss as reported - Amount that would have been included in net loss if we had accounted for all stock- based employee compensation at its theoretical fair value (374) -------------- Pro forma net loss $ (3,215) ============== Net loss per common share as reported, basic and diluted $ (0.16) ============== Pro forma net loss per common share, basic and diluted $ (0.18) ============== 3. Comprehensive Loss During each of the three months ended March 31, 2006 and 2005, the Company's comprehensive loss was the same as its net loss. 4. 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 March 31, 2006 and 2005 would have included an additional 6,000 and 11,000 shares, respectively, related to the Company's outstanding stock options and warrants. 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 March 31, 2006 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 March 31, 2006 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 April 28, 2006, Genelabs had cash, cash equivalents and restricted cash of approximately $6.2 million, which we expect would sustain existing operations only to approximately the beginning of the fourth quarter of 2006. As a result, there is substantial doubt as to the ability of Genelabs to continue as a going concern absent a substantial increase in cash from a new corporate collaboration or sale of equity securities. If we do not increase our cash or significantly reduce our expenditures by the third quarter of 2006, we may need to begin the process of ceasing operations, which may result in a complete loss of value for our shareholders. In addition, Genelabs does not currently satisfy the listing requirements of the Nasdaq Capital Market, requiring a minimum shareholder's equity balance of $2.5 million or market capitalization of at least $35 million, along with a price per share of at least $1.00, which could result in the delisting of Genelabs from that exchange. On April 4, 2006, we received notice from Nasdaq that we did not meet the Nasdaq Capital Market continued listing requirements, after which we submitted a plan to Nasdaq for our compliance. To date we have not received further written correspondence from Nasdaq on the matter. Effective January 1, 2006, Genelabs adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment", or SFAS 123R, which changes the accounting for share-based payment awards under our employee stock option and purchase plans. Under SFAS 123R the Company is required to recognize compensation expense based on estimates of the value of the share-based awards. Genelabs adopted SFAS 123R using the modified prospective transition method, an adoption method under which prior periods are not restated to reflect the impact of FAS123R for comparative purposes. Under SFAS 123R, the total share-based compensation expense recognized for the three months ended March 31, 2006 was $0.3 million, or approximately $0.01 per share. Prior to the adoption of SFAS 123R, Genelabs followed the disclosure only provisions of SFAS 123, as amended by SFAS 148, and accordingly did not recognize expense for employee stock option and purchase plans in its statement of operations. Results of Operations - First Quarter 2006 compared to First Quarter 2005 - ------------------------------------------------------------------------- Summary Genelabs' net loss was $3.4 million in the first quarter of 2006 compared to a net loss of $2.8 million for the first quarter of 2005. The higher net loss in the 2006 period compared to the 2005 period is primarily due to increased hepatitis C virus, or HCV, drug discovery expenses, expenses related to the adoption of a new accounting standard that requires expensing of the theoretical value of stock options we issue to employees, and increased general and administrative expenses, partially offset by lower expenses for the development of Prestara(TM), our investigational new drug for lupus. Revenue Contract revenue was $1.6 million in the first quarter of both 2006 and 2005. Our largest source of revenue in the first quarter of both 2006 and 2005 was a research collaboration and license agreement with Gilead Sciences, Inc., or Gilead, under which we recognized $1.4 million in each period. The agreement with Gilead was entered into in 2004 and has an initial term of three years, with Gilead having an option to extend for one additional year. Upon entering into the agreement we received an initial upfront payment of $8.0 million, which we have deferred and are recognizing into revenue over the term of our expected obligations under the agreement, or four years. In addition, we receive on-going quarterly payments to fund our program continuing work on the collaboration, which we recognize into revenue as earned. During the first quarter of both 2006 and 2005, we recognized $0.2 million in revenue from our two collaborations for development and commercialization of our investigational new drug for lupus, Prestara(TM). The collaborations are with Watson Pharmaceuticals, Inc., or Watson, for North America and Tanabe Seiyaku Co., Ltd., or Tanabe, for Japan, and the revenue that we recognize under these agreements represents previously received up-front payments which we deferred and are recognizing over the term of our expected obligations, which we presently estimate extend through December 31, 2008. Royalty revenue was $0.2 million in the first quarter of both 2006 and 2005. Our largest source of royalty revenue in both quarters was from licenses we have granted to sell certain HCV diagnostic products. 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 these discovery and development efforts, and accordingly, most of our costs are classified as research and development and are expensed as incurred. Research and development expenses include related salaries and benefits, clinical trial and related clinical manufacturing costs, contract and outside service fees, supplies and chemicals used in laboratories and allocated facilities and overhead costs. The majority of Genelabs' research and development is directed toward two major projects - developing Prestara(TM) as an investigational new drug for lupus and discovery of new drugs targeting HCV. The following table shows our research and development expenses by major project (in thousands): For the three months ended March 31, 2006 2005 Change ------------------------------------------------
Drug discovery (HCV) $ 1,914 $ 1,496 +28% Drug development (Prestara(TM)) 432 892 -52% Support costs and other research and development 1,243 874 +42% -------------------------------- Total research and development $ 3,589 $ 3,262 +10% ================================
Research and development expenses increased by $0.3 million in the first quarter of 2006 compared to the first quarter in 2005. Expenses for drug discovery comprise the largest single category of our research and development expenses. Drug discovery costs increased by $0.4 million in the first quarter of 2006 compared to the first quarter of 2005 due to a greater number of employees working on our HCV programs as a result of our hiring additional scientists. In addition, we entered into a contract for process synthesis and scale-up manufacturing for one of our HCV preclinical candidates in order to be able to initiate Investigational New Drug Application, or IND, enabling studies, also increasing costs. Drug development costs for Prestara, our investigational drug for lupus, were $0.5 million lower in the first quarter of 2006 than in the first quarter of 2005 as a result of our completion of an open-label follow-on study in 2005 and a significantly lower number of employees during the 2006 period. Support costs and other research and development costs were $0.4 million higher in the first quarter of 2006 than in the first quarter of 2005. These costs are primarily comprised of costs necessary to maintain a research and development facility, such as rent, insurance, depreciation, utilities, maintenance, security, support staff, the company bonus and, for the first quarter of 2006 only, stock-based compensation expense. These costs are allocated based on the headcount ratio between research and development and general and administrative employees. These support costs and other research and development expenses increased in the first quarter of 2006 compared to the first quarter of 2005 primarily for two key reasons, the first of which is a charge for stock-based compensation expense, which we are required to recognize beginning in the first quarter of 2006 due to the adoption of SFAS123R. The second reason for the increase in costs is due to our employee incentive bonus plan, under which we recorded no expense in the first quarter of 2006 as compared to a credit in the first quarter of 2005 following the departure of participants that had been in a long-term portion of the plan. 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 $47 million through March 31, 2006. Of this amount, $18 million relates to our HCV drug discovery programs which began in early 2002. During 2006, substantially all of our drug discovery efforts were directed toward three separate hepatitis C virus 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 mechanisms as our nucleoside program and we refer to the other as the non-nucleoside program. Our third HCV drug discovery program targets the HCV NS5a protein, a different viral enzyme that 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(TM) for systemic lupus erythematosus in 1993 when we licensed exclusive rights to patents related to Prestara from Stanford University. To potentially develop this investigational new drug we have incurred direct costs of approximately $50 million through March 31, 2006. 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. Going forward, we believe both of our HCV polymerase-targeted programs, nucleoside and non-nucleoside, are staffed at appropriate levels to address our objectives. We believe that, as we continue advancement of the preclinical candidates in the non-nucleoside program, our external costs will increase as we rely on outside sources to manufacture the drug material and conduct studies. During 2006, subject to receipt of additional funding, we also plan to continue work on our newest HCV drug discovery program, targeting the NS5a protein, and we intend to explore other drug targets as potential programs if our financial resources allow. However, the resources available to us, outcomes of current and planned scientific experiments and outcomes of corporate partnering discussions may cause us to revise this estimate. 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. General and Administrative Expenses General and administrative expenses were $1.6 million in the first quarter of 2006 compared to $1.4 million in the first quarter of 2005. Our general and administrative expenses consist primarily of personnel costs for executive management, finance, marketing, business development, human resources and legal departments, as well as professional expenses, such as legal and audit, and facilities costs such as rent and insurance. These expenses were higher in the first quarter of 2006 compared to the first quarter of 2005 due to higher legal expenses related to patent filing and prosecution and potential Company financing and business development activities, as well as stock-based compensation expense due to the adoption of SFAS 123R in the 2006 period. Liquidity and Capital Resources - ------------------------------- We assess liquidity primarily by the cash and cash equivalents available to fund our operations. Genelabs had cash, cash equivalents and restricted cash balances totaling $7.6 million at March 31, 2006. During the first three months of 2006, our cash and cash equivalents decreased by $2.6 million due to cash used in operations. Genelabs presently estimates that our current cash resources would be adequate to provide liquidity for our existing operations only to approximately the beginning of the fourth quarter of 2006. As a result, there is substantial doubt as to the ability of Genelabs to continue as a going concern absent a substantial increase in cash from a new corporate collaboration or sale of equity securities. We will require additional capital prior to this time to carry out our business plans in 2006 and thereafter and expect to continue to rely on outside sources of financing to meet our capital needs. If we do not increase our cash or significantly reduce our expenditures by the third quarter of 2006, we may need to begin the process of ceasing operations or liquidating, which may result in a complete loss of value for our shareholders. The ability of the Company to continue as a going concern is dependent upon its ability to obtain additional capital from a collaboration, equity financing or other means. In order to satisfy its projected cash needs for at least the next twelve months, Genelabs is pursuing various alternatives, including licensing its non-nucleoside HCV polymerase program, renegotiating the terms of a collaboration and pursuing investments from third-parties. If any of these transactions are completed we expect they would provide additional cash to the Company, although the amounts are not determinable. Genelabs may be unable to complete any of these transactions as currently contemplated or at all, and the outcome of these matters cannot be predicted at this time. Further, assuming the Company successfully raises additional funds, the Company may never achieve positive cash flow. If the Company is not able to secure additional funding the Company will be required to scale back its research and development programs and general and administrative activities and may not be able to continue in business. The accompanying consolidated financial statements do not include any adjustments to the specific amounts and classifications of assets and liabilities, which might be necessary should the Company be unable to continue in business. Longer-term, if we succeed in securing sufficient capital to allow us to continue drug discovery research and complete an additional clinical trial for Prestara, Genelabs' liquidity and capital resources may be materially impacted by success or failure in reaching milestones under corporate collaborations, the progress, if any, of the Company's other, unpartnered drug discovery programs and FDA actions with respect to our New Drug Application for Prestara. Since Genelabs' inception, the Company has operated at a loss and has 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. 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 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 is accounted for at cost, based on the lower of cost or market value method. This investment is the only item included in the balance sheet caption "Long-term investments." Genelabs may attempt to divest a portion of this investment, in which case changes in foreign currency exchange rates would impact the proceeds received upon sale of these shares. Because the book value of Genelabs' ownership percentage of Genovate is greater than our carrying cost, we currently do not believe that any foreign currency exchange rate changes would impact the value of this investment as reported in the financial statements unless the value of a Taiwan dollar depreciates by greater than 60% compared to the U.S. dollar, which, depending on other circumstances, might require Genelabs to record a non-cash charge to write-down the long-term investment. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and 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 Chief Financial Officer have 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 Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure (b) 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 will need to raise additional capital within the next few months, and if we are unable to timely secure adequate funds on acceptable terms, we will be required to cease our operations and will not be able to continue as a going concern. On March 31, 2006, Genelabs had cash, cash equivalents and restricted cash totaling approximately $7.6 million, which we presently estimate can sustain our existing operations only to approximately the beginning of the fourth quarter of 2006. We will need to raise additional capital in order to execute our business plans, provide adequate working capital to satisfy our obligations and continue as a going concern. While we are in the process of seeking additional funds, including entering into a new collaboration for our hepatitis C virus drug discovery program, selling equity, renegotiating an existing corporate collaboration, and/or other arrangements, it is possible that none of these efforts to seek additional funds will be successful. If these efforts are not successful by the third quarter of 2006, we may need to begin terminating operations and you may lose your entire investment. If one or more of these efforts are successful, the amount of funds we raise may still not be sufficient for us to sustain operations as planned or at all. As of the date of this filing, there is substantial doubt about the Company's ability to continue as a going concern due to its historical negative cash flow and because the Company does not currently have sufficient committed capital to meet its projected operating needs for at least the next twelve months. Additionally, our financial condition may lead our vendors and suppliers to require advance payments or security deposits, further depleting our resources, and may result in loss of some of our employees who seek employment elsewhere. If we raise additional funds through the issuance of equity, or securities convertible into equity, we may be required to do so at a price per share below then-current trading prices, thereby diluting our current shareholders. We may not be able to obtain additional funds on acceptable terms, or at all. Other sources of capital, such as a collaboration or strategic alliance, may require us to grant third parties rights to our intellectual property assets, or require us to adversely renegotiate the terms of one or more of our existing collaborations. We may also need to change our operating plans. Although we are currently discussing with third parties a collaboration for our HCV non-nucleoside drug discovery program, we may fail to enter into any agreement on acceptable terms, if at all. We also may be unable to find buyers willing to purchase our equity or to license other products or technology on commercially favorable terms, if at all. If additional funds are not available we may be required to cease operations, resulting in a complete loss of investment to our shareholders. In order to maintain its license to use radioactive research materials, Genelabs has established a $150,000 standby letter of credit in favor of the Radiologic Health Branch of the California Department of Health Services. If we are unable to raise additional funds, the letter of credit may be terminated and the radioactive materials license may be suspended or revoked. Because we do not qualify for listing on the Nasdaq quotation system, the value of your investment in Genelabs may substantially decrease. To remain listed on the Nasdaq Capital Market we must have at least $2.5 million in shareholders' equity or a market value of at least $35 million. Our shareholders' equity as of March 31, 2006 was a deficit of $0.8 million and as of May 10, 2006 the Company's market value was approximately $16 million. We currently do not comply with the minimum shareholder's equity or market capitalization requirements, and will not be able to comply with these requirements unless we are able to increase our shareholders' equity through a financing or other means or our stock price significantly increases. We have received a notice of non-compliance from Nasdaq and have submitted a plan for compliance but have not received any further written correspondence from Nasdaq on the matter. To remain listed on the Nasdaq Capital Market the closing bid price of our stock must be at least $1.00 per share. As of May 10, 2006, our closing bid price was approximately $0.89 per share. If our stock price does not increase above $1.00 per share, Nasdaq will issue a separate notice of non-compliance to us. If Genelabs is unable to meet or maintain compliance with all of the Nasdaq listing requirements, it will be delisted from the Nasdaq Capital Market. 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. 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 $232 million in net losses through March 31, 2006, including a net loss of $3.4 million for the quarter ended March 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 current operations only to approximately the beginning of the fourth quarter of 2006. We will require additional capital to carry out our business plans. The following are illustrations of potential impediments to our ability to successfully secure sufficient additional funds: o the current trading price of our stock will materially and adversely affect our ability to raise funds through the issuance of stock; o the amount of stock we may sell and capital we may raise privately without a shareholder vote is limited, and we may be unable to secure capital on a timely basis with acceptable terms if we must submit such a transaction to our shareholders for approval; o the listing of our stock on the Nasdaq Capital Market may materially and adversely affect our ability to raise funds through the issuance of stock because of factors such as reduced liquidity and the requirement to comply with state securities laws; o if we are unable to regain or maintain compliance with the Nasdaq's listing requirements, our ability to successfully obtain additional equity financing will be negatively impacted; o since our research programs are in an early stage, there are fewer opportunities to enter into collaborations with other companies and up-front payments for early-stage pharmaceutical research collaborations are generally smaller for projects that are further from potential marketability; o biotechnology research and development projects have a high risk of failure and the failure of our research-stage drug candidates or those of other companies could discourage funding sources from providing us with financing; and o discussions with the Food and Drug Administration have indicated that the Company will need to conduct at least one additional Phase III clinical trial of Prestara in order to qualify for approval, and the Company does not have the funds to conduct the trial. 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. The results of our clinical trial of Prestara(TM), Genelabs' drug candidate for systemic lupus erythematosus, were not positive, substantially decreasing the probability that Prestara will ever be approved for marketing and thus diminishing our business prospects. In order to satisfy conditions set by the U.S. Food and Drug Administration, or 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 powered to demonstrate, and in fact did not demonstrate, a statistically significant benefit in secondary endpoints such as amelioration of lupus symptoms. A 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. Because both our and Genovate's clinical trials did not meet their primary endpoints, the FDA will not approve Prestara without another Phase III clinical trial. It may not be possible to design and implement a trial that would successfully provide results sufficient to obtain FDA approval for Prestara, and Genelabs currently does not have the funds to conduct such a trial. 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; if others develop competing therapies; 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. 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. Genelabs has limited human and financial resources. 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. Large pharmaceutical companies have access to the latest equipment and have many more personnel available to focus on solving particular research problems, including those that Genelabs is investigating. Therefore, even if our research programs are successful, we may have a competitive disadvantage. Our collaborations may fail. We have entered into collaborations with Gilead, GlaxoSmithKline, or GSK, 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. In this regard, Gilead may not continue to fund our research beyond its obligation in the research contract, and GSK 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 the company 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 candidate 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 of the Company and/or the collaborator or rights to intellectual property. If we are unable to obtain the funds to ensure the continuance of our business or 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 do not have the resources to conduct preclinical development. We do not have the personnel or facilities to conduct the formal preclinical development of our hepatitis C compounds as necessary to file an application to conduct clinical trials in humans. Our experience in conducting preclinical development, including formal toxicology studies, is limited. We will need to outsource this activity and may need to retain more experienced personnel. Outsourcing is expensive, time-consuming and requires reliance on the performance of third parties. Because of our financial condition, stock performance and setbacks in our Prestara(TM) program, we may have difficulty hiring specialized personnel. We may be unable to attract or retain key personnel. Our ability to develop our business depends in part upon our attracting and retaining qualified management and scientific personnel. As the number of qualified personnel is limited, competition for such staff is intense. 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. Furthermore, the negative results from the most recent clinical trials of Prestara(TM) and the ensuing drop in our stock price, as well as the Company's declining cash position, have significantly diminished our future business prospects, thus making it more difficult to retain existing employees and to recruit new employees. Since the announcement of the results of our Phase III trial of Prestara in October 2004, substantially all of our clinical development staff have left the Company. The loss of 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. 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 depend on Gilead for nucleoside compounds for treatment of hepatitis C infections, and on GSK for the hepatitis E vaccine, to conduct preclinical and clinical development, to obtain regulatory approval and to manufacture and commercialize. 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. If our Japanese marketing partner for Prestara(TM) does not obtain approval to market Prestara in Japan, our business prospects will suffer because we do not have capabilities to develop Prestara for Japan ourselves, and we would lose a significant source of potential revenue. Our licensee in Japan, Tanabe, has not conducted clinical trials for Prestara in Japan. Given the most recent negative results in the clinical trials of Prestara and the similar formulation used in Taiwan, Tanabe may not proceed with clinical trials, or if it does, the results from such trials may not be positive. Our outside suppliers and manufacturers for Prestara(TM) and our hepatitis C compounds 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. We rely on another manufacturer for the scale up and production of our hepatitis C compounds. The disqualification of these suppliers and manufacturers 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 its active ingredient in anticipation of possible marketing approval. This inventory has exceeded its initial expiration date, although the expiration date of the active ingredient may be extended if it successfully passes re-testing. The following could harm our ability to manufacture Prestara or our hepatitis C compounds: o the unavailability at reasonable prices of adequate quantities of the active ingredient or intermediates; o the loss of a supplier's or manufacturer's regulatory approval; o the failure of a supplier or manufacturer to meet regulatory agency pre-approval inspection requirements; o the failure of a supplier or manufacturer to maintain compliance with ongoing regulatory agency requirements; o the inability to develop alternative sources in a timely manner or at all; o inability or refusal of the manufacturers to meet our needs for any reason, such as loss or damage to facilities or labor disputes; o manufacture of product that is defective in any manner; o competing demands on the contract manufacturer's capacity, for example, shifting manufacturing priorities to their own products or more profitable products for other customers; o complications in the scale-up or large-scale manufacturing of our hepatitis C compounds; and o our lack of cash resources. 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 the specific polymorphic form of DHEA we have used may be patentable, 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, no patents are currently 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. The lease for our facilities expires in November and we may not have the facilities to continue our operations. The lease for the facilities housing nearly all of our operations expires in November 2006. We may be unable to obtain an extension or renewal of the lease on acceptable terms, or at all. If we are unable to remain on our current premises, we may be unable to obtain alternative facilities due to our financial condition or for other reasons, and we may be unable to fully relocate our operations before termination of our current lease, thereby incurring a significant interruption in our business operations. Any relocation would result in substantial disruption of our operations and diversion of management and staff away from our core business activities. The terms for the existing or any new premises may require higher rent, advance payments, deposits or other terms disadvantageous to us. We sublease a portion of our premises to Genitope Corp. for approximately $150,000 per year and there is no assurance that the sublease will continue on favorable terms, or at all, or that we would be able to remove the space from any extension of our lease. Our facilities in California are located near an earthquake fault, and an earthquake could disrupt our operations and adversely effect results. Almost 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. The Company currently has insurance coverage for earthquake and flood damage, including business interruption coverage due to those events, with limits of $5 million and subject to a deductible which currently is approximately $1.6 million. There is no assurance that earthquake or flood insurance will continue to be available at a cost that is acceptable to the Company or that such insurance will be adequate to reimburse our losses. 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 other 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 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, including general liability insurance of $6 million, we may not be able to maintain this type of insurance in a sufficient amount. We currently maintain $5 million of product liability insurance for claims arising from the use of our products in clinical trials. In addition, product liability insurance is becoming increasingly expensive. As a result, we may not be able to obtain or maintain product liability insurance in the future 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. Market Risks 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, 2005 and December 31, 2005, the price of our common stock fluctuated between $6.15 and $1.70 per share, as adjusted for the reverse-split. Between January 1, 2006 and May 10, 2006, the price of our common stock fluctuated between $2.30 and $0.70 per share. In addition to the factors discussed in this Risk Factors section, a variety of events can impact the stock price, including the low percentage of institutional ownership of our stock, which contributes to lack of stability for the stock price. The availability of a large block of stock for sale in relation to our normal trading volume could also result in a decline in the market price of our common stock. In the event we do not obtain the capital necessary to continue as a going concern, we may be required to discontinue operations, which could result in the complete loss of investment to our shareholders. In addition, numerous events occurring outside of our control may also impact the price of our common stock, including general market conditions or those related to the biopharmaceutical industry. Other companies have defended themselves against securities class action lawsuits following periods of volatility in the market price of their common stock. If a party brings this type of lawsuit against us, it could result in substantial costs and diversion of management's time. Item 6. Exhibits Exhibit Number Description - ----------- --------------------------------------------------------------- 31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 31.2 Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GENELABS TECHNOLOGIES, INC. (Registrant) Principal Executive Officer: /s/ JAMES A.D. SMITH Date: May 15, 2006 ------------------------------------- James A.D. Smith President and Chief Executive Officer Principal Financial and Chief Accounting Officer: /s/ MATTHEW M. LOAR Date: May 15, 2006 ------------------------------------- Matthew M. Loar Chief Financial Officer EXHIBIT INDEX Exhibit Number Description - ----------- --------------------------------------------------------------- 31.1 Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 31.2 Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended. 32.1 Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. EX-31 2 james31.txt EXHIBIT 31.1 - CERTIFICATION Exhibit 31.1 CERTIFICATION I, James A.D. Smith, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Genelabs Technologies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 15, 2006 /s/ JAMES A.D. SMITH ----------------------------- James A.D. Smith President and Chief Executive Officer EX-31 3 matt31.txt EXHIBIT 31.2 - CERTIFICATION Exhibit 31.2 CERTIFICATION I, Matthew M. Loar, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Genelabs Technologies, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 15, 2006 /s/ MATTHEW M. LOAR ------------------------------ Matthew M. Loar Chief Financial Officer EX-32 4 jamat32.txt EXHIBIT 32.1 - CERTIFICATION Exhibit 32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C ss. 1350, as adopted), James A.D. Smith, President and Chief Executive Officer of Genelabs Technologies, Inc. (the "Company"), and Matthew M. Loar, Chief Financial Officer of the Company, each hereby certifies that, to the best of his knowledge: 1. The Company's Quarterly Report on Form 10-Q for the period ended March 31, 2006, to which this Certification is attached as Exhibit 32.1 (the "Periodic Report"), fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Periodic Report fairly presents, in all material respects, the financial condition of the Company at the end of the period covered by the Periodic Report and results of operations of the Company for the period covered by the Periodic Report. Dated: May 15, 2006 /S/ JAMES A.D. SMITH /S/ MATTHEW M. LOAR - --------------------------------------- ----------------------------------- James A.D. Smith Matthew M. Loar President and Chief Executive Officer Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----