UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

or

Commission File No. 0-19222

GENELABS TECHNOLOGIES, INC.

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 an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [   ]

There were 88,320,199 shares of the registrant’s common stock issued and outstanding on October 29, 2004.

Table of Contents

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 identified by the words “may,” “will,” “anticipates,” “intends,” “believes,” “expects,” “plans,” “potential,” and similar expressions. These forward-looking statements include, among others, statements regarding:

•		results and analysis of our recent Prestara™ Phase III clinical trial in the United States and the follow-on open label clinical trial;
•		the clinical trial of prasterone being conducted by a licensee in Taiwan;
•		possible actions, if any, we may take relating to our New Drug Application, or NDA, for Prestara, filed with the U.S. Food and Drug Administration, or FDA;
•		our ability to achieve any milestones in our agreements with Gilead Sciences or other collaborators;
•		estimates relating to our cash resources and our ability to obtain additional funding for our business plans;
•		our ability to secure and defend intellectual property rights important to our business; and
•		the potential success of 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.

        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 Business Risks section at the end of Item 2. Among these are the risks that clinical trial results of Prestara™ or similar formulations are abandoned, delayed, negative, inconclusive or not usable to support regulatory approval, that the FDA and foreign authorities may delay or deny approval of Prestara™, that we may not be able to raise sufficient funds to continue operations, that problems with our manufacturers or collaborators may negatively impact clinical trials, that our research programs may fail and that our attempts to license our technologies to others may fail. Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements, and the failure of such other assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. Most of these factors are difficult to predict accurately and are generally beyond our control. Except for our ongoing obligations to disclose material information under federal securities laws, we assume no obligation to update any such forward-looking statement for subsequent events. The risks and uncertainties under the captions “Business Risks” 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. Actual results could differ materially from those expressed or implied in these statements. 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.

See notes to condensed consolidated financial statements.

GENELABS TECHNOLOGIES, INC.

See notes to condensed consolidated financial statements.

GENELABS TECHNOLOGIES, INC.

See notes to condensed consolidated financial statements.

GENELABS TECHNOLOGIES, INC.

1. Significant Accounting Policies

     Basis of Presentation

     Genelabs Technologies, Inc., referred to as Genelabs or the Company, is a biopharmaceutical company focused on the discovery and development of novel pharmaceutical products to improve human health. The Company has built drug discovery and clinical development capabilities that can support various research and development projects. The Company is currently concentrating its capabilities on discovering and optimizing novel lead compounds that selectively inhibit replication of the hepatitis C virus, or HCV, and advancing preclinical development of its HCV research program. The Company is evaluating its lupus drug candidate, which recently failed to achieve the endpoints in a Phase III clinical trial in the United States.

     The accompanying unaudited condensed consolidated financial statements include the accounts of Genelabs Technologies, Inc. and its wholly owned subsidiaries, Accelerated Clinical Research Organization, Inc., Genelabs Diagnostic, Inc. and Genelabs Europe B.V. Genelabs Technologies, Inc. and its subsidiaries are collectively referred to as Genelabs or the Company. All intercompany accounts and transactions have been eliminated. The Company operates in one business segment, the discovery and development of pharmaceutical products. Prior to the disposition of Genelabs diagnostics business in April 2004, Genelabs accounted for its diagnostics subsidiary, Genelabs Diagnostics Pte. Ltd., or GLD, as a discontinued operation.

     The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. It is possible that actual amounts will differ from those estimates.

     These financial statements have been prepared in accordance with 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 and nine-month periods ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. 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, 2003. The comparative balance sheet as of December 31, 2003 has been derived from the audited financial statements at that date. Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications decreased research and development expenses by $444,000 for the nine months ended September 30, 2003 and increased general and administrative expenses by the same amount.

2. Stock-Based Compensation

     The Company grants employee stock options at an exercise price equal to the fair market value of the shares at the date of grant. The Company accounts for employee stock-based compensation using the intrinsic value method and, accordingly, recognizes no compensation expense for stock options granted to employees. The following table presents information showing the effects to the reported net loss and net loss per share if Genelabs had accounted for employee stock-based compensation using the fair-value method:

     On March 31, 2004, the Financial Accounting Standards Board (FASB) issued an Exposure Draft, “Share-Based Payment — An Amendment of FASB Statements No. 123 and 95” (proposed FAS 123R), which currently is expected to be effective for public companies in periods beginning after June 15, 2005. As proposed, Genelabs would be required to implement the standard in the third quarter of 2005 and the cumulative effect of adoption, if any, applied on a modified prospective basis, would be measured and recognized on the date of implementation, July 1, 2005. The proposed FAS 123R addresses the accounting for stock options issued to employees, and would eliminate the ability to account for employee stock options using the intrinsic value method currently used by the Company. Instead, the proposed FAS 123R would require that these options be accounted for using a fair-value based method, and the Company would be required to recognize an expense for stock options issued to employees and also for employees’ participation in the Company’s stock purchase plan. The FASB expects to issue a final standard by December 31, 2004. Genelabs is currently evaluating option valuation methodologies and assumptions in light of the proposed FAS 123R. Current estimates of option values using the Black-Scholes method (as shown above) may not be indicative of results from valuation methodologies ultimately adopted in the final rules.

3. Comprehensive Loss

     During each of the three months and nine months ended September 30, 2004 and 2003, the Company’s comprehensive loss was the same as the net loss.

4. Earnings per Share

     Net loss per share has been computed using the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share has not been presented, as, due to the Company’s net loss position, it is antidilutive. Had the Company been in a net income position, diluted earnings per share for the three months ended September 30, 2004 and 2003 would have included an additional 2,366,000 and 274,000 shares, respectively, and for the nine months ended September 30, 2004 and 2003, would have included an additional 2,846,000 and 261,000 shares, respectively, related to the Company’s outstanding stock options and warrants.

5. License and Collaboration Agreement with Tanabe and Stock Purchase Agreement

     In January 2004, Genelabs granted Tanabe Seiyaku Co. Ltd. (Tanabe) an exclusive license to Prestara™ in Japan and received a $2.0 million non-refundable initial license fee. Genelabs has accounted for the non-refundable license fee as unearned contract revenue and is amortizing the unearned contract revenue into the statement of operations as Genelabs fulfills its obligations to Tanabe, which are estimated to extend through December 31, 2008. Under the terms of the agreement, Genelabs is entitled to additional milestone payments of up to $10.0 million based on pre-determined development goals and Genelabs is also entitled to royalties on any sales of Prestara in Japan. Also in January 2004, Genelabs sold 818,897 shares of its common stock to Tanabe for $2.6 million, or $3.175 per share.

6. Sale of Diagnostics Business

     In April 2004, the Company closed the sale of its discontinued diagnostics subsidiary, GLD, and its immediate parent, Genelabs Asia Pte. Ltd., and received gross proceeds from the sale of $3.0 million. Prior to the sale Genelabs accounted for its diagnostics business as a discontinued operation. Net assets of the diagnostics business held for sale were $844,000 at March 31, 2004. Net proceeds from the sale were approximately $2.9 million, net of the costs of disposition. The Company has recorded a gain of approximately $2.0 million on the sale.

7. Subsequent Events

     On October 5, 2004, the Company announced that a Phase III clinical trial of its lupus drug candidate, Prestara™, did not reach its primary endpoint. The Company is continuing its analysis of the data and evaluating its development options for Prestara. As a result of the clinical trial not meeting its primary endpoint, the Company is extending the term over which it is amortizing a previously received up-front payment related to the development of Prestara, beginning in the third quarter of 2004. This change in accounting estimate reduced contract revenue and increased net loss by $292,000 for the three months and nine months ended September 30, 2004.

     On October 6, 2004, the Company received $8.9 million from Gilead Sciences, Inc. under a research collaboration and license agreement that was signed on September 29, 2004 with an October 1, 2004 effective date. The payment from Gilead included a nonrefundable $8.0 million upfront payment as well as research funding for one calendar quarter. Under the terms of the agreement, Gilead is obligated to make additional quarterly payments to Genelabs over a three-year period to fund Genelabs’ research to discover new nucleoside inhibitors of the HCV polymerase. In addition, Genelabs is entitled to milestone payments of up to $38.0 million for each Genelabs compound developed by Gilead under the agreement, based upon the achievement of specified development and regulatory goals. Genelabs is also entitled to royalties on any net sales of future products developed from the Genelabs compounds.

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

     The following discussion should be read in conjunction with the condensed consolidated financial statements and accompanying notes included elsewhere herein and in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2003 filed with the Securities and Exchange Commission on March 15, 2004.

Overview

     Genelabs Technologies, Inc., referred to as Genelabs or the Company, is a biopharmaceutical company pioneering the discovery and development of novel pharmaceutical products to improve human health. We have built drug discovery and clinical development capabilities that can support various research and development projects. We are also pursuing the discovery of novel antiviral compounds for treatment of hepatitis C infections, and have initiated preclinical development work in this area. We believe that these high-risk, potentially high-reward programs focus our research and development expertise in areas where we have the opportunity to be scientific pioneers and, if successful, we believe that these programs will yield products that will address diseases for which current therapies are inadequate. At the same time, our established capabilities can be utilized as we diversify our research and development programs. We are currently evaluating what actions to take regarding Prestara™, an investigational drug for women with systemic lupus erythematosus, which recently failed to meet its endpoints in a Phase III trial.

We are concentrating our capabilities on:

•		advancing preclinical development of our hepatitis C virus, or HCV, research program;
•		discovering additional novel lead compounds that selectively inhibit replication of HCV;
•		evaluating other targets for our research program; and
•		evaluating what actions to take regarding our Prestara™ clinical program.

     Our results of operations have fluctuated from period to period, and may continue to fluctuate in the future, based upon the progress of our research and development programs, variations in the level of expenditures that are dependent on the particular status of development each quarter, cash resources available to the Company, and the status of our collaborations with third parties. We are subject to risks common to companies in our industry and at our stage of development, including risks inherent in our research and development efforts, reliance upon our corporate collaborators and the uncertainty of regulatory approvals. We believe that many traditional financial measures of corporate performance, such as sales growth, net income or earnings per share are less important at our stage of development than other measures presently used by management to evaluate performance. The key measures of performance currently used at Genelabs are the progress of our research and development programs, the status of our corporate development and marketing relationships with corporate collaborators, and the securing of capital resources sufficient to enable us to further our research and development plans. Management utilizes these measures for corporate performance due to the great amount of time and capital that are required to get new drug products to the market. Should the Company be successful in its efforts to bring its products to market, the more traditional measures of corporate performance will become more relevant in evaluating performance.

Recent Developments

Prestara clinical trial

     On October 5, 2004, we announced that our Phase III confirmatory clinical trial, Study GL02-01, for our investigational new drug, Prestara (prasterone), also referred to as GL701, Aslera™ and Anastar™, failed to meet its primary endpoint. Study GL02-01 was a double-blind, placebo-controlled clinical trial that was designed to determine whether Prestara would improve the bone mineral density of women with systemic lupus erythematosus, or lupus, who were taking glucocorticoids. Genelabs previously completed a one-year Phase III clinical trial, designated Study GL95-02, which included a nested study in which the group of patients receiving Prestara had increased bone mineral density, compared to a decrease in the bone mineral density for the group of patients receiving placebo.

     Lupus is a severe, chronic and debilitating autoimmune disease that can affect the muscular, skeletal and nervous systems as well as the lungs, heart, kidneys, skin and joints. Prestara is a pharmaceutical formulation containing highly purified prasterone, the synthetic equivalent of dehydroepiandrosterone, or DHEA, a naturally occurring hormone.

     In 2000, we submitted our New Drug Application, or NDA, for Prestara to the U.S. Food and Drug Administration, or FDA. In 2002 we received an approvable letter which, among other things, required us to conduct an additional clinical trial to confirm a positive effect of Prestara on the bone mineral density of women with lupus who were receiving glucocorticoids, as was previously noted in a nested study contained in Study GL95-02. After receiving the approvable letter, we conducted a Phase III clinical trial at 26 sites in the United States and Mexico that was designed to confirm the positive effect on bone mineral density previously noted. On October 5, 2004 we announced that a preliminary analysis of the data from this trial indicated that Prestara did not demonstrate a statistically significant difference between the bone mineral density of the group of patients taking Prestara and the group taking placebo. Separately, 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. We are continuing to analyze the data in an attempt to determine the reasons why the trial did not detect a difference in bone mineral density between the Prestara and placebo treatment groups; however, it is not likely that the cause or causes of the trial results can be identified with certainty. We presently cannot estimate how long it will take us to complete the analysis of the data from Study GL02-01 and subsequently discuss the data with the FDA, nor can we estimate what we will learn from the completion of the analysis and from our discussions with the FDA.

     All patients who completed Study GL02-01 were eligible to enroll into a one-year open-label follow-on study, which we have designated Study GL03-01. GL03-01 is designed to dose all patients with Prestara and all patients are scheduled to have additional bone mineral density measurements at six months and twelve months. Approximately 115 patients from our double-blind Study GL02-01 elected to enroll into Study GL03-01. This study is ongoing. There can be no assurance that the data from GL03-01 will be positive or will have any positive effect on our Prestara NDA. We may later decide to terminate GL03-01 based on our analysis of GL02-01 or because of other factors.

     Separately, there is also a clinical trial of prasterone being conducted by Genovate Biotechnology Co., Ltd., referred to as Genovate, a Taiwan-based company that has a license from us for Prestara in most Asian countries. The Genovate study is a double-blind, placebo-controlled clinical trial similar in design to our Study GL02-01, with bone mineral density as its primary endpoint, but has a longer treatment duration of nine months, compared to six months for our study. While the Taiwan trial is not being conducted under a U.S. Investigational New Drug application, commonly referred to as an IND, we believe it is designed to comply with Good Clinical Practices, or GCPs, under the International Conference on Harmonization. The Genovate trial has enrolled 88 patients and the last patient visit currently is scheduled to occur in the

first quarter of 2005. There can be no assurance that the trial will ever be completed or that the results will be made available to us or will be usable to support our development program for Prestara. We cannot predict whether the Taiwan study will be positive, and even if the results of the Taiwan trial are positive, we do not know whether it would be useful for our plans to develop Prestara or whether it could overcome the failure of our U.S. trial to reach its endpoints. If the results of the Taiwan trial are positive, we intend to submit them to the FDA to support our Prestara NDA, however, we cannot predict whether the FDA would consider such data. Genelabs holds approximately 8% of the equity in Genovate, which was formerly called Genelabs Biotechnology Co., Ltd. The chairman of our board of directors, Irene A. Chow, Ph.D., is also chairman of the board of directors of Genovate.

Hepatitis C virus research collaboration and license agreement

     On September 29, 2004 Genelabs signed an agreement with Gilead Sciences, Inc., referred to as Gilead, to collaborate in the research, development and commercialization of novel compounds for the treatment of infection caused by the hepatitis C virus, or HCV, beginning October 1, 2004. On October 6, 2004, under the terms of the agreement, Gilead paid the Company a nonrefundable $8.0 million upfront payment and $0.9 million as the first installment of its obligation to pay $3.6 million in research funding for each of the first two years of the agreement, increasing to $4.0 million in the third year. In return the Company will devote a specified number of scientists to the program and provide Gilead with exclusive access to certain compounds developed by Genelabs in the program. The Company could also earn milestone payments for each such compound developed by Gilead under the agreement, based upon the achievement of specified development and regulatory goals. Gilead will receive exclusive worldwide license rights and is obligated to pay the Company a royalty on any net sales of future products developed from the Genelabs compounds.

Results of Operations – Third Quarter of 2004 compared to Third Quarter of 2003

     Summary

     Our net loss was $4.4 million for the three months ended September 30, 2004, compared to a net loss of $4.8 million for the three months ended September 30, 2003. The lower net loss in the 2004 period compared to the 2003 period is primarily due to lower research and development costs, partially offset by lower contract revenue.

     Contract Revenue

     Contract revenue was $0.4 million in the third quarter of 2004 compared to $0.7 million in the third quarter of 2003. During the third quarter of 2004, contract revenue was comprised of payments received regularly by us under royalty and contract service arrangements as well as the pro-rata recognition of revenue from two up-front license payments that were previously received. These two up-front license payments were both related to rights for Prestara™, our investigational drug for lupus, and we classify these payments as “unearned contract revenue” upon receipt and amortize these payments into revenue based on management’s estimates of the time it will take us to fulfill the significant obligations under each of the agreements.

     One of these up-front payments was a $10.0 million payment by Watson Pharmaceuticals, Inc., or Watson, in 2000 for the North American commercialization rights for Prestara. Effective with the beginning of the third quarter of 2004, we are extending the amortization period for the unearned contract revenue from the Watson agreement and thus reducing the quarterly revenue recognized under the agreement. We are extending the term now because we do not presently expect a U.S. Food and Drug Administration, or FDA, decision on approval of our New Drug Application, or NDA, by June 2005, the previous date through which we were amortizing the up-front payment from Watson. We extended the

term upon learning the results of our Phase III clinical trial, which did not demonstrate a beneficial effect of Prestara compared to placebo. The new amortization term extends to December 31, 2008. However, because we have not completed the analysis of the results of our clinical trial and have not met with the FDA to discuss the results, we presently do not know what we will decide for the future development of Prestara, and consequently the time it will take us to fulfill our obligations to Watson. We are able to determine, however, that these obligations will likely not be completed by June 2005 and as a consequence we have extended the amortization period. This amortization period may be changed again in the future once we determine our plan for the future development of Prestara in the United States. One possibility may be to cease further development of Prestara in the United States. After the extension of the term, contract revenue recognized in the third quarter of 2004 related to our agreement with Watson was approximately $0.1 million. The extension of the amortization period for these obligations reduced contract revenue by $0.3 million compared to the third quarter of 2003, and also compared to the amortization period that was in place immediately before the third quarter of 2004.

     In January 2004 we granted Tanabe Seiyaku Co. Ltd., or Tanabe, an exclusive license to Prestara in Japan and received a $2.0 million non-refundable initial license fee. We have accounted for the non-refundable license fee as unearned contract revenue and are recognizing the revenue as we fulfill our significant obligations to Tanabe, including supplying Tanabe with clinical data and regulatory correspondence, drug material for clinical research and formulation, and potentially supplying commercial material. The amount of time it may take us to fulfill our obligations to Tanabe could vary significantly, based upon, among other things, the length of our development program for Prestara, whether we discontinue development of Prestara, the length of Tanabe’s development program for Prestara and whether Tanabe chooses to purchase commercial material through Genelabs. Based on our estimates regarding these significant various obligations, we are amortizing the up-front fee from Tanabe through December 31, 2008, and recognized less than $0.1 million of the up-front license fee received from Tanabe during the third quarter of 2004.

     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 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™ as an investigational new drug for lupus and discovery of entirely new drugs. The following table breaks down our research and development expenses by major project (in thousands):

     Drug development costs for Prestara, our investigational drug for lupus, were approximately $0.9 million lower in the third quarter of 2004 than in the third quarter of 2003. The decrease in costs was due to a lower number of patients under treatment in the clinical trial we conducted to measure the effect of Prestara on the bone mineral density of women with lupus. The treatment period ended during the third quarter of 2004, while we were increasing enrollment and actively recruiting patients during the third quarter of 2003. Drug discovery costs were similar in both the third quarter of 2004 and the third quarter

of 2003, with inflationary-level increases related to personnel costs. In each of these periods substantially all of the drug discovery costs incurred were for our HCV program. Support costs and other R&D is primarily comprised of costs necessary to maintain a research and development facility, such as rent, insurance, depreciation, utilities, maintenance, security, support staff and an incentive performance bonus, all allocated based on the headcount ratio between research and development and general and administrative employees. These support costs and other R&D expenses were lower in the third quarter of 2004 compared to the third quarter of 2003 as the Company estimated a lower provision for the incentive performance bonuses in the 2004 period.

     Genelabs began work on its current drug development program, Prestara™ for systemic lupus erythematosus, in 1993 when Genelabs licensed exclusive rights to patents related to Prestara from Stanford University. To develop this drug candidate, we have built internal clinical development capabilities including clinical trial design, monitoring, analysis and reporting, regulatory affairs and quality control and assurance. Direct costs incurred to build these capabilities and advance Prestara through clinical trials to its current status with the FDA through September 30, 2004 have been approximately $46 million. In the fourth quarter of 2004, Genelabs unblinded the results of the Phase III clinical trial that was designed to evaluate the ability of Prestara to improve the bone mineral density of women with lupus taking glucocorticoids. The clinical trial failed to meet its primary and secondary endpoints. Genelabs is presently evaluating the results and preparing for discussions with the FDA prior to making a decision on the future development of Prestara. In the meantime, we expect to continue to incur additional costs for Prestara, which include an open-label one-year follow-on study to the double-blind trial recently completed, but the amount and timing of these future costs will depend on the results of the analysis of the clinical trial results, future decisions from the FDA and other regulatory authorities, and possibly the results of a trial currently being conducted by Genovate, a licensee in Taiwan. Collaborations for Prestara are with Watson Pharmaceuticals, Inc. for North America, Tanabe Seiyaku Co., Ltd. for Japan and Genovate for Australia, New Zealand and Asian countries except Japan.

     Genelabs’ current drug discovery efforts have evolved from a program that started in 1993 and initially focused on DNA as a target for drug intervention. Since initiating this drug discovery program, Genelabs has built medicinal chemistry, combinatorial chemistry, computational modeling, molecular biology, assay development and high-throughput screening, drug metabolism and pharmacokinetics capabilities. Genelabs has incurred direct drug discovery costs for these efforts through September 30, 2004 of approximately $37 million, which, in addition to building these drug discovery capabilities, includes the Company’s earlier DNA-binding drug discovery efforts. Our earlier drug discovery efforts generated numerous compounds, including a preclinical candidate for Aspergillus, an often fatal systemic fungal infection. We are presently concentrating substantially all of our drug discovery efforts on our programs to discover new therapeutics for treatment of hepatitis C viral infections and on further advancing our current HCV compounds, including additional testing of our preclinical drug candidates.

     Under the terms of the agreement with Gilead, beginning in the fourth quarter of 2004 Genelabs has committed to assign a minimum number of its scientists to work on this program. Genelabs does not expect its drug discovery research costs to increase in order for the Company to fulfill its obligations to Gilead, because there were a similar number of scientists working on the program prior to our entering into the Gilead agreement. Management continually evaluates the status of our drug discovery research programs and expects to continue to devote the majority of our drug discovery resources toward our hepatitis C drug discovery programs, while at the same time managing the level of expenditures to balance advancement of potential product candidates against Genelabs’ limited cash resources and the cash requirements for potential development of Prestara.

     Due to the nature of drug discovery research, 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 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.

     General and Administrative Expenses

     General and administrative expenses were $1.5 million in the third quarter of 2004 compared to $1.2 million in the third quarter of 2003. 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. The increased general and administrative costs during the third quarter of 2004 compared to the third quarter of 2003 were primarily patent-related costs for our hepatitis C drug discovery programs.

     Discontinued Operations

     During the second quarter of 2004 Genelabs completed the sale of its discontinued diagnostics business, Genelabs Diagnostics Pte. Ltd., or GLD, and, accordingly, there was no income or loss recorded for this operation during the third quarter of 2004.

Results of Operations – First Nine Months of 2004 compared to First Nine Months of 2003

     Summary

     Our net loss was $12.0 million for the first nine months of 2004 compared to a net loss of $13.3 million for the first nine months of 2003. The reduced net loss in the 2004 period compared to the 2003 period is primarily due to the $2.0 million gain on the sale of our discontinued diagnostics business, partially offset by lower contract revenue and higher general and administrative costs.

     Contract Revenue

     Contract revenue was $1.8 million in the first nine months of 2004 compared to $2.2 million in the first nine months of 2003. The amount recognized in the first nine months of 2004 was lower than in the first nine months of 2003 primarily because we extended the term over which we estimate we have significant obligations to Watson, our North American licensee for Prestara. Other sources of revenue include royalties, which were $0.5 million in the first nine months of 2004 and $0.4 million in the first nine months of 2003, and data analysis services for pharmaceutical companies, which were $0.3 million for the first nine months of 2004 and $0.4 million for the first nine months of 2003. In the first nine months of 2004, we also recognized $0.2 million in revenue from the $2.0 million nonrefundable up-front license fee we received from Tanabe in January 2004. There was no comparable revenue from Tanabe in the first nine months of 2003.

     Research and Development Expenses

     The following table breaks down our research and development expenses by major project (in thousands):

     Drug development costs for Prestara, our investigational drug for lupus, were approximately $0.1 million lower in the first nine months of 2004 than in the first nine months of 2003. Costs were similar in the 2004 period and the 2003 period as savings from a slightly lower average number of patients being treated in the Phase III clinical trial during the 2004 period were nearly offset by higher personnel costs. Drug discovery costs were also approximately the same in both the first nine months of 2004 and the first nine months of 2003, as higher on-going personnel costs and increased usage of supplies in the 2004 period offset costs related to a reduction in workforce that was implemented early in 2003. In each period, substantially all of the drug discovery costs incurred were for our HCV programs. Support costs and other R&D is primarily comprised of costs necessary to maintain a research and development facility and are allocated based on the headcount ratio between research and development and general and administrative employees. These support costs and other R&D expenses were also similar in the first nine months of 2004 and the first nine months of 2003.

     General and Administrative Expenses

     General and administrative expenses were $4.8 million in the first nine months of 2004 compared to $4.4 million in the first nine months of 2003, an increase that was primarily related to higher patent costs for compounds discovered in HCV programs as well as increased finance department costs related to the company’s efforts to comply with new external reporting requirements. Genelabs management expects general and administrative costs to continue to increase as a result of additional anticipated patent-related costs and additional costs of complying with various regulations.

     Discontinued Operations

     During the first nine months of 2004 Genelabs sold GLD and recorded a gain of $2.0 million. There was no comparable gain for same period of 2003.

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 balances totaling $19.5 million at September 30, 2004. During the first nine months of 2004, our cash and cash equivalents decreased by $7.0 million, which was largely due to $13.1 million used in operations, partially offset by $3.0 million received from the sale of our diagnostics business and $3.4 million received from the sale of our common stock. The $3.4 million received from the sale of our common stock will be used for general corporate purposes and included $2.6 million from the sale of common stock to Tanabe Seiyaku Co. Ltd. and $0.8 million from the exercise of stock options and warrants. Our cash used in operations was $4.5 million, $4.9 million, and $3.7 million during the third, second and first quarters of 2004, respectively. The cash used in operations for the second and third quarters of 2004 were each greater than the cash used in operations during the first quarter of 2004 because during the first quarter of 2004 we received $2.0 million from Tanabe as an initial license fee for the Japanese development and marketing rights for Prestara, and this amount reduced the cash used in operations. The cash used in operations during the first nine months of 2004

funded our development of Prestara for lupus and our research on the discovery of new treatments for hepatitis C virus infection.

     After giving effect to the $8.9 million we received from Gilead Sciences, Inc. early in the fourth quarter of 2004, we presently estimate that our current cash resources are adequate to provide liquidity into the first half of 2006. However, prior to then we will require additional capital to carry out our business plans, and we expect to continue to rely on outside sources of financing to meet our capital needs. The Company is considering entering into additional research collaborations, such as for the non-nucleoside portion of its hepatitis C virus drug discovery program, and is also evaluating the sale of non-core assets and exploring other potential collaborations as potential sources of funding. The Company may be unable to complete any of these transactions as currently contemplated or at all.

     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 and development costs for Prestara. The amount of additional costs in our business plans will depend on numerous factors including any FDA actions, progress of our research and development programs and the status of corporate partnership agreements.

     To meet our capital needs we will require additional funding, but additional funds may not be available on acceptable terms, if at all. The current trading price of our stock will materially and adversely affect our ability to raise funds through the issuance of stock. 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.

     Our future contractual obligations have not changed significantly from the amounts reported in our Annual Report on Form 10-K for the year ended December 31, 2003. Other than operating leases with third parties for our principal research, clinical development and office facilities, the Company does not have any off-balance sheet arrangements. The terms of the operating leases remain the same as disclosed in the Annual Report on Form 10-K for the year ended December 31, 2003.

Business Risks

     There are a number of business risks 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 that is included in our Annual Report on Form 10-K, which shareholders and prospective investors are encouraged to review.

Risks Related to Genelabs

The results of our confirmatory 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 and diminishing our business prospects.

     Genelabs has focused its development efforts to date on conducting clinical trials for an investigational new drug, Prestara (prasterone), also referred to as GL701, Aslera™ and Anastar™, for the treatment of women with systemic lupus erythematosus, or lupus. Lupus is a severe, chronic and debilitating autoimmune disease that can affect the musculoskeletal and nervous systems, lungs, heart, kidneys, skin and joints. Prestara is a pharmaceutical formulation containing highly purified prasterone, the synthetic equivalent of dehydroepiandrosterone or DHEA, a naturally occurring hormone.

     Before a drug can be marketed in the United States, the FDA must approve the drug’s New Drug Application, or NDA. In 2000, we submitted the NDA for Prestara to the FDA. In 2002 we received an

approvable letter which, among other things, required us to conduct an additional clinical trial to confirm a positive effect of Prestara on the bone mineral density of women with lupus who are receiving treatment with glucocorticoids. We conducted that clinical trial and a preliminary analysis of the data indicated that the 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. We are continuing to analyze the data in an attempt to determine the reasons why the trial failed, however, it is not likely that the cause or causes of failure can be identified with certainty.

     We are aware of an on-going clinical trial of prasterone which is being conducted by Genovate Biotechnology Co., Ltd., referred to as Genovate, a Taiwan-based company that has a license from us for Prestara in most Asian countries. We believe that the Genovate trial has enrolled 88 patients and that the last patient visit currently is scheduled to occur during the first quarter of 2005. There can be no assurance that the trial will ever be completed, that the results will be made available to us or that the results will be usable to support our development program for Prestara. Given the negative results in our trial in the U.S., there can be no assurance that the results in the Genovate trial will be positive or, even if the data is positive, that it will be useful for our development of Prestara in the United States or elsewhere.

     Moreover, preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. Negative or inconclusive results or adverse medical events during a clinical trial could delay, limit or prevent regulatory approval. Genelabs’ business plans depend on FDA approval of Prestara in the United States, and if we are not able to obtain FDA approval for Prestara in a timely manner, or if significant and new safety issues emerge, our business would suffer because we would not be entitled to a milestone payment from Watson, we would not receive royalties from Prestara sales in the United States, which are our most significant near-term source of potential revenue, and the prospects for Prestara in other countries would be substantially diminished.

Because we may not continue to qualify for listing on the Nasdaq quotation system, the value of your investment in Genelabs may substantially decrease.

     Genelabs currently does not meet the requirements of the Nasdaq National Market System, and has not met such requirements since the announcement of its negative clinical trial results on October 5, 2004. Although we have not received any notice from Nasdaq that we are not in compliance with their National Market listing standards, such letter may come in November if the closing bid price of our stock remains below $1.00. To maintain its listing on the Nasdaq National Market, Genelabs is required, among other things, to either maintain stockholders’ equity of at least $10 million or a market value of at least $50 million, as well as to maintain a closing bid price of at least $1.00 per share of common stock. If Genelabs is unable to meet or maintain compliance with these requirements, it may be delisted from the National Market System. If delisted from the Nasdaq National Market, Genelabs might apply for listing on the Nasdaq SmallCap Market. The Nasdaq SmallCap Market, however, also has listing requirements, which Genelabs may fail to meet for initial listing or with which Genelabs may fail to maintain compliance. Delisting from the National Market System could adversely affect the trading price of our common stock, and delisting from the Nasdaq SmallCap Market could significantly limit the liquidity of our common stock and adversely affect its trading price.

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 $216 million in net losses through September 30, 2004, including a net loss of $12.0 million in the first nine months of 2004 and a net loss of $19.8 million for the year ended December 31, 2003. 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 provide liquidity into the first half of 2006. However, we will still require additional capital to carry out our business plans. The following are illustrations of potential impediments to our ability to successfully secure additional funds:

•		the current trading price of our stock will materially and adversely effect our ability to raise funds through the issuance of stock;
•		we currently do not meet Nasdaq’s listing requirements and our ability to successfully complete an additional equity financing will be negatively impacted should we become unable to meet Nasdaq’s listing requirements in a timely manner;