UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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 o

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

There were 88,014,488 shares of the Registrant’s Common Stock issued and outstanding on April 15, 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:

•		estimates relating to the timing and completion of our pending clinical trials;
•		the results of our confirmatory clinical trial of Prestara™;
•		potential FDA actions with respect to our NDA for Prestara, including whether or not the Prestara NDA ultimately will receive marketing approval;
•		if the NDA for Prestara is ultimately approved, our plans and ability to successfully commercialize Prestara for systemic lupus erythematosus;
•		our ability to secure a European partner for Prestara;
•		our strategy for pursuing approval of Prestara in Europe, ability to obtain approval of Prestara in Europe, and the timing of any such approval;
•		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.

          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, and 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. We assume no obligation to update any such forward-looking statement for subsequent events or any reason why actual results might differ except as required by the Exchange Act. 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.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

GENELABS TECHNOLOGIES, INC.

*

The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date which are included in our Form 10-K for the year ended December 31, 2003 as filed with the Securities and Exchange Commission.

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 developing a late-stage product for lupus, discovering novel lead compounds that selectively inhibit replication of the hepatitis C virus, or HCV, and advancing preclinical development of its HCV research program.

          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. Genelabs accounts for its diagnostics operation, 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 months ended March 31, 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.

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:

3.

Comprehensive Loss

          During each of the three months ended March 31, 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 first quarter of 2004 and the first quarter of 2003 would have included an additional 1,324,000 and 233,000 shares, respectively, related to the Company’s outstanding stock options.

5.

License and Collaboration Agreement with Tanabe and Stock Purchase Agreement

          On January 28, 2004, Genelabs granted Tanabe Seiyaku Co. Ltd. (Tanabe) an exclusive license to Prestara™ in Japan and received a $2 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 million based on pre-determined development goals and Genelabs is also entitled to royalties on sales of Prestara in Japan. In connection with the agreement, on January 28, 2004, Genelabs also sold 818,897 shares of its common stock to Tanabe for $2.6 million, or $3.175 per share.

6.

Subsequent Event

          On April 21, 2004, the Company closed the sale of its discontinued diagnostics operation, GLD, and its immediate parent, Genelabs Asia Pte. Ltd., and Genelabs Technologies received proceeds from the sale of $3 million. The gain on sale of approximately $2 million will be recorded in the second quarter of 2004.

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

          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. Genelabs is pursuing regulatory approval of Prestara™, its investigational drug for women with systemic lupus erythematosus, a disease for which no new drug has been approved in the past 40 years and for which current therapies are not adequate. 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 have built drug discovery and clinical development capabilities that can support various research and development projects. We are concentrating our capabilities on:

•		developing our late-stage product for lupus, Prestara™;
•		discovering novel lead compounds that selectively inhibit replication of the hepatitis C virus, or HCV; and
•		advancing preclinical development of our HCV research program.

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

          Summary

          Genelabs’ net loss was $4.8 million for the three months ended March 31, 2004, compared to a net loss of $4.2 million for the three months ended March 31, 2003. The increased net loss is mainly attributable to higher research and development expenses due to clinical trial costs incurred for the development of Prestara™ for women with lupus.

          Contract Revenue

          Contract revenue was $0.7 million in the first quarter of 2004 and the first quarter of 2003. During the first quarter of 2004, the largest component of our contract revenue, $0.4 million, is from the recognition into revenue of a portion of a previously received license payment from Watson Pharmaceuticals, Inc., or Watson. This item is being amortized into revenue over the term Genelabs’ management estimates that we have significant obligations to Watson. We estimate that these significant obligations extend to the submission of a complete response to the approvable letter from the U.S. Food and Drug Administration, or FDA, and the FDA reaching a final decision regarding approval of our New Drug Application, or NDA. The date upon which we may receive a final FDA decision on approval will vary based upon, among other things, the time period necessary for the analysis of data from the clinical trial, the results of the trial, and the length of time the FDA will take to review the data submitted after the conclusion of the trial. Genelabs currently estimates that it will take until June 2005 for an FDA decision on the NDA.

          During the first quarter of 2004, we granted Tanabe Seiyaku Co. Ltd., or Tanabe, an exclusive license to Prestara in Japan and received a $2 million non-refundable initial license fee. We have accounted for the non-refundable license fee as unearned contract revenue and are amortizing the unearned contract revenue into the statement of operations 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 potential supply of 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, including any post-marketing studies, the length of Tanabe’s development program for Prestara and whether Tanabe chooses to purchase commercial material through Genelabs. Based on our best estimates from these significant various obligations, we are amortizing the up-front fee from Tanabe through December 31, 2008, and have recorded less than $0.1 million of the up-front license fee received from Tanabe into the statement of operations during the first 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 $0.7 million higher in the first quarter of 2004 than in the first quarter of 2003. The increase in costs is due to the clinical trial we are conducting to measure the effect of Prestara on the bone mineral density of women with lupus. The costs increased because there were significantly more patients enrolled in this clinical trial during the first quarter of 2004 than there were for the same period in 2003. Drug discovery costs decreased by $0.1 million in the first quarter of 2004 compared to the first quarter of 2003 primarily as a result of a reduction in the drug discovery workforce that was implemented in February 2003. In the first quarter of 2004, nearly all of the drug discovery costs incurred were for our HCV program, through which we are attempting to discover a new treatment for infection with the hepatitis C virus. In the first quarter of 2003, we were in the process of shifting substantially all of our drug discovery efforts to the HCV program, and approximately 70% of the drug discovery costs were for our HCV program, with the remaining 30% incurred on our DNA-binding/antifungal 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 the company 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 higher by $0.2 million in the first quarter of 2004 compared to the first quarter of 2003 because the Company’s low level of cash during the first quarter of 2003 did not make it probable that an incentive bonus would be paid. Accordingly, no provision for employee incentive bonuses was made in the first quarter of 2003, compared to a provision of $0.3 million during the first quarter of 2004.

          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 approvable status with the FDA through March 31, 2004 have been approximately $43 million. If the clinical trial results, currently expected in the fourth quarter of 2004, are positive and the FDA approves Prestara for lupus, Genelabs expects to continue work on this project, seeking approval in other countries and investigating other indications and potential uses of the investigational drug. If the clinical trial results are not positive and the FDA does not approve Prestara for lupus, Genelabs plans to evaluate the results and the requirements for approval prior to making a decision on further development. We expect to incur additional costs after 2004, but these will be dependent on the clinical trial results and future decisions from the FDA and regulatory authorities in Europe and other countries. Major collaborations for Prestara are with Watson Pharmaceuticals, Inc. in North America and with Tanabe Seiyaku Co., Ltd. in 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 March 31, 2004 of approximately $35 million, which, in addition to building these drug discovery capabilities, includes the Company’s earlier DNA-binding drug discovery efforts. Our drug discovery efforts have generated lead compounds for fungal, bacterial and viral infections. In addition, these efforts have generated a preclinical candidate for Aspergillus, an often fatal systemic fungal infection, and we have initiated preclinical studies in our hepatitis C virus research program. Our drug discovery efforts are presently concentrated on advancing our HCV drug discovery program, which includes the further testing of our preclinical drug candidates, as well as identification of additional potential lead compounds. 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. Management continually evaluates the status of our drug discovery research programs and expects to continue to devote resources toward our hepatitis C drug discovery program, 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 development of Prestara.

          General and Administrative Expenses

          General and administrative expenses were $1.4 million in the first quarters of both 2004 and 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.

          Income from Discontinued Operations of Diagnostics Subsidiary

          During the first quarter of 2004 Genelabs recorded income of $0.3 million from the discontinued operations of its diagnostics subsidiary, Genelabs Diagnostics Pte. Ltd., or GLD. During the first quarter of 2003 the operations of GLD broke-even, and we did not record any income for our diagnostics subsidiary. The higher income of GLD during the first quarter of 2004 was due to higher levels of product sales and a higher gross margin percentage. Because GLD is accounted for as a discontinued operation, GLD’s financial results are reported on a single line-item in the Company’s statement of

operations. Subsequent to the end of the first quarter of 2004, on April 21, 2004, we completed the sale of GLD and its immediate parent, Genelabs Asia Pte. Ltd.

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 $25.8 million at March 31, 2004. During the first quarter of 2004, our cash and cash equivalents balance decreased by $0.7 million, which was largely due to $3.7 million used in operations, partially offset by $3.0 million received from the sale of our common stock. The $3.0 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 $0.4 million from the exercise of stock options and warrants. During the first quarter of 2004, we also received $2.0 million from Tanabe for the Japanese development and marketing rights to Prestara™ as a non-refundable initial license fee. The cash used in operations during the first quarter of 2004 funded our development of Prestara for lupus and our research on the discovery of a new treatment for hepatitis C virus infection. Because the license fee we received from Tanabe has reduced the cash used in operations during the first quarter of 2004, the cash we use in operations during subsequent quarters of 2004 will be higher than in the first quarter of 2004, unless there are additional milestones received under existing agreements or new collaboration agreements with up-front consideration for Genelabs.

          After giving effect to the sale of our diagnostics business, which occurred during the second quarter of 2004, Genelabs estimates that our current cash resources are adequate to provide liquidity into 2005. However, we will require additional capital to carry out our business plans in 2005 and expect to continue to rely on outside sources of financing to meet our capital needs. The Company is negotiating licenses for the European rights to Prestara, which, if completed, we expect would provide additional cash resources to Genelabs. Genelabs is also evaluating the sale of non-core assets and exploring other potential partnerships as sources of funding. The Company may be unable to complete any of these transactions as currently contemplated or at all. In addition, the results of our clinical trial measuring the effect of Prestara on bone mineral density of women with lupus will have a material impact on our ability to secure funding and the amount and terms of funding that may be available.

          Longer-term, Genelabs’ liquidity and capital resources will be materially impacted by FDA actions with respect to our NDA for Prestara. If Prestara is approved for marketing in the U.S., Genelabs may receive a one-time milestone payment of up to $45 million from Watson. Receipt of a milestone payment from Watson would materially improve Genelabs’ liquidity and capital resources. However, Genelabs believes that the most important impact of the Watson collaboration for Genelabs’ long-term liquidity and capital resources is the significant royalties Genelabs is entitled to receive on net sales of Prestara. During the first three quarters after product launch, a separate royalty schedule applies to support the product launch.

          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.

          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, 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.

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

If the results of our confirmatory clinical trial of Prestara™, Genelabs’ drug candidate for systemic lupus erythematosus, are not positive, the FDA will not approve Prestara and our business prospects will suffer because the U.S. royalties for Prestara are the most significant near-term source of potential revenue.

          Genelabs has focused its development efforts to date on conducting clinical trials for an investigational new drug, Prestara, 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 our North American partner, Watson, can market Prestara in the United States, the FDA must approve the Prestara New Drug Application, or NDA, submitted by Genelabs. In 2000, we submitted the NDA for Prestara to the FDA. In 2001 we received a letter from the FDA stating that the Prestara NDA was not approvable, listing deficiencies that must be addressed before the NDA could be approved. Throughout 2001 we worked with the FDA to respond to these issues. In 2002 we received an approvable letter which, among other things, requires us to conduct an additional clinical trial to confirm the positive effect of Prestara we previously noted on the bone mineral density of women with lupus who are receiving treatment with glucocorticoids. Even if the results of our clinical trial are positive, the FDA still has the authority to decline to approve Prestara. Genelabs’ business plans depend on FDA approval of Prestara in the United States, and if the clinical trial currently underway does not confirm our previous findings or if significant and new safety issues emerge, the FDA will not approve our new drug application in a timely manner, if at all, and our business would suffer because 1) we would not be entitled to a milestone payment from Watson and 2) royalties we are entitled to receive from Prestara sales in the United States are our most significant near-term source of potential revenue.

If we are unable to find a European marketing partner for Prestara™ our business prospects will suffer because we do not have capabilities to market Prestara in Europe ourselves and we would lose a significant near-term source of revenue.

          Because we have limited sales, marketing and distribution capabilities and no established presence in Europe, our business plans include licensing the European marketing rights to Prestara to a larger pharmaceutical or biotechnology company with established marketing capabilities. If we are unable to find a European marketing partner, we would not be able to launch Prestara in Europe in a timely manner, if at all, even if it is approved. Our business would suffer because we would not be able to generate revenue from Prestara in Europe.

If the FDA and the EMEA do not approve Prestara™ for marketing, our business prospects will suffer because Prestara is our only near-term source of potential revenue.

          Before our North American partner, Watson, and any potential European partner can market Prestara in their respective territories, appropriate regulatory agencies must review and approve applications seeking to market the investigational drug which have been submitted by Genelabs. Our business plans depend on approval of Prestara in both the United States and in Europe. If the regulatory agencies do not approve one or both of our applications in a timely manner, our business would suffer because we have no other near-term source of potential revenue.

          If the regulatory agencies determine that Prestara can only be approved with significant additional requirements and we determine that it is not feasible for us to satisfy one or more of the requirements requested, we could be forced to abandon the development of Prestara. We cannot predict whether the regulatory agencies will require the submission of additional data in order to approve our applications, what these requirements may be, whether we will be successful in responding to requests from these agencies for additional requirements or whether there will be additional substantial obstacles to, or delays in, our development of Prestara for lupus.

          Similar regulatory requirements exist in Japan and elsewhere in the world. Genelabs has not conducted any clinical trials for Prestara for lupus in other countries. We plan to enter into collaborations or licensing agreements for commercializing Prestara in other areas with pharmaceutical companies that have resources greater than Genelabs. If we do not enter into these agreements, we may not be able to sell, or might face delays related to commercial introduction of, Prestara in these other territories, because we lack the necessary resources.

If Prestara™ is approved in the United States or Europe but does not gain sufficient market acceptance, our business will suffer because we would not receive anticipated royalties to fund future operations.

          A number of factors may affect the market acceptance of Prestara for lupus, even if it is approved, including:

•		availability and level of reimbursement by insurance companies or government programs such as Medicaid;
•		the price of Prestara relative to other drugs for lupus treatment;
•		the perception by patients, physicians and other members of the health care community of the effectiveness and safety of Prestara for the treatment of lupus;
•		the effectiveness of sales and marketing efforts by our licensees;
•		side effects;
•		competition from other prescription and over-the-counter products; and
•		unfavorable publicity concerning Prestara or other drugs on the market.

          In addition, if regulatory authorities fail to restrict the sale of dietary supplement DHEA products, which do not require a prescription, the market may not accept Prestara. A number of dietary supplement manufacturers market products containing DHEA as dietary supplements in the United States. Prestara contains highly purified prasterone, the synthetic equivalent of DHEA, as the active ingredient. The body produces DHEA, an androgenic hormone or steroid hormone that develops and maintains masculine characteristics, which is not a component of the diet. While we have consistently maintained that a governmental entity should regulate DHEA as a drug and as a controlled substance, neither the FDA nor the Drug Enforcement Agency, or DEA, has taken any specific action to date to limit or regulate the sale

of dietary supplement DHEA. The FDA and DEA may not wish to, or may be unable to, regulate DHEA in the future. We have submitted documentation to the FDA requesting clarification of DHEA’s status as a drug and removal from the market as a dietary supplement. We have also submitted documentation to the DEA requesting clarification of DHEA’s status as an anabolic steroid, a steroid that promotes the storage of protein and growth of tissue. Anabolic steroids are scheduled as controlled substances. If the FDA restricts the marketing of DHEA as a dietary supplement or the DEA agrees that DHEA is an anabolic steroid, DHEA may no longer be publicly available as a dietary supplement. In the event that Prestara receives FDA approval, the concurrent sale of these dietary supplement products could significantly adversely affect or significantly limit the market for or the selling price of Prestara.

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

          Regulatory requirements applicable to pharmaceutical products tend to make the substitution of suppliers and manufacturers costly and time consuming. We rely on a single supplier of prasterone, the active ingredient in Prestara, and we rely on a single finished product manufacturer, Patheon Inc., for production of Prestara capsules and for packaging. The disqualification of 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 Prestara as a finished product and for its active ingredient.

          Our manufacturing and supply agreement with Patheon for Prestara capsules has an initial term through December 31, 2008, and is renewable for three-year terms thereafter, unless either party provides the other with twelve months’ notice prior to the end of the then-current term. The Patheon manufacturing supply agreement also provides for termination by either party upon failure of the other party to remedy a material breach within sixty days or upon bankruptcy of the other party; by us in the event of an action preventing us from importing, exporting, purchasing or selling the product; or by Patheon on six months’ prior notice if we assign the agreement to an assignee that is not acceptable to Patheon. Our supply agreement for prasterone, the active ingredient in Prestara, has an initial term through August 27, 2005 and is automatically renewed for one-year periods unless either party provides the other with two years’ notice. The supplier may not terminate without cause during the initial term. The active ingredient supply agreement also provides for termination by either party upon failure of the other party to remedy a material breach within sixty days or upon bankruptcy of the other party.

          We believe that we are current in all material obligations under both of these agreements. In the event of termination or expiration of one or both of these agreements, we believe that we would be able to find alternative suppliers, however, we may not be able to secure these arrangements in a timely manner or on favorable terms and the amount of time and expense involved in transferring the process of manufacture, and receiving regulatory qualifications, could negatively impact the timing or probability of approval of our NDA, or if the product is approved by the FDA, the supply of the product to the market.

          The FDA requires the existence of at least one qualified manufacturer before it will approve a drug for commercialization. If we fail to maintain a relationship with at least one qualified supplier of prasterone and at least one qualified manufacturer of the Prestara finished pharmaceutical product it would negatively impact our business because the NDA could not be approved by the FDA. If our NDA is approved and our supplier or manufacturer fails to meet and maintain compliance with FDA requirements or if they fail to manufacture Prestara active ingredient, capsules and packaging as required for our needs, we may not be able to ship product in a timely manner, if at all. This failure could

negatively impact our relationships with customers and would harm sales of Prestara. The following could harm our ability to manufacture and market Prestara:

•		the unavailability of adequate quantities of the active ingredient for commercial sale;
•		the loss of a supplier’s or manufacturer’s regulatory approval;
•		the failure of a supplier or manufacturer to meet regulatory agency pre-approval inspection requirements;
•		the failure of a supplier or manufacturer to maintain compliance with ongoing regulatory agency requirements;
•		the inability to develop alternative sources in a timely manner or at all;
•		an interruption in supply of prasterone or finished product; and
•		competing demands on the contract manufacturer’s capacity, for example, shifting manufacturing priorities to their own products or more profitable products for other customers.

We are dependent on Watson Pharmaceuticals to market Prestara™ in North America and if Prestara is approved by the FDA and they fail to meet expected levels of sales our business will suffer.

          We must rely on Watson to market Prestara in North America. Because royalties from sales of Prestara would be our primary near-term source of revenue, successful marketing, promotion and distribution of this product in the United States are critical to our success. Though Genelabs has the right to co-promote the product in the United States beginning the third calendar year after the first commercial sale of the product by Watson, we currently have limited internal sales, marketing and distribution capabilities and are entirely dependent on Watson to promote Prestara. If Prestara is approved by the FDA and Watson fails to promote Prestara, our business will suffer because we will not receive anticipated revenue from product sales. Though the agreement with Watson requires them to use commercially reasonable efforts to promote the sale, marketing and distribution of the product in their territory, it does not prevent them from marketing competing products should they become available. Our agreement with Watson provides us with the right to terminate the agreement or make it non-exclusive in the event that Watson fails to meet specified minimum sales requirement or materially breaches the agreement; however, it may be difficult or impossible to find a marketing partner to replace Watson should they breach the agreement or fail to meet these minimum requirements.

          Our ability to market Prestara in Europe will depend upon our ability to obtain a European partner. Similar to the United States, successful marketing, promotion and distribution of this product in Europe are important to our success. As we have limited capabilities and will rely on our potential future European partner for marketing, promotion and distribution, if they fail to promote Prestara our business will suffer because we will not receive anticipated revenue from product sales.

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

          We have incurred losses each year since our inception and have accumulated approximately $209 million in net losses through March 31, 2004, including a net loss of $4.8 million in the first three months of 2004 and a net loss of $19.8 million for the twelve months ended December 31, 2003. If the FDA approves Prestara, we anticipate realizing a net loss at least until Prestara is sufficiently accepted by the market, and we may never achieve profitability. If the FDA does not approve Prestara, we may never be profitable and our revenues may never be sufficient to fund operations.

          On April 30, 2004, after giving effect to the cash received from the sale of our diagnostics business on April 21, 2004, Genelabs had cash, cash equivalents and short-term investment balances totaling approximately $27 million. Genelabs estimates that our current cash resources are adequate to provide liquidity into 2005. 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:

•		our stock price and market capitalization are low, therefore there are limited funds we can raise through equity financings;
•		our ability to successfully complete an additional equity financing will be negatively impacted should we become unable to meet Nasdaq’s listing requirements;
•		our ability to find a European marketing partner for Prestara would be negatively impacted if we receive indications that the EMEA’s review of our MAA is unlikely to result in approval of our application; and
•		our research programs are in an early stage, therefore 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.

          The results of our clinical trial measuring the effect of Prestara on the bone mineral density of women with lupus and future FDA actions with respect to our NDA for Prestara will each have a material impact on our ability to successfully secure funding in the future. If Prestara™ is ultimately approved for marketing in the U.S., Genelabs may receive a milestone payment of up to $45 million and significant royalties on Watson’s net sales of Prestara. However, the clinical trial results may not be positive and/or the FDA may never approve Prestara and, even if they do, we may never receive a milestone payment or royalties on net sales.

          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, 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.

If we are unable to obtain patents or protect our intellectual property rights, we would lose competitive advantage.

          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. It is not possible to obtain patent protection for the 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 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 drug discovery programs; however, no patents are currently issued. A number of patents have issued covering Genelabs’ 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 that we do not currently know about now or in the future. We might not 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.

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 research has been focused on a limited number of mechanisms which have not been proven as a viable mechanism of drug action, such as DNA-binding. Although we have identified an antifungal compound that has met our criteria for advancement to preclinical status, we have not devoted resources to preclinical development of this compound, but have initiated preclinical development in our HCV research program in early 2004. Genelabs’ product candidates, other than Prestara, are in an early stage of research. The goal of our research programs is to discover novel chemical compounds and develop them into drugs. 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 have a competitive disadvantage.

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 the following 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. While we believe that the amount of general liability insurance we carry, $6 million, is sufficient for typical risks regarding our handling of these materials, it may not be sufficient to cover extraordinary or unanticipated events. We do not specifically insure against environmental liabilities. 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, such as Prestara for lupus, if approved, 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 industry and sufficient for risks we typically face, we may not be able to maintain this type of insurance for any of our clinical trials or 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, 2003 and December 31, 2003, the price of our common stock fluctuated between $1.12 and $2.85 per share. Between January 1, 2004 and April 30, 2004, the price of our common stock fluctuated between $2.01 and $3.25 per share. In addition to the factors discussed in this Business Risks 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 addition, numerous events occurring outside of our control may also impact the price of our common stock, including market conditions 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.

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 may be unable to meet the requirements of the Nasdaq National Market System in the future. 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 bid price of at least $1.00 per share of common stock. If Genelabs is unable to meet 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 would significantly limit the liquidity of our common stock and would adversely affect its trading price.

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) 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.

          (b) 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 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 6. Exhibits and Reports on Form 8-K

(a) Exhibits

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Confidential treatment has been requested with respect to certain portions of this document.

(b)

Reports on Form 8-K

          During the quarter ended March 31, 2004, we filed the following reports on Form 8-K:

          On February 13, 2004, we filed a Current Report on Form 8-K announcing the retirement of Dr. Irene Chow from her responsibilities as Chief Executive Officer and the appointment of Mr. James A.D. Smith as Chief Executive Officer.

          On March 15, 2004, we filed a Current Report on Form 8-K attaching a press release for our 2003 full year and fourth quarter financial results.

          After the quarter ended March 31, 2004, we filed the following report on Form 8-K:

          On April 22, 2004, we filed a Current Report on Form 8-K announcing the completion of the sale of our diagnostics business.

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.

EXHIBIT INDEX

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Confidential treatment has been requested with respect to certain portions of this document.