All statements in Management's Discussion and Analysis of Financial Condition and Results of Operations that are not historical are forward-looking statements. All estimates for periods later than September 30, 2008 of costs, expenses, revenue, savings, future amortization periods and other items are forward-looking statements. Statements regarding possible actions or decisions in periods ending after September 30, 2008 by Genelabs and other parties, including collaborators and regulatory authorities, are forward-looking statements. Actual results may differ from the forward-looking statements due to a number of risks and uncertainties that are discussed under "Risk Factors" and elsewhere in this Quarterly Report on Form 10-Q. Shareholders and prospective investors in the Company should carefully consider these risk factors. We disclaim any obligation to update these statements for subsequent events.
Genelabs Technologies, Inc. ("Genelabs" or the "Company") is a biopharmaceutical company engaged in the discovery and development of pharmaceutical products to improve human health. Our primary business objective is to translate research into novel therapeutics for disease areas with significant unmet medical needs. Currently, our product pipeline consists of infectious disease projects focused on HCV infection as well as a late-stage clinical asset for HEV that is being developed by GlaxoSmithKline. We are seeking to balance our pipeline by advancing our next generation drug compounds into a clinical stage where we can efficiently position these compounds for successful commercialization through collaborations with major pharmaceutical partners.
During 2008, we have continued to focus on five separate HCV programs. Two of these programs target the HCV NS5b RNA-dependent RNA polymerase (the enzyme directly responsible for replication of the HCV genome), although through different mechanisms. We refer to one of these programs as our nucleoside polymerase inhibitor program and the other as our non-nucleoside polymerase inhibitor program. We also have two programs that target specific HCV proteins, one known as NS5a and the other as NS4b. The fifth program is directed at inhibiting the function of the HCV replication complex, or replicase, which is comprised of several different HCV-encoded and host-encoded proteins. Our non-nucleoside program is partnered with Novartis Institutes for BioMedical Research ("Novartis"). The research phase of the collaboration was completed on June 2, 2008. Novartis is continuing the research and development of collaboration compounds internally.
On October 29, 2008, we entered into an Agreement and Plan of Merger (the "Merger Agreement") with SmithKline Beecham Corporation ("SKB"), a wholly-owned subsidiary of GlaxoSmithKline plc ("GSK"), and Gemstone Acquisition Corporation (the "Merger Sub"), a California corporation and wholly-owned subsidiary of SKB, whereby the Merger Sub will merge with and into us and we will become an indirect wholly-owned subsidiary of GSK (the "Merger"), subject to the satisfaction or waiver of specified closing conditions, including, among others, the tender by our shareholders of at least 90% of the outstanding shares of our common stock on a fully-diluted basis, unless otherwise agreed.
Under the terms of the Merger Agreement, each share of our common stock issued and outstanding immediately prior to the effective time of the Merger will be converted into the right to receive $1.30 in cash, without interest. In addition, all of our unvested stock options will vest prior to the effective time of the Merger and any issued and outstanding stock options with an exercise price per share less than $1.30 will be converted into the right to receive an amount in cash equal to the excess of $1.30 per share over the exercise price per share of such stock option, less any withholding tax.
The Merger Agreement provides that, during the period between the date of the Merger Agreement and the closing of the Merger, the Company will operate its business in the ordinary course. The Merger Agreement also includes certain termination rights for both us and GSK. The Merger Agreement provides that in certain circumstances, we may be required to pay GSK a termination fee of $3,000,000 and up to an additional $500,000 to reimburse GSK's expenses. These fees would be in addition to significant costs that we have incurred and expect to further incur on our own related to the Merger, including investment banking fees, legal fees, and other costs necessary to complete the Merger. Many of these costs have been or will be incurred irrespective of whether or not the Merger is consummated.
Unless otherwise indicated, the discussions in this document, including the description of our business and our management's discussion and analysis of financial condition and results of operations and our unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2008 contained in this Quarterly Report on Form 10-Q, relate to the Company as a stand-alone entity and do not reflect the impact of the proposed Merger.

Results of Operations - Three Months Ended September 30, 2008 Compared to Three
Months Ended September 30, 2007
   Introduction
   Our net loss was $4.9 million in the third quarter of 2008 compared to a net
loss of $0.1 million for the third quarter of 2007. The increase in net loss was
primarily the result of a decrease in research collaboration contract revenue. A
more detailed discussion of the changes in our statement of operations follows.
   Revenue
   The following table shows our revenue by major category for the third quarter
ended September 30, 2008 and 2007 (dollars in thousands):

                                                                       For the three months ended
                                                                             September 30,
                                                                     2008                   2007
HCV non-nucleoside compound drug discovery research
collaboration (Novartis)                                          $         -          $         1,867
HCV nucleoside compound drug discovery research
collaboration (Gilead)                                                      -                    2,490
Other contract revenue                                                     30                       47

Total contract revenue                                                     30                    4,404
Royalty revenue                                                           270                      236

Total revenue                                                     $       300          $         4,640

We received a non-refundable, up-front payment from our collaboration partners at the time that each of the above collaborations began. We recognize these payments into revenue over the term of our estimated potential research obligations under the agreements.
We did not recognize any revenue under our collaboration with Novartis during the third quarter of 2008 because the research phase of the collaboration, and our obligations to Novartis under the program, ended on June 2, 2008. As of September 30, 2008, we have no remaining unearned contract revenue under the collaboration.
We did not recognize any revenue under our collaboration with Gilead during the third quarter of 2008 because the research phase of the collaboration, and our obligations to Gilead under the program, ended on September 30, 2007. Additionally, during the second quarter of 2008, we announced that Gilead exercised its right to terminate the collaboration agreement and return to Genelabs all licenses to the compounds developed under the program. Research and Development Expenses
Because we are in the business of drug discovery and development and to date have not developed any products that have been approved for sale, the majority of our resources are devoted to drug discovery and development efforts, and accordingly, most of our costs are classified as research and development and expensed as incurred. Research and development expenses include related salaries and benefits, supplies and chemicals used in laboratories, preclinical trials, compound manufacturing costs, contract and outside service fees and allocated facilities and overhead costs. The vast majority of our research and development resources are directed toward the discovery of new drugs targeting HCV. The following table shows our research and development expenses by major category (dollars in thousands):

                                                       For the three months ended
                                                              September 30,
                                                        2008                2007
 Drug discovery (HCV)                               $       2,404       $       2,030
 Drug development                                              83                 170
 Support costs and other research and development           1,168               1,135

 Total research and development                     $       3,655       $       3,335

Expenses for drug discovery comprise the largest category of our research and development expenses. Drug discovery costs increased in the third quarter of 2008 compared to the third quarter of 2007 as a result of an increase in the average number of scientists that we had working on our HCV programs during the 2008 period.
Support costs and other research and development are primarily costs associated with maintaining our research and development facility, such as rent, insurance, depreciation, utilities, maintenance and security, as well as the cost of support staff and our bonus and equity-based compensation. These costs are allocated based on relative headcount between research and development and general and administrative employees. These costs increased overall in the third quarter of 2008 as compared to the same period in 2007. The modest increase was the net result of increases in our depreciation and equity-based compensation expenses which were largely offset

by a decrease in employee incentive bonus expense in the respective periods. The increase in depreciation expense is the result of laboratory and facility improvements that we completed and placed into service in the first quarter of 2008. The increase in equity-based compensation expense resulted primarily from stock options granted under equity-based compensation plans approved by our shareholders in June 2007.
Genelabs' drug discovery process includes ongoing identification of potential lead compounds, refinement of lead compounds through a process known as lead optimization and continued testing of our preclinical drug candidates. To support the drug discovery process, we have built medicinal chemistry, combinatorial chemistry, computational modeling, molecular biology, assay development and high-throughput screening, drug metabolism, pharmacokinetics and toxicology capabilities. Since initiating our first drug discovery program in 1993, we have incurred direct drug discovery costs of approximately $68 million through September 30, 2008. Since initiating our first HCV drug discovery programs in early 2002, we have incurred direct costs of approximately $38 million and recognized revenue of $38 million under these programs through September 30, 2008.
Management continually evaluates the status of our drug discovery and development programs and expects that resources will continue to be devoted toward these efforts. However, those plans may be affected by the future outcomes of current and planned scientific experiments and the proposed acquisition by GSK. Additionally, in the event that the proposed acquisition by GSK is not consummated, those plans will be affected by our need to balance our limited cash resources and our various drug discovery and development opportunities.
General and Administrative Expenses
General and administrative expenses were $1.6 million in the third quarter of 2008 compared to $1.7 million in the third quarter of 2007. Our general and administrative expenses consist primarily of personnel costs for executive management, finance, business development, human resources and legal departments. General and administrative expenses also includes professional expenses, such as audit and legal, including intellectual property costs associated with our drug discovery and development programs, and allocated facilities costs, such as rent, insurance, depreciation, utilities, maintenance and security, as well as the cost of support staff and our bonus and share-based compensation.
Other Income
Interest and other income were approximately $0.1 million and $0.3 million in the third quarters of 2008 and 2007, respectively. The decrease in interest in the third quarter of 2008 compared to the third quarter of 2007 is primarily the result of lower interest rates.
Results of Operations - Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
Introduction
Our net loss was $10 million for the first nine months of 2008 compared to a net loss of $1 million for the first nine months of 2007. The increase in net loss was primarily the result of revenue recognized under our collaboration with Gilead in the 2007 period, with no comparable revenue in the first nine months of 2008. We also recorded a gain on the disposition of our investment in Genovate Biotechnology Co., Ltd. in the 2007 period with no similar transaction in the first nine months of 2008. A more detailed discussion of the changes in our statement of operations follows.
Revenue
The following table shows our revenue by major category for the nine months ended September 30, 2008 and 2007 (dollars in thousands):

                                                                      For the nine months ended
                                                                            September 30,
                                                                      2008                 2007
HCV non-nucleoside compound drug discovery research
collaboration (Novartis)                                          $      6,637         $       5,600
HCV nucleoside compound drug discovery research
collaboration (Gilead)                                                       -                 6,470
Other contract revenue                                                      90                   142

Total contract revenue                                                   6,727                12,212
Royalty revenue                                                            711                   718

Total revenue                                                     $      7,438         $      12,930

We recognized higher revenue under our collaboration with Novartis in the first nine months of 2008, as compared to the same period in 2007, because, in the fourth quarter of 2007, we shortened the revenue recognition period for the up-front payment we received under the program to end on June 2, 2008, the date that the research phase of the collaboration ended.
We did not recognize any revenue under our collaboration with Gilead during the nine months ending September 30, 2008 because the research phase of the collaboration, and our obligations to Gilead under the program, ended on September 30, 2007.
Research and Development Expenses
The following table shows our research and development expenses by major category (dollars in thousands):

                                                        For the nine months ended
                                                              September 30,
                                                        2008                2007
 Drug discovery (HCV)                               $       7,315       $       6,830
 Drug development                                             359                 577
 Support costs and other research and development           4,242               3,609

 Total research and development                     $      11,916       $      11,016

Drug discovery costs increased in nine months ending September 30, 2008 compared to the nine months ending September 30, 2007 as a result of an increase in the average number of scientists that we had working on our HCV programs during the 2008 period. Support costs and other research and development costs increased in the nine months ending September 30, 2008, as compared to the nine months ending September 30, 2007, primarily as a result of an overall increase in our depreciation and equity-based compensation expenses.
General and Administrative Expenses
General and administrative expenses were $6.0 million in the nine months ending September 30, 2008 compared to $5.0 million in the nine months ending September 30, 2007. The increase is primarily the result of costs associated with the resignation of our former President and Chief Executive Officer in the first quarter of 2008, administrative headcount hired in late 2007, a non-recurring financial advisory fee and higher intellectual property filing costs.
Other Income
During the nine months ending September 30, 2007 we recorded a gain of approximately $1.2 million on the disposition of our investment in Genovate Biotechnology Co., Ltd. There was no similar transaction during the nine months ending September 30, 2008.
Interest and other income were approximately $0.6 million and $0.9 million in the nine months ending September 30, 2008 and 2007, respectively. The decrease in interest in the first nine months of 2008 compared to the same period in 2007 is primarily the result of lower interest rates. Liquidity and Capital Resources
We assess liquidity primarily by the cash and cash equivalents available to fund our operations. We had cash and cash equivalents of $24.1 million at September 30, 2008.
We presently estimate that our current cash resources would be adequate to provide liquidity for our existing operations into fiscal year 2010 if the proposed acquisition by GSK were not to be consummated and assuming that, in such event, we would not be required to pay GSK a termination fee or expenses.
Longer-term, we believe our liquidity and capital resources as a stand-alone company will be materially impacted by our success or failure, or the success or failure of our collaborators, in reaching milestones covered under corporate collaborations, the progress of our unpartnered drug discovery programs, the ability to enter into or modify existing corporate collaborations, regulatory actions regarding our investigational drugs and our ability to raise funds from investors.

Since our inception, we have operated at a loss and have funded operations primarily through public and private offerings of equity securities and, to a lesser extent, contract revenues. If we were to remain as a stand-alone company, we would expect to continue incurring substantial costs, including research costs for drug discovery. The amount of additional costs in our business plans will depend on numerous factors including the progress of our research and development programs and the actions of corporate collaborators. To meet our capital needs through 2010 and beyond, we will require additional funding, but additional funds may not be available on acceptable terms, if at all, due to various factors, including our ability to continue trading on the Nasdaq Capital Market. The unavailability of additional funds could delay or prevent the development, approval or marketing of some or all of our product candidates and technologies, which would have a material adverse effect on our business, financial condition and results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk

Genelabs' exposure to market risk for changes in interest rates relates primarily to the Company's cash equivalents. We consider the interest rate risk minimal, as substantially all investments are in a money market fund that invests primarily in high-quality, government-issued debt securities and we have not invested in derivative instruments. As of September 30, 2008, the overall average maturity of Genelabs' short-term investment portfolio was less than 90 days, leaving only minimal exposure to changes in interest rates. Item 4T. Controls and Procedures
Evaluation of Disclosure Controls and Procedures The Company's management, with the participation of the Company's President and Chief Executive 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 this evaluation, the Company's President and Chief Executive Officer concluded that, as of the end of such period, the disclosure controls and procedures were effective in providing reasonable assurance that the information required to be disclosed in our Securities and Exchange Commission reports (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our President and Chief Executive Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.