Ore Pharmaceutical (GLGC) 10-Q 2006 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934

For the quarterly period ended June 30, 2006

OR

o Transition Report Pursuant To Section 13 Or 15(d) Of The Securities Exchange Act Of 1934

For the transition period from _______________ to _______________

Commission File Number: 0-23317

GENE LOGIC INC.

(Exact name of registrant as specified in its charter)

Delaware	06-1411336
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)

610 Professional Drive

Gaithersburg, Maryland 20879

(Address of principal executive offices)

(301) 987-1700

(Registrant’s phone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days:YES xNO o

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

Large accelerated filer o Accelerated filer x Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES oNO x

The number of shares outstanding of the Registrant’s Common Stock, $.01 par value, was 31,809,631 as of July 31, 2006.

GENE LOGIC INC.

TABLE OF CONTENTS

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Consolidated Condensed Balance Sheets at June 30, 2006 and December 31, 2005	3
	Consolidated Condensed Statements of Operations for the Three and Six Months Ended June 30, 2006 and 2005	4
	Consolidated Condensed Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005	5
	Notes to Consolidated Condensed Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Results of Operations and Financial Condition	13
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	20
Item 4.	Controls and Procedures	20
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3.	Defaults Upon Senior Securities	22
Item 4.	Submission of Matters to a Vote of Security Holders	22
Item 5.	Other Information	23
Item 6.	Exhibits	23
Signatures		24

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PART IFINANCIAL INFORMATION

Item 1.Financial Statements

GENE LOGIC INC.

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands, except share data)

	June 30,			December 31,
	2006			2005
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	24,824		$	43,946
Marketable securities available-for-sale		34,669			38,179
Accounts receivable, net of allowance of $499 and $709 as of June 30, 2006 and December 31, 2005, respectively
		1,822			3,544
Unbilled services		4,827			7,779
Inventory, net		2,830			3,117
Prepaid expenses		3,197			2,403
Other current assets		986			961
Total current assets		73,155			99,929
Property and equipment, net		28,667			30,682
Long-term investments		2,964			3,239
Goodwill		12,913			12,913
Other intangibles, net		11,716			13,399
Other assets		964			557
Total assets	$	130,379		$	160,719
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable	$	2,996		$	5,630
Accrued compensation and employee benefits		4,504			6,702
Other accrued expenses		3,708			4,269
Current portion of capital lease obligations		132			144
Current portion of long-term debt		498			497
Acquired technologies payable		3,500			3,492
Deferred revenue		9,633			11,595
Total current liabilities		24,971			32,329
Capital lease obligations, net of current portion		—			57
Long-term debt, net of current portion		103			127
Deferred rent		2,938			3,350
Total liabilities		28,012			35,863
Commitments and contingencies		—			—
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000 shares authorized; and no shares issued and outstanding as of June 30, 2006 and December 31,
2005		—			—
Common stock, $.01 par value; 60,000,000 shares authorized; 31,809,631 and 31,771,835 shares issued and outstanding as of June 30, 2006
and December 31, 2005, respectively		318			318
Additional paid-in-capital		386,281			385,586
Accumulated other comprehensive loss		(179	)		(78	)
Accumulated deficit		(284,053	)		(260,970	)
Total stockholders' equity		102,367			124,856
Total liabilities and stockholders' equity	$	130,379		$	160,719

See accompanying notes.

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GENE LOGIC INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Revenue:
Genomics services	$	4,683		$	14,166		$	13,431		$	27,405
Preclinical services		6,600			5,820			10,634			12,254
Drug repositioning services		9			147			29			214
Total revenue		11,292			20,133			24,094			39,873
Expenses (1):
Cost of preclinical services		7,172			6,618			13,580			13,808
Database production		7,566			8,021			15,299			16,203
Research and development		2,541			1,380			4,981			2,841
Selling, general and administrative		5,951			7,743			14,470			15,276
Total expenses		23,230			23,762			48,330			48,128
Loss from operations		(11,938	)		(3,629	)		(24,236	)		(8,255	)
Interest (income), net		(755	)		(617	)		(1,528	)		(1,117	)
Other (income) expense		103			(402	)		100			(427	)
Write-down of equity investment		—			—			275			—
Net loss	$	(11,286	)	$	(2,610	)	$	(23,083	)	$	(6,711	)
Basic and diluted net loss per share	$	(0.35	)	$	(0.08	)	$	(0.73	)	$	(0.21	)
Shares used in computing basic and diluted
net loss per share		31,809			31,742			31,798			31,725
(1) Line items include non-cash stock compensation expense as follows (see Note 2):
Cost of preclinical services	$	43		$	—		$	101		$	—
Database production		43			—			101			—
Research and development		27			—			63			—
Selling, general and administrative		122			—			285			—
Total non-cash stock compensation expense	$	235		$	—		$	550		$	—

See accompanying notes.

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GENE LOGIC INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Six Months Ended
	June 30,
	2006			2005
Cash flows from operating activities:
Net loss	$	(23,083	)	$	(6,711	)
Adjustments to reconcile net loss to net cash flows from operating activities:
Depreciation and amortization		7,200			7,443
Inventory impairment		675			—
Write-down of equity investment		275			—
Non-cash stock compensation expense		550			—
Gain on sale of marketable securities available-for-sale		(31	)		—
Loss on abandonment of patents		23			18
Loss on disposal of property and equipment		—			50
Laboratory facility impairment		476			—
Accrued interest relating to acquired technologies payable		8			72
Changes in operating assets and liabilities:
Accounts receivable and unbilled services		4,674			(2,683	)
Inventory		(388	)		(1,292	)
Prepaids and other assets		(1,226	)		380
Accounts payable		(2,634	)		(1,756	)
Accrued expenses and deferred rent		(3,230	)		3,621
Deferred revenue		(1,962	)		7,590
Net cash flows from operating activities		(18,673	)		6,732
Cash flows from investing activities:
Purchases of property and equipment		(2,002	)		(9,992	)
Purchases of licenses and patent costs		(425	)		(236	)
Software development costs		(628	)		(889	)
Database upgrade costs		(887	)		(720	)
Purchase of marketable securities available-for-sale		(19,275	)		(5,944	)
Proceeds from sale and maturity of marketable securities available-for-sale		22,715			26,694
Net cash flows from investing activities		(502	)		8,913
Cash flows from financing activities:
Proceeds from issuance of common stock to employees		145			187
Repayments of capital lease obligations and equipment loan		(92	)		(88	)
Net cash flows from financing activities		53			99
Net increase (decrease) in cash and cash equivalents		(19,122	)		15,744
Cash and cash equivalents, beginning of period		43,946			53,237
Cash and cash equivalents, end of period	$	24,824		$	68,981
Supplemental disclosure:
Interest paid	$	12		$	19

See accompanying notes.

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GENE LOGIC INC.

Notes to Consolidated Condensed Financial Statements

June 30, 2006

(in thousands, except share and per share data)

(Unaudited)

Note 1 — Organization and summary of significant accounting policies

Description of Business

Gene Logic Inc., including its wholly owned subsidiaries, Gene Logic Laboratories Inc. (formerly TherImmune Research Corporation), Gene Logic Ltd. (United Kingdom subsidiary) and Gene Logic K.K. (Japan subsidiary), (collectively “Gene Logic” or the “Company”), provides drug discovery and development services and solutions to pharmaceutical and biotechnology companies worldwide and United States Government agencies. The Company’s services are organized into three business segments: genomics and toxicogenomics services (“Genomics Division”), preclinical contract research services (“Preclinical Division”) and drug repositioning services (“Drug Repositioning Division”).

The Genomics Division consists of proprietary gene expression and toxicogenomics databases, toxicogenomics services, software tools, microarray data generation and analysis and other professional services and solutions. These services are designed to help customers discover and prioritize drug targets, identify biomarkers, predict toxicity and understand the mechanism of toxicity and obtain insights into the efficacy of specific compounds. The Preclinical Division consists of in vivo (in life) research studies and related laboratory services to enable customers primarily in the United States to assess the safety and pharmacologic effects of candidate compounds for the purpose of seeking FDA approval to initiate human trials. The Drug Repositioning Division, which resulted from the acquisition of certain technologies in 2004 that continue to be developed, consists of an integrated multi-technology platform used to assist customers in (i) identifying alternative indications for failed, stalled or deprioritized drug candidates, and in the future, potentially assist customers in (ii) expanding indications for currently marketed drugs; and (iii) prioritizing and identifying indications for compounds entering preclinical development.

The Company is currently conducting a review of its overall business strategy with the assistance of outside consultants. As a result of this review, the Company may contemplate a range of actions that could have a material impact on its business as it is presently conducted. The Company expects to complete its review by late September 2006. Using preliminary findings from this review, the Company recently initiated a restructuring of its Genomics Division intended to reduce its cash use. The Company gave notice of termination to approximately 80 employees, effective October 5, 2006, which will result in severance costs of $1,800. Once fully implemented, the Company estimates that these staff reductions will reduce its annual salary and fringe benefits costs by approximately $8,000. The Company expects to realize additional savings in certain non-employee costs in connection with this restructuring.

Basis of Presentation

The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. The consolidated condensed balance sheet as of June 30, 2006, consolidated condensed statements of operations for the three and six months ended June 30, 2006 and 2005 and the consolidated condensed statements of cash flows for the six months ended June 30, 2006 and 2005 are unaudited, but include all adjustments (consisting of normal recurring adjustments) that the Company considers necessary for a fair presentation of the financial position, operating results and cash flows, respectively, for the periods presented. Although the Company believes that the disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote information normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). All material intercompany accounts and transactions have been eliminated in consolidation.

Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying unaudited consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

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Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Inventory

Inventory is stated at the lower of cost or market. Cost for microarrays and laboratory reagents is determined using the first-in, first-out method and cost for tissue samples is determined using the average cost method. All inventory is reviewed for impairment and appropriate reserves are recorded. All inventory is classified as raw materials. The following table sets forth information on the composition of the Company’s inventory as of the indicated periods:

	June 30,			December 31,
	2006			2005
Microarrays	$	2,969		$	2,199
Laboratory reagents		404			324
Tissue samples		1,809			2,248
		5,182			4,771
Less:
Microarray lower of cost or market reserve		(675	)		—
Tissue sample reserves		(1,677	)		(1,654	)
Inventory, net	$	2,830		$	3,117

Comprehensive Loss

The Company accounts for comprehensive loss as prescribed by Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income”. Comprehensive income (loss) is the total net income (loss) plus all changes in equity during the period except those changes resulting from investment by and distribution to owners. Total comprehensive loss, which primarily includes unrealized gains or losses in the Company’s marketable securities available-for-sale, was $11,314 and $2,552 for the three months ended June 30, 2006 and 2005, respectively, and $23,184 and $6,637 for the six months ended June 30, 2006 and 2005, respectively.

New Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) which clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of this Interpretation to have a material impact on its financial statements.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment”(“SFAS 123R”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the three and six months ended June 30, 2006 includes compensation expense for all stock-based compensation awards granted (i) prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123, “Accounting for Stock-Based Compensation”(“SFAS 123”) and (ii) after January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. For the first half of 2006, stock-based compensation awards consisted of options awarded under the 1997 Equity Incentive Plan and the 1997 Non-Employee Directors’ Stock Option Plan. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting period and typically occurs ratably over periods ranging from two to four years. Prior to the adoption of SFAS 123R, the Company recognized stock-based compensation expense in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R. See Note 2 to the Consolidated Condensed Financial Statements for a further discussion on stock-based compensation.

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The Company’s results of operations for the three and six months ended June 30, 2006 were impacted by the recognition of $235 and $550, respectively, in non-cash expense related to the fair value of the Company’s stock-based compensation awards. Based on outstanding share-based awards as of December 31, 2005, the Company estimates that non-cash stock compensation expense in 2006 will be approximately $700 to reflect the continued vesting of outstanding stock option grants that remained unvested as of December 31, 2005. The impact of stock compensation expense in future periods will be dependent on the number and type of share-based payments issued to employees and non-employee directors and this estimate does not include the impact of other possible stock-based awards that could be made during the balance of 2006.

In November 2005, the Financial Accounting Standards Board issued FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”). FSP FAS 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. FSP FAS 115-1, which is effective for reporting periods after December 31, 2005, also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The adoption of FSP FAS 115-1 had no material impact on the Company’s financial position, results of operations or cash flows.

Note 2 — Stock-based compensation

At June 30, 2006, the Company has the following stock-based compensation plans: 1997 Equity Incentive Plan (the “Stock Plan”), 1997 Non-Employee Directors’ Stock Option Plan (the “Directors’ Plan”) and Employee Stock Purchase Plan (the “ESPP”).

Stock Plan

The Company has a Stock Plan, under which the Compensation Committee (the “Committee”) of the Company’s Board of Directors, at its discretion, can grant stock options to employees, certain employee directors and consultants of the Company and related corporations. The Stock Plan currently authorizes the grant of stock options for up to 10,600,000 shares of Common Stock. The stock options granted under the Stock Plan expire at the earlier of termination or the date specified by the Committee at the date of grant, but not more than ten years from such grant date. As noted later, the Stock Plan was amended upon approval of the Stockholders in June 2006, to allow the issuance of restricted stock awards and to make certain other changes.

Directors’ Plan

The Company has a Directors’ Plan to provide for granting of stock options to purchase up to 900,000 shares of Common Stock to non-employee directors of the Company. Stock options are to be granted at the fair market value of the Common Stock at the grant date. The stock options granted under the Directors’ Plan expire ten years from such grant date.

ESPP

The Company has an ESPP that currently allows for an aggregate of 1,250,000 shares of Common Stock to be purchased. The ESPP allowed employees to purchase shares of Common Stock of the Company at each purchase date, through payroll deductions of up to a maximum of 15% of their combined salary and bonus, at 85% of the lesser of the market price of the shares at the time of purchase or the market price on the beginning date of an offering (or, if later, the date during the offering when the employee was first eligible to participate), with a limit of 600 shares per purchaser per purchase date. The ESPP was suspended effective February 1, 2005.

Prior to January 1, 2006, the Company accounted for these plans under the recognition and measurement provisions of APB 25. Accordingly, the Company recognized compensation expense, if any, only to the extent that the fair value of the underlying stock on the date of grant exceeded the exercise or acquisition price of the stock or stock-based award. Any resulting compensation expense was recognized ratably over the associated service period, which was generally the option vesting period. No stock-based compensation expense was recognized in the Consolidated Condensed Statement of Operations for the three and six months ended June 30, 2005, as all stock options granted by the Company had been granted with an exercise price equal to the fair value on the grant date and the ESPP was considered non-compensatory under APB 25.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the first half of 2006 included compensation expense for all stock-based compensation awards granted (i) prior to, but not yet vested as of, January 1, 2006 based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (ii) after January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.

As a result of adopting SFAS 123R, the Company’s net loss in the Consolidated Condensed Financial Statements for the three and six months ended June 30, 2006 was $235 and $550, respectively, higher than if the Company had continued to account for stock-based

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compensation under APB 25. The impact on basic and diluted net loss per share for the three and six months ended June 30, 2006 was $0.01 and $0.02 per share, respectively.

Prior to January 1, 2006, the Company provided pro forma disclosure amounts in accordance with SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure”, as if the fair value method defined by SFAS 123R had been applied to its stock-based compensation. To facilitate quarter-to-quarter comparisons, the following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair value recognition provisions of SFAS 123R to stock-based compensation for the indicated period:

	Three Months			Six Months
	Ended			Ended
	June 30,			June 30,
	2005			2005
Net loss, as reported	$	(2,610	)	$	(6,711	)
Add: Stock-based employee compensation expense included
in reported net loss		—			—
Deduct: Stock-based employee compensation expense determined
under fair value-based method for all awards		(530	)		(1,145	)
Pro forma net loss	$	(3,140	)	$	(7,856	)
Basic and diluted net loss per share:
As reported	$	(0.08	)	$	(0.21	)
Pro forma	$	(0.10	)	$	(0.25	)

A recent amendment to the Stock Plan was approved by the Stockholders in June 2006, allowing the issuance of restricted stock awards, in addition to stock options. The amendment also eliminates awards to consultants after June 1, 2006, enables the Compensation Committee to structure awards to be performance-based, eliminates option repricing except (i) in connection with a change in capitalization of the Company or (ii) with stockholder approval and extends the term of the Stock Plan.

The Company determined the fair value of each option grant on the date of grant using the Black-Scholes option pricing model for the indicated periods, with the following assumptions:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Weighted average fair value of grants	$	1.04		$	1.24		$	1.11		$	1.26
Expected volatility		57	%		51	%		55	%		52	%
Risk-free interest rate		5.11	%		3.61% to 3.73	%		4.49% to 5.11	%		3.41% to 3.93	%
Expected lives		3 years			3 years			3 years			3 years
Dividend rate		0	%		0	%		0	%		0	%

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The following is a summary of option activity for the six months ended June 30, 2006:

				Outstanding Options
						Weighted
						Average
				Weighted		Remaining		Aggregate
				Average		Contractual		Intrinsic
	Shares			Exercise Price		Life (Years)		Value
Outstanding at January 1, 2006		5,515,504		$	6.86
Options granted		101,500		$	2.66
Options exercised		(37,796	)	$	3.85
Options cancelled		(492,433	)	$	6.60
Outstanding at June 30, 2006		5,086,775		$	6.82		5.7	$	41
Vested and expected to vest at June 30, 2006		4,850,423		$	6.96		5.6	$	41
Exercisable at June 30, 2006		4,443,176		$	7.28		5.3	$	41

The aggregate intrinsic value in the table above represents the total intrinsic value (the difference between the Company’s closing stock price on the last trading day of the second quarter of 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on June 30, 2006. This amount is subject to change based on changes to the fair market value of the Company’s Common Stock. Total intrinsic value of options exercised for the six months ended June 30, 2006 was not material.

As of June 30, 2006, $585 of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 2.0 years. This estimate does not include the impact of other possible stock-based awards that may be made during the balance of 2006, nor does it take into account the restructuring which was announced in August 2006, as described in Note 4.

Cash received from option exercises for the six months ended June 30, 2006 was $145.

Note 3 — Segment information

The Company’s operations are organized into three business segments: Genomics Division, Preclinical Division and Drug Repositioning Division, all of which are more fully described in Note 1.

The following table presents revenue and operating income (loss) for each of these segments. Management uses these measures to evaluate segment performance. To arrive at operating income (loss) for each segment, management has included all direct costs for providing the segment’s services and an allocation for corporate overhead on a consistent and reasonable basis. Management has excluded interest (income) expense, other (income) expense and write-down of equity investment, and could also exclude certain unusual or corporate-related costs in the future. In addition, while the Company’s Consolidated Condensed Statements of Operations include adjustments to reflect the elimination of inter-segment transactions, individual segments may include these types of transactions. Management does not believe these transactions are material and believes that their inclusion would not impact either management’s or shareholders’ understanding of the operations of the segments. For purpose of clarity, revenue is reported net of inter-segment transactions. The Company does not identify or allocate, nor does management evaluate, assets by segment.

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The following table sets forth information on reportable segments for the indicated periods:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Genomics Services
Revenue	$	4,683		$	14,166		$	13,431		$	27,405
Operating income (loss) (1)		(6,064	)		1,669			(9,873	)		2,504
Depreciation and amortization expense		2,498			2,601			4,970			5,410
Preclinical Services
Revenue	$	6,600		$	5,820		$	10,634		$	12,254
Operating income (loss) (1)		(2,502	)		(2,838	)		(7,466	)		(5,840	)
Depreciation and amortization expense		829			782			1,655			1,769
Drug Repositioning Services
Revenue	$	9		$	147		$	29		$	214
Operating income (loss) (1)		(3,372	)		(2,460	)		(6,897	)		(4,919	)
Depreciation and amortization expense		290			146			575			264

(1) Includes non-cash stock compensation expenses of $86, $83 and $66and $201, $193 and $156 for the three and six months ended June 30, 2006, respectively, for Genomics services, Preclinical services and Drug repositioning services.

A reconciliation of segment operating income (loss) to net loss for the indicated periods is as follows:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2006			2005			2006			2005
Segment Operating Income (Loss)
Genomics services	$	(6,064	)	$	1,669		$	(9,873	)	$	2,504
Preclinical services		(2,502	)		(2,838	)		(7,466	)		(5,840	)
Drug repositioning services		(3,372	)		(2,460	)		(6,897	)		(4,919	)
		(11,938	)		(3,629	)		(24,236	)		(8,255	)
Interest (income), net		(755	)		(617	)		(1,528	)		(1,117	)
Other (income) expense		103			(402	)		100			(427	)
Write-down of equity investment		—			—			275			—
Net loss	$	(11,286	)	$	(2,610	)	$	(23,083	)	$	(6,711	)

During the three months ended June 30, 2006, one customer of the Company’s Genomics and Preclinical Divisions accounted for 10% or more of the Company’s revenue (10.6%). During the six months ended June 30, 2006, no customer accounted for 10% or more of the Company’s revenue. During the three and six months ended June 30, 2005, one Genomics Division customer accounted for 10% or more of the Company’s revenue (18.2% and 11.0%, respectively). The following table sets forth information on the composition of the Company’s total revenue by geographic region:

	Geographic Region
	North America		Europe		Pacific Rim
For the three months ended:
June 30, 2006		72%		16%		12%
June 30, 2005		49%		27%		24%
For the six months ended:
June 30, 2006		72%		14%		14%
June 30, 2005		51%		19%		30%

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Note 4 — Subsequent event

As previously discussed in Note 1, the Company has notified approximately 80 employees that their employment will terminate effective October 5, 2006, consistent with the Worker Adjustment and Retraining Notification (WARN) Act. When the terminations are effective, the affected employees will be given severance that is expected to cost approximately $1,800, which costs will be recorded in the third quarter of 2006, but not paid until the fourth quarter of 2006 due to the timing of the actual termination date.

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

This Quarterly Report on Form 10-Q (“Form 10-Q”) contains forward-looking statements regarding future events and the future results of Gene Logic Inc. (“Gene Logic”) that are based on current expectations, estimates, forecasts and projections about the industries in which Gene Logic operates and the beliefs and assumptions of the management of Gene Logic. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” variations of such words, and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause or contribute to such differences include those discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 under the section entitled “Risk Factors” and in Part II, Item 1A of this Form 10-Q. Gene Logic undertakes no obligation to revise or update publicly any forward-looking statements to reflect any change in management’s expectations with regard thereto or any change in events, conditions, or circumstances on which any such statements are based.

Unless the context otherwise requires, references in this Form 10-Q to “Gene Logic,” “Gene Logic Laboratories Inc.,” “Gene Logic Ltd.,” “Gene Logic K.K.,” the “Company,” “we,” “us,” and “our” refer to Gene Logic Inc. and its wholly owned subsidiaries. Gene Logic®, GeneExpress®, BioExpress®, ToxExpress®, ASCENTA® and Genesis Enterprise System® are registered trademarks of Gene Logic. Drug Repositioning and Selection™, SCIANTIS™, ToxScreen™, ToxShield™, ToxEdge™, ToxPlus™ and Phase R^SM are trademarks of Gene Logic.

Overview

We conduct our operations through three business segments:

· Genomics Division: we sell subscriptions and perpetual licenses to our proprietary gene expression and toxicogenomics databases, and provide toxicogenomics services, software tools, microarray data generation and analysis and other professional services and solutions to customers worldwide to help in their drug research and development.

· Preclinical Division: we provide in vivo (in life) studies and related laboratory services to enable customers primarily in the United States to assess the safety and pharmacologic effects of candidate compounds for the purpose of seeking FDA approval to initiate human trials.

· Drug Repositioning Division: we have partnerships with customers to identify alternative indications for their failed, stalled or deprioritized drug candidates through the application of an integrated multi-technology platform, with the goal of returning such candidates to the drug development pipeline.

We are currently conducting a review of our overall business strategy with the assistance of outside consultants. As a result of this review, we may contemplate a range of actions that could have a material impact on our business as it is presently conducted. We expect to complete our review by late September 2006. Using preliminary findings from this review, we recently initiated a restructuring of our Genomics Division intended to reduce its cash use. We gave notice of termination to approximately 80 employees, effective October 5, 2006, which will result in severance costs of $1.8 million. Once fully implemented, we estimate that these staff reductions will reduce our annual salary and fringe benefits costs by approximately $8 million. We expect to realize additional savings in certain non-employee costs in connection with this restructuring.

Historically, we have derived a majority of our Genomics Division revenue from licenses to our databases, in the form of multi-year subscriptions and annual subscriptions to our smaller databases or a subset of our larger databases; more recently, we have also granted perpetual licenses to our data and/or software tools. Fees are payable ratably over the life of the agreement for multi-year agreements, ratably or up-front for shorter-term agreements and, in the case of perpetual licenses, upon delivery of the data or software. Generally, our Genomics Division contracts may be terminated in the event of breach by either party not cured within any applicable cure period. In the past, we have invested in new database content, upgraded our databases and developed new versions of our software tools. Future investments in these areas are being evaluated as part of our strategic review of our Genomics Division.

Our Preclinical Division revenue is primarily from fixed price contracts, under which a portion of the contract price is due at the time the study starts, with the balance payable upon the achievement of various milestones over the study’s duration. We also receive some revenue from cost plus contracts with United States Government agencies, under which we are reimbursed for our budgeted costs, subject to periodic audit, and receive a fixed fee. Costs under cost plus contracts are reimbursed monthly, along with a pro rata portion of the fixed fee. Contracts may range in duration from a few weeks to several years. Most of our Preclinical Division contracts may be terminated by the customer at any time, subject to payment to us of certain costs and, in some instances, a portion of our profit or fixed fee, or a cancellation fee.

The success of the Preclinical Division is dependent on our capacity and on our achieving optimal use of that capacity. Results in 2006 are beginning to show the positive impact of our recent capacity expansion and other improvements in operations and business development.

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Our Drug Repositioning Division resulted from our acquisition of certain technology from Millennium Pharmaceuticals, Inc. (“Millennium”) in 2004. We have invested, and continue to invest, significant amounts in the development of the Drug Repositioning technologies and of the Drug Repositioning Division.

We have established partnerships to reposition drug candidates with several pharmaceutical and biotechnology customers. Under these agreements, we do not typically derive up-front revenue. Generally, a partner agrees to make available a stated number of failed, stalled or deprioritized drug candidates as to which we will conduct the initial evaluation using our integrated multi-technology platform, at our expense. We will inform our partner of any possible new indications we identify. In some instances, our partner has the option to elect to have us conduct mutually agreed upon animal model validation studies based on our hypothesis, which may be partially or entirely at our expense. Validated drug candidates would then be returned to a partner’s pipeline at its sole election and we could receive milestone payments if a drug candidate is returned to the partner’s development pipeline and royalties and/or milestone payments based on sales if the drug candidate begins commercial sales. If a partner declined a drug candidate for an indication we had found, we could in some cases acquire the rights to develop the drug candidate for the particular indication. We have acquired one such candidate, but have not established a development plan for that candidate. Under the terms of another agreement, we may become equal owners with our partner of drug candidates for which potential new therapeutic utility is discovered and we would jointly decide how to proceed with the development, commercialization and funding of such candidate.

Revenue from our Drug Repositioning Division has not been significant to date and we do not expect to receive significant revenue under any of our drug repositioning agreements in 2006.

We have incurred operating losses in each year since our inception, including losses of $48.3 million in 2005, $28.5 million in 2004 and $24.8 million in 2003. At June 30, 2006, we had an accumulated deficit of $284.1 million. Our losses have resulted principally from costs incurred in the development, marketing and sale of services from our Genomics and Preclinical Divisions, development of the Drug Repositioning Division, the impairment of our Preclinical Division goodwill and acquisitions of research and development. These costs have exceeded our revenue and we expect to incur additional operating losses in the future.

Results of Operations

Three Months Ended June 30, 2006 and 2005

Total Revenue. Total revenue decreased 44% to $11.3 million for the three months ended June 30, 2006 as compared to $20.1 million for the same period in 2005. During the three months ended June 30, 2006, one customer of our Genomics and Preclinical Divisions, accounted for greater than 10% of our total revenue. During the three months ended June 30, 2005, one Genomics Division customer, accounted for greater than 10% of our total revenue. During the three months ended June 30, 2006 and 2005, 12% and 24% of our total revenue, respectively, was from customers in the Pacific Rim, and 16% and 27% of our total revenue, respectively, was from customers in Europe. The decline in revenue from customers in the Pacific Rim reflects the impact of agreements for Genomics services that were terminated, renegotiated at reduced service levels or transitioned into perpetual licenses in 2005. The decline in revenue from customers in Europe primarily reflects the impact of a deliverable to a Genomics Division customer in 2005 which did not recur at the same level in 2006.

Genomics Services Revenue. Revenue from our Genomics services, the majority of which consists of fees from subscription agreements to our BioExpress and ToxExpress System databases, was $4.7 million for the three months ended June 30, 2006, a decrease of $9.5 million, or 67%, from $14.2 million for the same period in 2005. The 2006 decrease in revenue resulted from declining subscription revenue, the absence of anticipated sales of perpetual licenses to database products that failed to materialize and slower than anticipated sales growth for microarray data generation and analysis services. Specifically, the 2006 results reflect the absence of $6.9 million in subscription fees from agreements that have expired and $3.1 million in additional fees from customers to whom we granted perpetual licenses to certain data, partially offset by higher revenue of $0.8 million from increased microarray data generation and analysis services in 2006. For 2006, we presently anticipate our Genomics Division revenue to be significantly lower than previously anticipated.

In 2006, long-term subscription agreements with five customers will expire by their terms and two agreements allow for early termination at the customer’s election. These agreements accounted for 20% of our total 2005 revenue and 28% of our 2005 Genomics services revenue. Also, these agreements accounted for 33% and 59% of our total revenue and Genomics services revenue, respectively, for the six months ended June 30, 2006. As to the two agreements that were subject to early termination at the customer’s election, one customer terminated its agreement early and one customer elected to continue its agreement. As to the remaining five agreements, three agreements have expired by their terms and one was terminated by mutual agreement. Two of these customers purchased perpetual licenses to data and software in connection with their respective terminations. Negotiations are underway for the remaining agreement. There is no assurance that the remaining agreement scheduled to expire will be extended or that any agreement resulting from our discussions with such customer will be on terms comparable to, or as favorable to us, as the existing subscription agreement.

Preclinical Services Revenue. Revenue from our Preclinical services, which consist of fees from preclinical safety and pharmacology studies and related laboratory services, was $6.6 million for the three months ended June 30, 2006, an increase of $0.8 million, or 13%,

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from $5.8 million for the same period in 2005. The increase is primarily attributable to increased utilization of capacity and an increase in the number of large-animal studies conducted in the three months ended June 30, 2006. For the remainder of 2006, we expect continued improvements in revenue due to increased utilization of our capacity.

Cost of Preclinical Services Revenue. Cost of Preclinical services revenue consists of direct and indirect costs related to conducting preclinical safety and pharmacology studies and related laboratory services, including direct and indirect labor, study materials and facility costs and depreciation. Cost of preclinical services revenue increased $0.6 million for the three months ended June 30, 2006 to $7.2 million from $6.6 million for the same period in 2005 reflecting higher revenue of $0.8 million in 2006, partially offset by slight improvements in gross margins to negative 9% for the three months ended June 30, 2006 from negative 14% in the same period in 2005. When compared to the first quarter of 2006, gross margins for the second quarter of 2006 improved significantly from negative 59% to negative 9%, which reflects an improving trend in our business. For the remainder of 2006, we expect gross margins to continue to improve, largely as a result of increased capacity utilization.

Database Production Expense. Database production expenses, which consist primarily of costs related to the acquisition and processing of tissues and overhead expenses needed to generate the content of the BioExpress and ToxExpress System databases and costs to provide microarray data generation and analysis services, decreased to $7.6 million for the three months ended June 30, 2006 from $8.0 million for the same period in 2005. The decrease consisted primarily of a $1.3 million reduction in database content generation expenses, including $0.8 million in lower costs for agreements with third parties, partially offset by a $0.7 million lower of cost or market impairment of inventory in 2006. For the remainder of 2006, we expect database production expenses to decrease largely due to reductions in related personnel.

Research and Development Expense. Research and development expenses, which consist primarily of costs associated with the ongoing development of our drug repositioning technologies, increased to $2.5 million for the three months ended June 30, 2006 from $1.4 million for the same period in 2005. The increase was primarily a result of increased development efforts related to our drug repositioning technologies and evaluation of customer-supplied drug candidates under the terms of our drug repositioning partnerships. For the remainder of 2006, we expect research and development expenses to increase modestly, as we continue to develop our drug repositioning technologies and do repositioning work on customer-supplied drug candidates.

Selling, General and Administrative Expense. Selling, general and administrative expenses, which consist primarily of sales, marketing, accounting, legal, human resources and other general corporate expenses, decreased to $6.0 million for the three months ended June 30, 2006 from $7.7 million for the same period in 2005. The decrease is largely due to a reduction of $0.8 million in costs under our 2006 annual employee incentive compensation plan due to our Genomics Division revenue shortfall and other savings from general cost controls over a wide range of expense categories, partially offset by $0.1 million in non-cash compensation expense resulting from the impact of the Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). Beginning in the fourth quarter of 2006, we expect selling, general and administrative expenses to be lower as a result of the reduction in our workforce.

Net Interest Income. Net interest income increased to $0.8 million for the three months ended June 30, 2006 from $0.6 million for the same period in 2005, due to increases in our rates of return on investments, partially offset by a decline in the balance of our cash and cash equivalents and marketable securities available-for-sale.

Other (Income) Expense. Other (income) expense was an expense of $0.1 million for the three months ended June 30, 2006 compared to income of $0.4 million for the same period in 2005, due to foreign currency transaction losses and gains in 2006 and 2005, respectively, relating to our subscription agreements with our Japanese customers. As a result of changing our distribution arrangements in Japan, beginning in 2005, agreements with our Japanese customers are now denominated in Japanese Yen.

Six Months Ended June 30, 2006 and 2005

Total Revenue. Total revenue decreased 40% to $24.1 million for the six months ended June 30, 2006 as compared to $39.9 million for the same period in 2005. During the six months ended June 30, 2006, no customer accounted for greater than 10% of our total revenue. During the six months ended June 30, 2005, one Genomics Division customer accounted for greater than 10% of our total revenue. During the six months ended June 30, 2006 and 2005, 14% and 30% of our total revenue, respectively, was from customers in the Pacific Rim, and 14% and 19% of our total revenue, respectively, was from customers in Europe. The decline in revenue from customers in the Pacific Rim reflects the impact of agreements for Genomics services that were terminated, renegotiated at reduced service levels or transitioned into perpetual licenses in 2005.

Genomics Services Revenue. Revenue from our Genomics services was $13.4 million for the six months ended June 30, 2006, a decrease of $14.0 million, or 51%, from $27.4 million for the same period in 2005. The 2006 decrease in revenue resulted from declining subscription revenue, the absence of anticipated sales of perpetual licenses to database products that failed to materialize and slower than anticipated sales growth for microarray data generation and analysis services. Specifically, the 2006 results reflect the absence of $11.9 million in subscription fees from agreements that have expired, $2.1 million in additional fees from customers to whom we granted perpetual licenses

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to certain data and/or software and reduced revenue of $2.0 million from certain agreements with existing customers renegotiated at reduced service levels, partially offset by higher revenue of $1.4 million from increased microarray data generation and analysis services in 2006.

Preclinical Services Revenue. Revenue from our Preclinical services was $10.6 million for the six months ended June 30, 2006, a decrease of $1.6 million, or 13%, from $12.3 million for the same period in 2005. The decrease is primarily attributable to a decline in both the number and size of studies conducted during the first quarter of 2006, partially offset by increased utilization of capacity and an increase in the number of large-animal studies conducted during the second quarter of 2006, which reflects an improving trend in our business.

Cost of Preclinical Services Revenue. Cost of preclinical services revenue decreased $0.2 million for the six months ended June 30, 2006 to $13.6 million from $13.8 million for the same period in 2005 reflecting lower revenue of $1.6 million in 2006, partially offset by declines in gross margins to negative 28% for the six months ended June 30, 2006 from negative 13% in the same period in 2005.

Database Production Expense. Database production expenses decreased to $15.3 million for the six months ended June 30, 2006 from $16.2 million for the same period in 2005. The decrease consisted primarily of a $1.9 million reduction in database content generation expenses, including $1.3 million in lower costs for agreements with third parties, partially offset by a $0.7 million lower of cost or market impairment of inventory in 2006.

Research and Development Expense. Research and development expenses increased to $5.0 million for the six months ended June 30, 2006 from $2.8 million for the same period in 2005. The increase was primarily a result of increased development efforts related to our drug repositioning technologies and repositioning work on customer-supplied drug candidates.

Selling, General and Administrative Expense. Selling, general and administrative expenses decreased to $14.5 million for the six months ended June 30, 2006 from $15.3 million for the same period in 2005. The decrease is largely due to a reduction of $0.8 million in costs under our 2006 annual employee incentive compensation plan due to our Genomics Division revenue shortfall, partially offset by $0.3 million in non-cash compensation expense as a result of the impact of SFAS 123R.

Write-down of Equity Investment. In connection with our investment in MetriGenix, we had entered into a subscription agreement granting MetriGenix a license to use our BioExpress System and had been issued a warrant to enable us to maintain our 15% equity ownership in MetriGenix, which would terminate upon termination of the subscription agreement. In March 2006, we terminated the subscription agreement by mutual agreement and the warrant was therefore terminated. As a result, we recorded a $0.3 million write-down of the fair value of this warrant during the six months ended June 30, 2006. At June 30, 2006, the remaining book value of our investment in MetriGenix was $3.0 million, which we believe approximates fair value.

Net Interest Income. Net interest income increased to $1.5 million for the six months ended June 30, 2006 from $1.1 million for the same period in 2005, due to increases in our rates of return on investments, partially offset by a decline in the balance of our cash and cash equivalents and marketable securities available-for-sale.

Other (Income) Expense. Other (income) expense was an expense of $0.1 million for the six months ended June 30, 2006 compared to income of $0.4 million for the same period in 2005, due to foreign currency transaction losses and gains in 2006 and 2005, respectively, relating to our subscription agreements with our Japanese customers. As a result of changing our distribution arrangements in Japan, beginning in 2005, agreements with our Japanese customers are now denominated in Japanese Yen.

Liquidity and Capital Resources

From inception through June 30, 2006, we have financed our operations and acquisitions through the issuance and sale of equity securities and payments from customers. As of June 30, 2006, we had approximately $59.5 million in cash, cash equivalents and marketable securities available-for-sale, compared to $82.1 million as of December 31, 2005.

Net cash from operating activities decreased to a negative $18.7 million for the six months ended June 30, 2006 from a positive $6.7 million for the same period in 2005, primarily due to our increased net loss for the six months ended June 30, 2006 and the timing of customer payments (including prepayments) for our services in 2005 and payments under our compensation and retention plans in 2006. We presently anticipate that our use of cash for the second half of 2006 will be slightly higher than that in the first half of 2006 as a result of anticipated operating losses and payments of $3.5 million to Millennium as the final payment of the technology acquisition price (as discussed below) and severance benefits for those employees included in the restructuring.

During the six months ended June 30, 2006 and 2005, our investing activities consisted primarily of purchases, sales and maturities of available-for-sale securities, capital expenditures and software development and database upgrade costs. Capital expenditures for the six months ended June 30, 2006 and 2005 were $2.0 million and $10.0 million, respectively. The decrease in capital expenditures was primarily

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due to the completion in 2005 of our Preclinical Division capacity expansion and other facility renovations. For the remainder of 2006, we expect to incur capital expenditures for additional equipment purchases of no greater than $1 million.

We have capitalized software development costs of $0.6 million and $0.9 million for the six months ended June 30, 2006 and 2005, respectively. These costs related to efforts to enhance the software platform of our BioExpress and ToxExpress System databases. Also, we have incurred database upgrade costs of $0.9 million and $0.7 million for the six months ended June 30, 2006 and 2005, respectively, enhancing the content of our databases using microarrays from Affymetrix. Any future investments in upgrades and new versions of our software tools are being evaluated as part of our strategic review of our Genomics Division.

Our financing activities, other than the repayment of capital lease obligations and an equipment loan, have primarily consisted of the exercise of stock options.

In July 2004, we purchased and licensed certain drug repositioning technologies and hired a research team from Millennium. We contractually agreed to spend an aggregate of $14.5 million to develop and commercialize these technologies. We have met that commitment. During the second quarter of 2006, Millennium agreed to allow us to defer the final purchase price payment of $3.5 million for approximately 30 days and that payment was made in cash during July 2006.

To generate our gene expression data, we use Affymetrix microarrays, instrumentation and software. Under the terms of our current supply and license agreement, we agreed to purchase a minimum of $7.5 million in products and services from Affymetrix in 2006. As of June 30, 2006, we have purchased $3.6 million in products and services related to this commitment.

Specific future financial commitments as of June 30, 2006 are set forth in the following table:

			Within 6
	Total		Months		2007 & 2008		2009 & 2010		Beyond 2010
Capital lease obligations	$	138	$	77	$	61	$	—	$	—
Long-term debt		613		477		109		27		—
Acquired technologies payable		3,500		3,500		—		—		—
Payment obligations to Affymetrix		3,907		3,907		—		—		—
Operating leases		23,386		3,126		10,456		6,786		3,018
Total	$	31,544	$	11,087	$	10,626	$	6,813	$	3,018

We believe that existing cash, cash equivalents and marketable securities available-for-sale and anticipated payments from customers will be sufficient to support our operations for the foreseeable future. However, our cash requirements may change as a result of the current review of our overall business strategy, including any actions that we take as a result of that review. These estimates are forward-looking statements that involve risks and uncertainties. Our actual future capital requirements and the adequacy of our available funds will depend on many factors, including those discussed under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005 and in Part II, Item 1A of this Form 10-Q.

Critical Accounting Policies

Our consolidated condensed financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. The following discussion highlights what we believe to be the critical accounting policies and judgments made in the preparation of these consolidated condensed financial statements.

Revenue Recognition

Revenue is recognized in accordance with the SEC’s Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). SAB 104 requires that four basic criteria be met before revenue can be recognized: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred or services rendered; 3) the fee is fixed and determinable; and 4) collectability is reasonably assured. As to 1), our business practices require that our services be performed pursuant to contracts with our customers. As to 2), we recognize revenue when services are rendered to our customers. Determination of 3) and 4) are based on management’s judgments regarding the fixed nature of our arrangements, taking into account termination provisions and the collectability of fees under our arrangements. In addition, management reviews costs billed under our government contracts to ensure compliance with governmental regulations and cost and profit estimates on uncompleted contracts. Should changes in conditions cause management to determine these criteria are not met for certain future

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arrangements, that any billed costs under our government contracts are not allowed or that cost or profit estimates change resulting in losses under such contracts, revenue recognized for any reporting period would be adjusted and could be adversely affected.

In accordance with Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”, revenue recognized for any multiple-element contract is allocated to each element of the arrangement based on the relative fair value of the element. The determination of fair value of each element is based on our analysis of objective evidence from comparable sales of the individual element. If we are unable to determine evidence of fair value for any undelivered element of the arrangement, revenue for the arrangement is deferred and recognized using the revenue recognition method appropriate to the predominant undelivered element.

Genomics Services Revenue. The majority of Genomics services revenue consists of fees earned under subscription agreements for all or parts of our gene expression databases, the BioExpress System and ToxExpress System, which are typically for a specific multi-year term. We have also granted to some customers perpetual licenses to certain data from our BioExpress and ToxExpress System databases and software tools. In addition, we derive a smaller but growing percentage of revenue from providing other services, including various toxicogenomics reports, microarray data generation and analysis and other professional services and subscriptions to smaller solutions. Revenue from subscription agreements is recognized ratably over the period during which the customer has access to the database. Certain subscription agreements have included a right of early termination (which, in some instances, is subject to conditions) by the customer, without penalty, on a specified date prior to the normal expiration of the term. If any agreement has a right of early termination, revenue is recognized ratably over the subscription term up to the possible date of early termination, based on subscription fees earned under the agreement through the possible date of early termination. If such early termination does not occur, the balance of the subscription fees earned under the agreement is recognized as revenue ratably over the remaining term of the agreement. Revenue from perpetual licenses to data and software for which the Company is not obligated to provide continuing support or services is recognized when the data and/or software has been delivered. Revenue from perpetual licenses for which the Company is obligated to provide continuing support or services is recognized during the period such support or services are provided. Revenue from other services is recognized when the services are performed. Our agreements generally provide for termination in the event of a breach of the agreement by either party or a bankruptcy or insolvency of either party.

During 2005, we entered into several contractual arrangements with multiple deliverables, such as licenses to access our BioExpress and ToxExpress System databases and microarray data generation and analysis and other professional services. For some of these arrangements, we were unable to determine objectively and reliably the fair value of individual undelivered elements, and in such arrangements, we recognize all revenue using the revenue recognition method appropriate to the predominant undelivered element. We also defer the direct and incremental expenses associated with the delivery of services for which revenue has been deferred and recognize these expenses as we recognize the related revenue. The timing of revenue recognition associated with agreements we enter into in future periods may also be dependent on our ability to objectively and reliably determine the fair value of deliverables included in those agreements.

Preclinical Services Revenue. Preclinical services revenue is primarily derived from fixed price contracts with pharmaceutical and biotechnology companies. In addition, we derive revenue from cost plus contracts with United States Government agencies. Revenue is recognized on fixed price contracts as services are performed, based primarily upon the percentage of hours worked (including subcontractor hours) compared to the total estimated hours for the contract. We believe that hours worked is the best measure of proportional performance under fixed price contracts. Revenue is recognized on cost plus contracts on the basis of the direct costs incurred plus allowable indirect costs and an allocable portion of the fee earned. Billings under government contracts are based on provisional billing rates which permit recovery of fringe benefits, overhead and general and administrative expenses not exceeding certain limits. These indirect expense rates are subject to review by the United States Government on an annual basis. When the final determination of the allowable rates for any year has been made, billings may be adjusted accordingly. Cost and profit estimates are reviewed periodically as the work progresses, and adjustments, if needed, are reflected in the period in which the estimates are revised. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined.

Goodwill and Other Intangible Assets Impairment

In 2003, we recorded goodwill of $43.0 million as a result of the acquisition of TherImmune Research Corporation, now renamed Gene Logic Laboratories Inc. In addition, we’ve previously recorded value for goodwill and other intangible assets, including licenses to technologies or data, patent costs and software development and database upgrade costs. The determination of whether or not these other intangible assets are impaired involves significant judgment, including the following: (i) our licenses and internally developed intellectual property may not provide valid and economical competitive advantage; and (ii) services may become obsolete before we recover the costs incurred in connection with their development.

Under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, we are required to perform an annual impairment test of our goodwill and periodic reviews of our other intangible assets. In addition, we are required to test for impairment at any point we have an indication that impairment may exist. We have elected to perform our annual impairment test of goodwill as of October 1. The goodwill impairment test that we have historically selected consisted of a ten-year discounted cash flow

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analysis, including the determination of a terminal value, and required management to make various judgments and assumptions, including revenue growth rates and discount rates, which management believed to be reasonable. Our annual impairment test as of October 1, 2004 did not indicate an impairment of our goodwill.

During September 2005, we determined in conjunction with our annual strategic planning process and as part of our annual testing of goodwill, that the carrying value of the goodwill that resulted from the April 1, 2003 acquisition of TherImmune (now Gene Logic Laboratories Inc., our Preclinical Division) was likely impaired, due to lower than expected performance, including lower than anticipated revenue and declining gross margins. To assist in the process of determining goodwill impairment loss, we obtained an appraisal from an independent valuation firm. The estimated fair value of our Preclinical Division declined in 2005, as compared to 2004, primarily due to changes in the assumptions of likely future net cash flows from this business. As a result of our review, we recorded a non-cash expense of $32.8 million in 2005 representing the implied impairment of goodwill of our Preclinical Division.

No impairment existed in the carrying value of goodwill of our Genomics Division.

Our assessment of the fair value of our Genomics Division and Preclinical Division is dependent on subjective estimates we make of inherently uncertain future net cash flows over extended periods. Accordingly, our estimates for future periods of net cash flows may change as market conditions and circumstances dictate, including the current review of our overall business strategy and any actions that we take as a result of that review. Future impairment tests of our goodwill and other intangibles may result in additional impairment charges based on these changing estimates.

Accounts Receivable and Unbilled Services

Our ability to collect outstanding receivables and unbilled services from our customers is critical to our operating performance and cash flows. Typically, arrangements with our customers require that the payments for our services be made in advance, based upon the achievement of milestones or in accordance with predetermined payment schedules. We have an allowance for doubtful accounts based on our estimate of accounts receivable that are at risk of collection. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, an increase in the allowance for doubtful accounts may be required.

Inventory

We maintain an inventory of tissue samples collected from various commercial and academic sites that are used to expand the content of our databases. We assess the quality and supply of samples in excess of our current requirements in determining appropriate reserves. Our methods for calculating these reserves are based both on historical performance and management estimates. Inventory reserves are reviewed for adjustment on an ongoing basis. Changes in tissue quality and/or our requirements for their use could potentially cause adjustments to these reserves in future periods.

We also maintain an inventory of microarrays and reagents used to generate genomic data for our databases and for services in our Genomics Division. This inventory is valued at the lower of cost or market. Certain items in inventory may be considered impaired, obsolete, or excessive and as such, we may establish an allowance to reduce the carrying value of these items to their net realizable value. Based on certain estimates, assumptions and judgements made from information available at the time, we determine the appropriate amount of any such inventory allowance. If these estimates or assumptions, or the market for the use of our microarrays and reagents change, we may be required to record additional reserves.

Equity Investments

Following the write-down of $0.3 million in the first quarter of 2006, we hold an equity investment in one company (MetriGenix) with a remaining book value of $3.0 million as of June 30, 2006. We record an investment impairment charge when it is believed that an investment has experienced a decline in value that is other than temporary. Future adverse changes in market conditions or poor operating results of the underlying investee could result in our inability to recover the carrying value of this investment that may not be reflected in such an investment’s current carrying value, thereby possibly requiring an impairment charge in the future.

Recently Issued Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48") which clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the adoption of this Interpretation to have a material impact on our financial statements.

Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method, and therefore have not restated results for prior periods. Under this method, we recognize compensation expense for all share-based payments granted after January 1, 2006 and for those that were granted prior to, but have not yet vested as of, January 1, 2006, in accordance with SFAS 123R. For the first half of 2006, stock-based compensation awards consisted of options awarded under the 1997 Equity Incentive Plan and the 1997 Non-Employee Directors’ Stock Option Plan. Under the fair value recognition provisions of SFAS 123R, we recognize stock-based compensation net of an estimated forfeiture rate and recognize the compensation cost for those shares expected to vest on a straight-line basis over the requisite service period of the award. Prior to SFAS 123R adoption, we accounted for share-based payments under

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Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and accordingly, were required to recognize compensation expense only to the extent that the fair value of the underlying stock on the date of grant exceeded the exercise or acquisition price of the stock or stock-based award. Since stock options granted by us in the last several years have been granted with an exercise price equal to the fair value on the grant date, we did not recognize any expense for such options prior to our adoption of SFAS 123R.

Our results of operations for the three and six months ended June 30, 2006 were impacted by the recognition of $0.2 million and $0.6 million, respectively, in non-cash expense related to the fair value of our stock-based compensation awards. Based on outstanding share-based payments as of January 1, 2006, we estimate that non-cash stock compensation expense in 2006 will be approximately $0.7 million to reflect the continued vesting of outstanding stock option grants that remained unvested as of January 1, 2006. The impact of stock compensation expense in future periods will be dependent on the number and type of share-based payments issued to employees and non-employee directors and this estimate does not include the impact of other possible stock-based awards that could be made during the balance of 2006.

In November 2005, the Financial Accounting Standards Board issued FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”). FSP FAS 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. FSP FAS 115-1, which is effective for reporting periods after December 31, 2005, also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The adoption of FSP FAS 115-1 had no material impact on our financial position, results of operations or cash flows.

Item 3.Quantitative and Qualitative Disclosure about Market Risk

We have exposure to financial market risks, including changes in interest rates. At June 30, 2006, we had cash and cash equivalents of $24.8 million and marketable securities available-for-sale of an additional $34.7 million. We invest our excess cash primarily in money market funds, obligations of the United States Government and its agencies and marketable debt securities of companies with strong credit ratings. These instruments have maturities of twenty-four months or less when purchased. We do not utilize derivative financial instruments, derivative commodity instruments or other market risk sensitive instruments, positions or transactions in any material fashion. Accordingly, we believe that, while the instruments we hold are subject to changes in the financial standing of the issuer of such securities, we are not subject to any material risks arising from changes in foreign currency exchange rates, commodity prices, equity prices or other market changes that affect market risk sensitive instruments. Based on our cash and cash equivalents and marketable securities available-for-sale balances at June 30, 2006, a hypothetical 100 basis point adverse movement in interest rates would have resulted in an increase in the net loss of approximately $0.3 million for the six months ended June 30, 2006. Actual changes in rates may differ from the hypothetical assumptions used in computing this exposure.

Since the beginning of 2005 and as a result of changing our distribution arrangements in Japan, we have been subject to risk from changes in foreign exchange rates relating to revenue from our Japanese customers, as such agreements are now denominated in Japanese Yen. Such changes could result in foreign currency exchange gains or losses. As a policy, we convert our customer payments made in Japanese Yen to United States dollars upon receipt of such payment. Revenue derived from the Pacific Rim as a percentage of total revenue was 14% for the six months ended June 30, 2006, and was primarily derived from our customers in Japan. Exchange rate fluctuations between the United States dollar and the currencies of these countries could result in positive or negative fluctuations in the amounts relating to revenue reported in our consolidated condensed financial statements. A hypothetical 10% adverse change in average foreign currency movements would have resulted in an increase in the net loss of approximately $0.3 million for the six months ended June 30, 2006. There can be no assurance that losses related to this currency risk will not occur.

Item 4.Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of June 30, 2006, under the supervision and with the participation of our management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), an evaluation was performed of the effectiveness of the design and operation of our “disclosure controls and procedures” (“Disclosure Controls”). These are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Exchange Act, such as this Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the United States Securities and Exchange Commission (“SEC”). Disclosure Controls are also designed to reasonably assure that such information is accumulated and communicated to our management, including the CEO and CFO as appropriate, to allow timely decisions regarding required disclosure. Based on that evaluation, our CEO and CFO have concluded that, as of June 30, 2006, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time

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periods specified by the SEC, and that material information relating to us is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared.

Our management, including the CEO and CFO, does not expect that our Disclosure Controls or our internal control over financial reporting will prevent or detect all errors and all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based, in part, on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal controls over financial reporting during the second quarter of 2006 that materially affected or are reasonably likely to materially affect our internal controls over financial reporting.

PART IIOTHER INFORMATION

Item 1.Legal Proceedings

We are not currently a party to any material legal proceedings.

Item 1A.Risk Factors

As a result of the strategic review currently underway and the recently initiated restructuring of our Genomics Division, the following risk factors should be added to those previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and our other subsequent filings with the SEC.

We May Not Be Able To Identify Or Implement a Business Strategy That Will Achieve Our Objectives.

We are currently exploring various business strategies designed to improve the performance and value of our businesses and enhance the value of our assets for our stockholders. We may not be able to identify desirable options or implement any of these strategic options on favorable terms, or at all, which could have a material adverse impact on the value of our business. In addition, whether or not we are successful in identifying and implementing alternative strategic options, we may experience impairments to the book value of one or more of our existing assets, including but not limited to, property and equipment, goodwill and other intangibles.

As a Result Of Uncertainty About Our Long-Term Business Strategy, We May Have Difficulty Attracting Or Retaining Customers And Employees.

As previously discussed, we recently initiated a restructuring of our Genomics Division intended to reduce its cash use and, as a result of our strategic review, we may contemplate a range of actions that could have a material impact on our business as it is presently conducted, none of which may be successful.  Because of this uncertainty, customers and employees may have concerns about our future and may be hesitant to commit to a long-term relationship with us and existing employees may be distracted from their job responsibilities and seek other employment. We may also find it difficult to recruit new employees due to uncertainty over our future.  If customers do not believe that we will continue to support, enhance or update our services, they could be less willing to purchase those services. Therefore, until we announce a comprehensive strategy, and it becomes clear that the strategy is viable, our relationships with our customers and employees may be adversely affected.

We May Be Unable To Secure Additional Financing To Implement a Business Strategy That We Would Like To Pursue.

We believe that existing cash, cash equivalents and marketable securities available-for-sale will be adequate to fund our operations for the foreseeable future.  However, we may need additional debt or equity financing to implement any new business strategies.  Additional

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financing may not be available when needed or, if available, such financing may not be on favorable terms. If additional financing is obtained through the issuance of equity securities or debt convertible to equity, our existing stockholders may experience significant dilution.

If We Are Unable To Maintain Compliance With NASDAQ’s Listing Requirements, Our Stock Could Be Delisted Which Would Negatively Impact Our Liquidity And Our Stockholders’ Ability To Sell Shares.

Our listing on the NASDAQ Global Market is conditioned upon our continued compliance with the NASDAQ Marketplace Rules, including a rule that requires that the minimum bid price per share for our common stock not be less than $1.00 for 30 consecutive trading days. Given the recent price levels for our common stock, we cannot assure that we will be able to continue to comply with such rules. If we fail to comply and cannot remedy our noncompliance during any applicable notice or grace periods, our common stock could be delisted from the NASDAQ Global Market.  The delisting of our common stock would likely have a material adverse effect on the trading price, volume and marketability of our common stock.

Upon a delisting from the NASDAQ Global Market, our common stock would become subject to the penny stock rules of the SEC, in which event it is possible that the price of our common stock would further decline and likely that our stockholders would find it more difficult to sell their shares.

As a Result Of The Restructuring Of Our Genomics Division, Insufficient Staffing To Support Operations Could Adversely Affect Demand For Our Services And Our Revenue.

We have announced a significant restructuring of our Genomics Division that, once implemented, will reduce our future operating expenses. While we believe our personnel reductions have targeted areas not necessary to our ability to serve customers, there can be no assurance that these changes will not have a negative impact on our ability to keep retained staff or provide adequate services to our customers.  If we fail to maintain acceptable service levels, we may lose customers and/or the opportunity to provide more services.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.Defaults Upon Senior Securities

None.

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

The Company held its Annual Meeting of Stockholders on June 1, 2006 (“Annual Meeting”). At the Annual Meeting, the Company’s stockholders elected two directors to the Company’s Board of Directors, approved an Amended and Restated 1997 Equity Incentive Plan and ratified the selection of our independent auditors, as described below. At the Annual Meeting, 29,248,151 shares, out of a total of 31,805,069 shares of Common Stock outstanding at the record date, were represented in person or by proxy.

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The proposals considered at the Annual Meeting were voted on as follows:

		For	Withheld
1	To elect two directors to hold office until the 2009 Annual Meeting
	of Stockholders or his earlier resignation or removal.
	Charles L. Dimmler, III	26,856,500	2,391,651
	G. Anthony Gorry, Ph.D.	26,852,020	2,396,131
	The following individuals' term of office as a director continue after
	the meeting: Jules Blake, Ph.D.; Michael J. Brennan, M.D., Ph.D.;
	Frank L. Douglas, M.D., Ph.D.; Mark D. Gessler and J. Stark
	Thompson, Ph.D.
		For	Against	Abstain	Broker Non-Votes
2	To approve an Amended and Restated 1997 Equity Incentive Plan,	15,370,236	2,837,659	61,689	10,978,567
	including to authorize the issuance of restricted stock awards,
	establish a process for performance-based awards and extend the
	term of the plan.
		For	Against	Abstain
3	To ratify the selection of Ernst & Young LLP as the Company's	27,840,538	264,608	1,143,005
	independent registered public accounting firm for the year ending
	December 31, 2006.

Item 5.Other Information

None.

Item 6.Exhibits

31 Certifications pursuant to Rule 13a-14(a)/15d-14(a).

32 Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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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.

GENE LOGIC INC.

Date:August 9, 2006

By:  /s/ Philip L. Rohrer, Jr.

Philip L. Rohrer, Jr.

Chief Financial Officer

(Principal Financial and Accounting Officer)

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