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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended March 31, 2006

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 Or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from  to

Commission
file number: 000-32239



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XENOGEN CORPORATION

(Exact name of registrant as specified in its charter)



|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|Delaware                                                       |  | 77-0412269                             
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)
|                                                               | 
|860 Atlantic Avenue, Alameda, California                       |  | 94501                                  
|(Address of principal executive offices)                       |  | (Zip Code)                             

(510) 291-6100

(Registrants telephone 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  x    No ̈

Indicate by check mark whether the registrant is a large accelerated filer, or a non-accelerated filer. See definition of accelerated filer and
large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                    |  |                         
|------------------------ |  | ------------------ |  | ------------------------
|Large accelerated filer ̈ |  | Accelerated filer ̈ |  | Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes ̈No  x

At May 1, 2006, 20,460,461 shares of the registrants common stock, $.001 par value, were outstanding.



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##### Table of Contents

TABLE OF CONTENTS



|                               |  |                                                                                       |  |     
|------------------------------ |  | ------------------------------------------------------------------------------------- |  | ----
|                               |  |                                                                                       |  | Page
|PART I  FINANCIAL INFORMATION |  | 1                                                                                    
|                               |  |                                                                                      
|Item 1.                        |  | Financial Statements                                                                  |  | 1   
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 15  
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk.                           |  | 23  
|Item 4.                        |  | Controls and Procedures                                                               |  | 24  
|                               | 
|PART II  OTHER INFORMATION    |  | 25                                                                                   
|                               |  |                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                     |  | 25  
|Item 1A.                       |  | Risk Factors                                                                          |  | 25  
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 41  
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |  | 42  
|Item 4.                        |  | Submission of Matters to a Vote of Security Holders                                   |  | 42  
|Item 5.                        |  | Other Information                                                                     |  | 42  
|Item 6.                        |  | Exhibits                                                                              |  | 42  
|                               | 
|Signatures                     |  | 43                                                                                   



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##### Table of Contents

PART I

FINANCIAL INFORMATION



|Item 1. | Financial Statements (Unaudited).
|------- | ---------------------------------

XENOGEN
CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

(Unaudited)



|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                                                                                            |  | March 31, 2006 |          |   | December 31, 2005 |  
|ASSETS                                                                                                                                                                                                                      |  |                |          |   |                   |   |          |  
|Current assets:                                                                                                                                                                                                             |  |                |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                   |  | $              | 18,049   |   |                   | $ | 20,478   |  
|Short term investments                                                                                                                                                                                                      |  |                | 261      |   |                   |   | 259      |  
|Accounts receivablenet of allowance for doubtful accounts of $807 and $801 at March 31, 2006 and December 31, 2005,
respectively                                                                                           |  |                | 6,626    |   |                   |   | 13,141   |  
|Inventory                                                                                                                                                                                                                   |  |                | 4,656    |   |                   |   | 3,601    |  
|Prepaid expenses and other current assets                                                                                                                                                                                   |  |                | 1,896    |   |                   |   | 2,037    |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Total current assets                                                                                                                                                                                                        |  |                | 31,488   |   |                   |   | 39,516   |  
|Property and equipmentnet                                                                                                                                                                                                  |  |                | 2,861    |   |                   |   | 2,106    |  
|Purchased intangible assetsnet                                                                                                                                                                                             |  |                |         |   |                   |   | 3        |  
|Other noncurrent assets                                                                                                                                                                                                     |  |                | 1,108    |   |                   |   | 1,204    |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Total assets                                                                                                                                                                                                                |  | $              | 35,457   |   |                   | $ | 42,829   |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                        |  |                |          |   |                   |   |          |  
|Current liabilities:                                                                                                                                                                                                        |  |                |          |   |                   |   |          |  
|Accounts payable                                                                                                                                                                                                            |  | $              | 3,101    |   |                   | $ | 3,857    |  
|Accrued compensation                                                                                                                                                                                                        |  |                | 1,440    |   |                   |   | 2,298    |  
|Deferred revenue                                                                                                                                                                                                            |  |                | 9,074    |   |                   |   | 9,739    |  
|Accrued restructuring charges                                                                                                                                                                                               |  |                | 289      |   |                   |   | 289      |  
|Loans payablecurrent portion                                                                                                                                                                                               |  |                | 670      |   |                   |   | 953      |  
|Capital lease obligations                                                                                                                                                                                                   |  |                |         |   |                   |   | 1        |  
|Other accrued liabilities                                                                                                                                                                                                   |  |                | 3,447    |   |                   |   | 3,368    |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                                                                   |  |                | 18,021   |   |                   |   | 20,505   |  
|Noncurrent liabilities:                                                                                                                                                                                                     |  |                |          |   |                   |   |          |  
|Loans payable                                                                                                                                                                                                               |  |                | 8,064    |   |                   |   | 8,099    |  
|Deferred rent                                                                                                                                                                                                               |  |                | 297      |   |                   |   | 358      |  
|Accrued restructuring charges                                                                                                                                                                                               |  |                | 890      |   |                   |   | 962      |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Total noncurrent liabilities                                                                                                                                                                                                |  |                | 9,251    |   |                   |   | 9,419    |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Commitments and contingencies (Note 9)                                                                                                                                                                                      |  |                |          |   |                   |   |          |  
|Stockholders equity:                                                                                                                                                                                                       |  |                |          |   |                   |   |          |  
|Common stock, $0.001 par value; 100,000,000 shares authorized at March 31, 2006 and December 31, 2005, respectively; 20,451,979 and
20,213,952 issued and outstanding at March 31, 2006 and December 31, 2005, respectively |  |                | 21       |   |                   |   | 20       |  
|Additional paid-in capital                                                                                                                                                                                                  |  |                | 200,057  |   |                   |   | 199,152  |  
|Accumulated deficit                                                                                                                                                                                                         |  |                | (191,893 | ) |                   |   | (186,267 | )
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Total stockholders equity                                                                                                                                                                                                  |  |                | 8,185    |   |                   |   | 12,905   |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                  |  | $              | 35,457   |   |                   | $ | 42,829   |  
|                                                                                                                                                                                                                            |  |                |          |   |                   |   |          |  

The accompanying notes are an integral part of these condensed consolidated financial statements.



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##### Table of Contents

XENOGEN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share data)

(Unaudited)



|                                                       |  |                              |            |   |      |   |            |  
|------------------------------------------------------ |  | ---------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                       |  | Three Months Ended March 31, |           
|                                                       |  | 2006                         |            |   | 2005 |  
|Revenue:                                               |  |                              |            |   |      |   |            |  
|Product                                                |  | $                            | 4,338      |   |      | $ | 5,293      |  
|Contract                                               |  |                              | 2,582      |   |      |   | 2,271      |  
|License                                                |  |                              | 1,814      |   |      |   | 1,710      |  
|                                                       |  |                              |            |   |      |   |            |  
|Total revenue                                          |  |                              | 8,734      |   |      |   | 9,274      |  
|                                                       |  |                              |            |   |      |   |            |  
|Cost of revenue:                                       |  |                              |            |   |      |   |            |  
|Product                                                |  |                              | 2,680      |   |      |   | 3,438      |  
|Contract                                               |  |                              | 2,453      |   |      |   | 2,259      |  
|License                                                |  |                              | 203        |   |      |   | 319        |  
|                                                       |  |                              |            |   |      |   |            |  
|Total cost of revenue                                  |  |                              | 5,336      |   |      |   | 6,016      |  
|                                                       |  |                              |            |   |      |   |            |  
|Gross margin                                           |  |                              | 3,398      |   |      |   | 3,258      |  
|                                                       |  |                              |            |   |      |   |            |  
|Operating expenses:                                    |  |                              |            |   |      |   |            |  
|Research and development                               |  |                              | 1,892      |   |      |   | 2,334      |  
|Selling, general and administrative                    |  |                              | 6,808      |   |      |   | 5,308      |  
|Depreciation and amortization                          |  |                              | 367        |   |      |   | 635        |  
|                                                       |  |                              |            |   |      |   |            |  
|Total operating expenses                               |  |                              | 9,067      |   |      |   | 8,277      |  
|                                                       |  |                              |            |   |      |   |            |  
|Loss from operations                                   |  |                              | (5,669     | ) |      |   | (5,019     | )
|Other income (loss)net                                |  |                              | 206        |   |      |   | (15        | )
|Interest income                                        |  |                              | 126        |   |      |   | 57         |  
|Interest expense                                       |  |                              | (289       | ) |      |   | (168       | )
|                                                       |  |                              |            |   |      |   |            |  
|Net loss                                               |  | $                            | (5,626     | ) |      | $ | (5,145     | )
|                                                       |  |                              |            |   |      |   |            |  
|Weighted average number of common shares outstanding   |  |                              | 20,303,013 |   |      |   | 14,821,840 |  
|                                                       |  |                              |            |   |      |   |            |  
|Loss per share data (basic and diluted):               |  |                              |            |   |      |   |            |  
|Net loss per share attributable to common stockholders |  | $                            | (0.28      | ) |      | $ | (0.35      | )
|                                                       |  |                              |            |   |      |   |            |  

The accompanying notes are an integral part of these condensed consolidated financial statements.



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XENOGEN CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                  |  |                              |        |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                                                  |  | Three Months Ended March 31, |       
|                                                                                  |  | 2006                         |        |   | 2005 |  
|Cash flows from operating activities:                                             |  |                              |        |   |      |   |        |  
|Net loss                                                                          |  | $                            | (5,626 | ) |      | $ | (5,145 | )
|Reconciliation of net loss to net cash used in operating activities:              |  |                              |        |   |      |   |        |  
|Noncash stock-based compensation expense                                          |  |                              | 331    |   |      |   | 46     |  
|Amortization of investments                                                       |  |                              |       |   |      |   | 30     |  
|Depreciation and amortization                                                     |  |                              | 381    |   |      |   | 635    |  
|Noncash interest expense related to warrants and other deferred financing charges |  |                              | 90     |   |      |   |        |  
|Noncash interest income                                                           |  |                              | (45    | ) |      |   | (50    | )
|Changes in operating assets and liabilities:                                      |  |                              |        |   |      |   |        |  
|Accounts receivable                                                               |  |                              | 6,515  |   |      |   | 354    |  
|Prepaid expenses and other assets                                                 |  |                              | 149    |   |      |   | 449    |  
|Inventory                                                                         |  |                              | (1,060 | ) |      |   | (143   | )
|Accounts payable                                                                  |  |                              | (529   | ) |      |   | 671    |  
|Accrued compensation and other liabilities                                        |  |                              | (779   | ) |      |   | (494   | )
|Deferred revenue                                                                  |  |                              | (665   | ) |      |   | (1,323 | )
|Accrued restructuring charges                                                     |  |                              | (72    | ) |      |   | (67    | )
|Deferred rent                                                                     |  |                              | (61    | ) |      |   | (54    | )
|                                                                                  |  |                              |        |   |      |   |        |  
|Net cash used in operating activities                                             |  |                              | (1,371 | ) |      |   | (5,091 | )
|                                                                                  |  |                              |        |   |      |   |        |  
|Cash flows from investing activities:                                             |  |                              |        |   |      |   |        |  
|Purchase of property and equipment                                                |  |                              | (1,355 | ) |      |   | (32    | )
|Investment interest                                                               |  |                              | 41     |   |      |   | 71     |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Net cash provided by (used in) investing activities                               |  |                              | (1,314 | ) |      |   | 39     |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Cash flows from financing activities:                                             |  |                              |        |   |      |   |        |  
|Proceeds from issuance of common stock, net of issuance costs                     |  |                              | 575    |   |      |   | 29     |  
|Repayment of loans                                                                |  |                              | (318   | ) |      |   | (343   | )
|Capital lease payments                                                            |  |                              | (1     | ) |      |   | (9     | )
|                                                                                  |  |                              |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                               |  |                              | 256    |   |      |   | (323   | )
|                                                                                  |  |                              |        |   |      |   |        |  
|Net decrease in cash and cash equivalents                                         |  |                              | (2,429 | ) |      |   | (5,375 | )
|Cash and cash equivalents, beginning of year                                      |  |                              | 20,478 |   |      |   | 19,423 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Cash and cash equivalents, end of year                                            |  | $                            | 18,049 |   |      | $ | 14,048 |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Supplemental disclosure of cash flow informationcash paid for interest           |  | $                            | 201    |   |      | $ | 147    |  
|                                                                                  |  |                              |        |   |      |   |        |  
|Supplemental disclosure of non-cash investing activities:                         |  |                              |        |   |      |   |        |  
|Purchase of property and equipment in trade accounts payable                      |  | $                            | 19     |   |      | $ | 42     |  
|                                                                                  |  |                              |        |   |      |   |        |  

The accompanying notes are an integral part of these condensed consolidated financial statements.



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XENOGEN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



|1. | Basis of Presentation
|-- | ---------------------

The information presented in
the Condensed Consolidated Financial Statements at March 31, 2006 and for the three months ended March 31, 2006 and 2005, is unaudited but includes all adjustments, consisting only of normal recurring adjustments, which we believe to be
necessary for a fair presentation of the periods presented. The results of operations for the three months ended March 31, 2006 are not necessarily indicative of the results to be expected for a full year, or any other future period.

The Condensed Consolidated Balance Sheet amounts at December 31, 2005, have been derived from audited financial statements. This
Quarterly Report on Form 10-Q should be read in conjunction with our audited Consolidated Financial Statements as of and for the year ended December 31, 2005, which are included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission on March 24, 2006.

In accordance with the rules and regulations of the Securities and Exchange Commission,
unaudited condensed consolidated financial statements may omit or condense certain information and disclosures normally required for a complete set of financial statements prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP). Accordingly, certain information and disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The
condensed consolidated balance sheet at December 31, 2005 was derived from audited financial statements, but does not include all disclosures required by GAAP. We believe that the notes to the condensed consolidated financial statements contain
disclosures adequate to make the information presented not misleading.

On February 10, 2006, we entered into a definitive Agreement
and Plan of Merger (the Merger Agreement) with Caliper Life Sciences, Inc. (Caliper) and its subsidiary, Caliper Holdings, Inc. (Caliper Holdings), pursuant to which we will be merged with and into Caliper
Holdings and become a wholly-owned subsidiary of Caliper. We currently expect the Merger to be completed late in the second quarter or early in the third quarter of 2006. The Merger Agreement has an outside termination date of August 31, 2006.
We have had recurring losses from operations and ended the quarter with approximately $18.3 million in cash. We believe that our current cash, together with revenues from sales of IVIS imaging instruments in the second quarter, will be sufficient to
funds our operations beyond the closing of the merger with Caliper. In the event the Merger is not consummated, our existing working capital at March 31, 2006 may not be sufficient to meet our operating, working capital, investing and
financing requirements for the next twelve months, and we will need to reevaluate our current plans and business operations and substantially reduce our operating expenses, raise additional capital or take other actions in order to continue as an
independent company. We have not made any adjustments to our condensed consolidated financial statements to reflect the impact of contingent future actions we might take as described above.



|2. | Summary of Significant Accounting Policies
|-- | ------------------------------------------

Principles of ConsolidationThe condensed consolidated financial statements include the accounts of Xenogen and our wholly-owned subsidiary, Xenogen Biosciences. All significant intercompany accounts and transactions have been
eliminated.



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XENOGEN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Use of EstimatesThe preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

ReclassificationsCertain prior year amounts have been reclassified to conform to current year presentation. These reclassifications had no
effect on net loss or loss per share, and related to the elimination of equipment purchases included in trade accounts payable from both investing and operating activities.

Cash and Cash EquivalentsWe consider all short-term, highly liquid investments with original maturity of three months or less to be cash
equivalents.



|3. | Stock-Based Compensation
|-- | ------------------------

Beginning in the first
quarter of 2006, we adopted the Statement of Financial Accounting Standards No. 123(R), Share-based Payment(SFAS 123(R)), and elected to adopt the standard using the modified prospective transition method. Stock-based compensation cost
under this transition method was based on our original pro forma disclosures under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) for all options granted prior to 2006 that were
not fully vested as of December 31, 2005. Previous reported amounts related to these option shares have not been restated.

In
November 2005, all unvested stock options with an exercise price equal to or greater than $5.01 per share were accelerated and became fully vested at that time. The decision to accelerate the vesting of these options was made primarily to reduce
compensation expense that would have been recorded in conjunction with our adoption of SFAS 123(R), which we believe to be in the best interest of stockholders. The impact of the acceleration to stock-based compensation as determined under SFAS 123
was a $2.6 million expense increase in pro forma stock-based compensation for the fourth quarter of 2005.

We did not make any stock option
grants during the first quarter of 2006, but will base the fair value and associated compensation expense on any new stock option grant in accordance with the provisions of SFAS 123(R). The fair value of stock options that we previously granted was
based on the Black-Scholes model option-pricing formula and a multiple option award approach. The fair value of our options was then amortized using the graded vesting method over the options vesting period, which is generally four years. Prior to
January 1, 2006, we followed Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and interpretations as permitted by SFAS 123. Under APB 25, Stock-based compensation expense was recorded
based on stock option intrinsic value which was calculated as the difference between the stock option exercise price and the underlying stocks market value on the date of grant. Under this method, when a stock option price equaled the market
price of the underlying stock on the date of grant, no compensation expense is recognized. Since our 2004 initial public offering, all of our stock options were granted at the underlying market price of our stock.

The Black-Scholes model requires the use of highly subjective assumptions including the options expected life, risk free interest rate, dividend
yield, and the price volatility of the underlying stock. The expected option life assumed for all current stock options was five years and was based on historical employee termination and option exercise rates. The risk free rates were based on U.S.
Treasury yields for notes with comparable terms with our option life assumption. In addition, no dividend payouts were assumed to occur for the purposes of the fair market valuation. Lastly, the volatility assumption was based on a



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XENOGEN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



combination of historical volatilities of both our stock and benchmarked companies. The minimum value basis for pricing options was used for all grants made
prior to Xenogen becoming a publicly traded company in July 2004.

The following weighted-average assumptions were used for determining the fair value of
our stock option grants through December 31, 2005 (no stock option grants were made during the first quarter of 2006):



|                                          |  |                 |  
|----------------------------------------- |  | --------------- | -
|                                          |  | WeightedAverage |  
|Dividend yield                            |  |                |  
|Volatility                                |  | 31.3            | %
|Risk-free interest rate                   |  | 3.9             | %
|Weighted average expected life (in years) |  | 5               |  

The following table summarizes relevant information as to reported results of the impact of SFAS
123 as if the fair value recognition provisions of SFAS No. 123 had been applied (in thousands, except per share data) as of for the three months ended March 31, 2005:



|                                                                                                         |  |               |        |  
|-------------------------------------------------------------------------------------------------------- |  | ------------- | ------ | -
|                                                                                                         |  | March 31,2005 |       
|Net loss as Reported:                                                                                    |  | $             | (5,145 | )
|                                                                                                         |  |               |        |  
|Stock-based compensation as determined under APB 25                                                      |  |               | 48     |  
|Stock-based compensation determined under the fair value based method for all awards, net of forfeitures |  |               | (856   | )
|                                                                                                         |  |               |        |  
|Pro forma net Loss under SFAS 123                                                                        |  | $             | (5,953 | )
|                                                                                                         |  |               |        |  
|Basic and diluted net loss attributable to common stockholders loss per share:                           |  |               |        |  
|As reported                                                                                              |  | $             | (0.35  | )
|Pro forma under SFAS 123                                                                                 |  | $             | (0.40  | )

For the three months ended March 31, 2006 and 2005, stock-based compensation expense was
$331,000 and $46,000, respectively, and was reflected in our condensed consolidated statements of operations as follows:



|                                    |  |                             |     |      |   |     |  
|----------------------------------- |  | --------------------------- | --- | ---- | - | --- | -
|                                    |  | Three Months EndedMarch 31, |    
|                                    |  | 2006                        |     | 2005 |  
|Cost of revenue:                    |  |                             |     |      |   |     |  
|Product                             |  | $                           | 22  |      | $ | (15 | )
|Contract                            |  |                             | 55  |      |   | (4  | )
|License                             |  |                             | 11  |      |   | (2  | )
|                                    |  |                             |     |      |   |     |  
|Total cost of revenue               |  |                             | 88  |      |   | (21 | )
|Research and development            |  |                             | 33  |      |   | (77 | )
|Selling, general and administrative |  |                             | 210 |      |   | 144 |  
|                                    |  |                             |     |      |   |     |  
|TOTAL                               |  | $                           | 331 |      | $ | 46  |  
|                                    |  |                             |     |      |   |     |  

The increase in stock-based compensation expense was largely the result of the adoption of SFAS
123(R) offset in part from the effect variable accounting treatment in 2005 on certain stock options issued in 2003



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XENOGEN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



given stock market fluctuations since December 31, 2004 and the associated impact to those stock options intrinsic value.

The stock-based compensation expense in future years on options granted, but unvested as of March 31, 2006 is anticipated as follows.



|                                                |  |                      |    
|----------------------------------------------- |  | -------------------- | ---
|                                                |  | Amount (in millions)
|Deferred Compensation Amortization For the Year |  |                      |    
|April 1, 2006  December 31, 2006               |  | $                    | 0.6
|2007                                            |  |                      | 0.3
|2008 and later years                            |  |                      | 0.1
|                                                |  |                      |    
|TOTAL                                           |  | $                    | 1.0
|                                                |  |                      |    

Stock Option Plans

1996 Plan - In 1996, our board of directors adopted the 1996 Stock Option Plan (the 1996 Plan). On December 1, 2003, we issued options covering 281,332 shares of our common stock pursuant to an
option exchange program, initiated in May 2003. Pursuant to the terms of the option exchange program, eligible optionees were offered the opportunity to exchange outstanding options to purchase our common stock with an exercise price of $0.70 or
more for options to purchase our common stock that would be issued at least six months and one day following the cancellation date of the exchanged options with an exercise price equal to the fair market value of such common stock on the date of
grant, subject to the optionee continuing to provide services to us through the grant date of the new options. The vesting provisions of the original options would carry over to the newly issued options. We have evaluated this transaction in the
context of guidance in EITF 00-23, Issues Related to the Accounting For Stock Compensation Under APB Opinion No. 25 and FASB Interpretation No. 44, and have concluded that the reissued options require variable accounting
treatment because they were granted with an exercise price less than the fair market value of the underlying common stock at the date of grant. For the three months ended March 31, 2005, we recorded a credit to stock-based compensation expense
of approximately $0.4 million due to the decrease in the intrinsic value of the variable stock options.

Given the adoption of SFAS 123(R),
there was no impact resulting from the change in intrinsic value during the first quarter of 2006.

In April 2004, the 1996 Plan was amended where by no
additional shares would be granted out of the plan upon the creation of the 2004 Equity Incentive Plan. Under the amendment, any shares returned to the 1996 Plan resulting from repurchase or termination of options would be reauthorized under the
2004 Equity Incentive Plan. Given the amendment, there were no authorized shares available for future grant issuance under the 1996 Plan at March 31, 2006 or 2005. During the three month period ended March 31, 2006 and 2005, 29,260 and
79,865 option shares, respectively, were cancelled and returned to the 2004 Equity Incentive Plan.

2004 Equity Incentive Plan - In
April 2004, our board of directors adopted our 2004 Equity Incentive Plan (the 2004 Plan). The 2004 Plan, which was approved by our stockholders in May 2004, became effective upon the completion of our initial public offering. During the
first quarter of 2006, no options were granted under the 2004 Plan. During the three month period ended March 31, 2006, 25,860 options were



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



cancelled and returned to the 2004 Plan, and no options under the 2004 Plan were cancelled during the comparable period in 2005. As of March 31, 2006,
474,553 shares were available for future issuance, including the reauthorizations from cancellations under the 1996 Plan. Stock-based compensation under the 1996 Plan and 2004 Plan on a combined basis amounted to $260,000 for the three month period
ended March 31, 2006. There was a credit to expense of $31,000 under these plans on a combined basis for the three month period ended March 31, 2005.

2004 Director Stock Plan - Our 2004 director stock plan was adopted by our board of directors in April 2004 and approved by our stockholders in May 2004. This plan became effective upon the completion of our
initial public offering and provides for the periodic grant of restricted stock to our directors.

During the first quarter of 2006, there were no stock
grants awarded or forfeited under the plan. During the first quarter of 2005, a total of 8,081 shares were issued to a director and 2,381 shares were forfeited by a director who resigned from our board of directors. The forfeited shares were
returned to the plan. As of March 31, 2006 and 2005, 79,865 and 144,300 shares, respectively, were available for future issuance. In connection with the stock awards issued under this plan, we recorded approximately $71,000 and $77,000 in
stock-based compensation expense during the three months ended March 31, 2006 and 2005, respectively.



|4. | Restructuring Charges
|-- | ---------------------

In September 2002, we
implemented a restructuring program (the Restructuring Plan) to bring our expenses more in line with revised revenue and cash flow projections. This plan included the closure of the St. Louis facility related to the facilitys
remaining lease obligation of $2,108,000. We recorded the remaining obligation on the St. Louis facility as a restructuring charge in accordance with Emerging Issues Task Force 94-3, Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity, and Staff Accounting Bulletin 100, Restructuring and Impairment Charges.

The following table depicts the
restructuring activity during the first quarter ended March 31, 2006 (in thousands):



|                                  |  |                   |       |  
|--------------------------------- |  | ----------------- | ----- | -
|                                  |  | VacatedFacilities |      
|Accrued restructuring charges:    |  |                   |       |  
|Ending balance, December 31, 2005 |  | $                 | 1,251 |  
|Expenditures                      |  |                   | (72   | )
|                                  |  |                   |       |  
|Ending balance, March 31, 2006    |  | $                 | 1,179 |  
|                                  |  |                   |       |  

At March 31, 2006, approximately $289,000 was recorded as current accrued restructuring
charges and approximately $890,000 was recorded as noncurrent accrued restructuring charges on our consolidated balance sheets. We expect to pay the accrued lease obligations over the remaining term of the lease, which terminates in 2010.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



|5. | Inventory
|-- | ---------

Inventories are stated at the lower of
standard cost, which approximates actual cost or market. Cost is based on the first in, first out method. Inventories consisted of the following (in thousands):



|                 |  |               |       |                  |   |      
|---------------- |  | ------------- | ----- | ---------------- | - | -----
|                 |  | March 31,2006 |       | December 31,2005
|Raw Materials    |  | $             | 2,816 |                  | $ | 1,861
|Work-in-Progress |  |               | 672   |                  |   | 1,210
|Finished Goods   |  |               | 1,168 |                  |   | 530  
|                 |  |               |       |                  |   |      
|                 |  | $             | 4,656 |                  | $ | 3,601
|                 |  |               |       |                  |   |      



|6. | Product Warranty
|-- | ----------------

We warrant our IVIS Imaging
Systems for a period of generally one year from the date of installation and offer extended warranty coverage beyond the initial period at the option of the customer. We accrue for estimated warranty costs concurrent with the recognition of revenue.
The warranty accrual is based upon our historical experience and is included in other current liabilities in our condensed consolidated balance sheets. The amounts charged and accrued against the warranty reserve are as follows (in thousands):



|                                         |  |               |      |   |                  |   |      |  
|---------------------------------------- |  | ------------- | ---- | - | ---------------- | - | ---- | -
|                                         |  | March 31,2006 |      |   | December 31,2005 |  
|Balance, beginning of year               |  | $             | 441  |   |                  | $ | 246  |  
|Current year accrual                     |  |               | 123  |   |                  |   | 714  |  
|Warranty expenditures charged to accrual |  |               | (147 | ) |                  |   | (519 | )
|                                         |  |               |      |   |                  |   |      |  
|Balance, end of year                     |  | $             | 417  |   |                  | $ | 441  |  
|                                         |  |               |      |   |                  |   |      |  



|7. | Property and Equipment
|-- | ----------------------

Property and equipment,
net, consist of the following (in thousands):



|                               |  |               |         |   |                  |   |         |  
|------------------------------ |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                               |  | March 31,2006 |         |   | December 31,2005 |  
|Furniture and office equipment |  | $             | 4,029   |   |                  | $ | 4,001   |  
|Laboratory equipment           |  |               | 9,099   |   |                  |   | 9,077   |  
|Leasehold improvements         |  |               | 5,762   |   |                  |   | 4,750   |  
|                               |  |               |         |   |                  |   |         |  
|                               |  |               | 18,890  |   |                  |   | 17,828  |  
|Less accumulated depreciation  |  |               | (16,029 | ) |                  |   | (15,722 | )
|                               |  |               |         |   |                  |   |         |  
|                               |  | $             | 2,861   |   |                  | $ | 2,106   |  
|                               |  |               |         |   |                  |   |         |  

Depreciation expense was approximately, $364,000 and $484,000 for the three months ended
March 31, 2006 and 2005, respectively. An additional amount of depreciation related to our IVIS Imaging System rental equipment pool was classified under product cost of revenue in the amount of $14,000 for the three month period ended
March 31, 2006. During the comparable period last year, depreciation on the equipment rental pool was recorded as depreciation expense. There was no such reclassification of depreciation expense for the comparable period last year.

The cost of assets held under capital leases included in fixed assets was approximately $263,000 at both March 31, 2006 and December 31,
2005. Accumulated depreciation of assets held under capital leases was approximately $262,000 and $261,000 at March 31, 2006 and December 31, 2005, respectively.



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



|8. | Loans Payable
|-- | -------------

On August 2, 2005, we entered
into an Amended and Restated Loan and Security Agreement (the SVB Loan Agreement) with our subsidiary Xenogen Biosciences Corporation (XBC) and Silicon Valley Bank (SVB). We also entered into a Loan and Security
Agreement, dated as of August 2, 2005 (the PFG Loan Agreement), with XBC and Partners for Growth, L.P. (PFG). The SVB Loan Agreement amends and restates a Loan and Security Agreement entered into between Xenogen and SVB on
September 10, 2003 (the Original Agreement), and provides for revolving borrowings of up to $13.0 million. Up to $2.0 million of the availability under the SVB Loan Agreement may be used for letters of credit and cash management
services. All borrowings under the Original Agreement, aggregating to $5.8 million, were consolidated into the SVB Loan Agreement and have been applied against the amount available under the SVB Loan Agreement. Loans under the SVB Loan Agreement
mature on August 2, 2007 and bear interest at a floating rate equal to the greater of SVBs prime rate plus 150 basis points or 5.5%. The SVB Loan Agreement contains restrictions on our ability to, among other things, dispose of assets,
undertake mergers or acquisitions, incur indebtedness, create liens on assets, make investments and pay dividends or repurchase stock. It also requires us to maintain a remaining months liquidity ratio of at least 6:1. The remaining
months liquidity ratio consist of a ratio of our cash and cash equivalents plus 80% of eligible accounts receivable less amounts outstanding under the SVB Loan Agreement, to net income plus depreciation and amortization for the three-month
period most recently ended. The SVB Loan Agreement also provides that if our modified quick ratio drops below 2:1, a new form of loan agreement attached as exhibit to the SVB Loan Agreement will become applicable and our borrowings will be limited
to the lesser of $13.0 million or 80% of the amount of our eligible accounts receivable. Our modified quick ratio is defined as the ratio of our unrestricted cash and cash equivalents plus eligible accounts plus availability under the PFG Loan
Agreement to outstanding loans and other extensions of credit under the SVB Loan Agreement. The SVB Loan Agreement contains events of default that include, among other things, non-payment of principal, interest or fees, breaches of covenants,
material adverse changes, bankruptcy and insolvency events, cross-defaults, unpaid judgments, inaccuracy of representations and warranties and events constituting a change in control. As of March 31, 2006 and December 31, 2005, we had
borrowed $8.0 million under the SVB Loan Agreement and utilized an additional $0.8 million towards certain real estate letters of credit, leaving us $4.2 million in potential borrowings under the SVB Loan Agreement subject to the restrictions
discussed above.

The PFG Loan Agreement provides for revolving borrowings in an amount up to the lesser of $5.0 million, or 50% of our
current assets minus the amount of any loans outstanding under the SVB Loan Agreement. At March 31, 2006, under the borrowing formula, the entire $5.0 million would be available for borrowing. Any loans that are made under the PFG Loan Agreement
mature on July 28, 2007 and bear interest at a floating rate equal to the prime rate plus 400 basis points. The PFG Loan Agreement contains restrictions, that are applicable when we have requested a borrowing or when loans are outstanding under
the PFG Loan Agreement, on our ability to, among other things, dispose of assets, undertake mergers or acquisitions, incur indebtedness, create liens on assets, make investments and pay dividends or repurchase stock . The PFG Loan Agreement contains
events of default that include, among other things, non-payment of principal, interest or fees, breaches of covenants, material adverse changes, bankruptcy and insolvency events, cross-defaults, unpaid judgments, inaccuracy of representations and
warranties and events constituting a change in control.

In connection with the PFG Loan Agreement, on August 2, 2005, we entered into
a Warrant Purchase Agreement under which we issued a Warrant to PFG. Following a share and price adjustment pursuant to the terms of the Warrant, the Warrant is exercisable for 222,680 shares of our common stock at an exercise price



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XENOGEN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



of $2.91 per share. As of March 31, 2006, 111,340 of these Warrant shares were exercisable. The number of shares for which the Warrant is currently
exercisable will increase by 4,639 at the end of each month during which a loan is outstanding under the PFG Loan Agreement. If no loans are outstanding during a calendar month, the total number of shares of our common stock for which the Warrant
may be exercisable will be reduced by 4,639. No loans were outstanding under the PFG Loan Agreement since inception of the agreement through March 31, 2006. The Warrant may be exercised by making a cash payment or through a cashless exercise by
the surrender of warrant shares having a value equal to the exercise price of the Warrant being exercised. The Warrant expires on August 1, 2012. The non-contingent portion of the Warrant, or 111,340 shares, was valued at approximately $266,000
and recorded as deferred interest to be amortized to expense over the PFG loan term of 24 months. The Warrant was valued using the Black-Scholes method with the following assumptions: a risk-free interest rate of 4.2%, a contractual term of 7 years,
zero dividend yield, and a volatility factor of 80.2%. The portion of the Warrant that was contingent was not valued.

Debt financing,
legal and other expenses associated with the SVB and PFG loan agreements were capitalized as deferred interest and debt costs inclusive of the fair market value of the PFG Warrant above. The total amount capitalized was approximately $705,000 and
will be amortized to expense over 24 months corresponding to the term of both the SVB and PFG agreements. As of March 31, 2006, approximately $238,000 of the deferred fees was amortized as interest.

At March 31, 2006 and December 31, 2005, we were in compliance with financial covenants under the SVB Loan Agreement and Original Agreement, as
applicable. In addition, we were in compliance with financial covenants under the PFG Loan Agreement as of March 31, 2006 and December 31, 2005.



|9. | Commitments and Contingencies
|-- | -----------------------------

Purchase
CommitmentsWe had various purchase order commitments totaling approximately $3.5 million as of March 31, 2006.

Operating
Leases - On March 15, 2006, we signed Amendment No. 7 to our 860 Atlantic Avenue lease agreement providing us with a lease extension until August 31, 2006 with an option to renew until December 31, 2006 and a right to
terminate the lease term early after April 30, 2006 upon 60 days prior written notice. The amount of the monthly lease payment remains $44,213. The following is the schedule of minimal rental commitments under our operating agreements as of
March 31, 2006 (in thousands):



|                          |  |   |       
|------------------------- |  | - | ------
|Years Ending December 31, |  |  
|Remaining 2006            |  | $ | 2,786 
|2007                      |  |   | 3,618 
|2008                      |  |   | 3,718 
|2009                      |  |   | 3,183 
|2010                      |  |   | 1,347 
|Thereafter                |  |   | 304   
|                          |  |   |       
|TOTAL                     |  | $ | 14,956
|                          |  |   |       



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Legal Proceedings On March 7, 2005, AntiCancer filed a lawsuit against us in the
U.S. District Court for the Southern District of California alleging infringement of five patents of AntiCancer. The complaint seeks damages and injunctive relief against the alleged infringement. On March 29, 2005, AntiCancer amended its
complaint to include an additional claim seeking a judgment that one of our imaging patents, 5,650,135, is invalid. On May 10, 2005, we filed our answer to AntiCancers amended complaint. We denied all of AntiCancers allegations and
asserted various affirmative defenses, including our position that AntiCancers patents, including some of the patents cited in its complaint, and patent claims relating to in vivo imaging of fluorescence are invalid. We are vigorously
defending ourselves against AntiCancers claims and believe AntiCancers complaint is without merit. Concurrent with filing our answer to AntiCancers complaint, we filed our own counterclaims against AntiCancer. Our counterclaims
allege that AntiCancer infringes two of our U.S. patents, 5,650,135 and 6,649,143, both relating to in vivo imaging and with a priority date before AntiCancers patents cited in its amended complaint. Both parties seek injunctive relief
and an unspecified amount of damages, including enhanced damages for willful infringement. We intend to vigorously pursue our claims against AntiCancer. The court has scheduled the Markman hearing for June 13, 2006 through June 15, 2006,
and the trial is scheduled to begin in May 14, 2007.

We were named as a co-defendant in a lawsuit filed on August 9, 2001 in the Superior Court
of California, County of San Diego, Case No. GIC 772297, by plaintiff AntiCancer. The complaint sought unspecified damages and contained five causes of action against us, all of which are based on alleged false statements regarding plaintiff and
plaintiffs technology, including trade libel, defamation, intentional interference with contract, intentional interference with prospective economic advantage and unfair competition. On March 30, 2006, we signed a Settlement Agreement and
Mutual General Release with AntiCancer pursuant to which AntiCancer released us from all claims relating to this lawsuit and agreed to dismiss, with prejudice, the complaint filed with the court in exchange for a one-time, $1 million cash payment.
We paid the $1 million to AntiCancer on April 3, 2006 and the complaint was dismissed on April 7, 2006. We accrued the settlement amount in our consolidated financial statements for the year ended December 31, 2005. The cost of the
settlement amount was included in our selling general and administrative expenses for the year ended December 31, 2005, and was reflected as other accrued liabilities on our condensed consolidated balance sheet as of
December 31, 2005 and March 31, 2006. This settlement does not affect the patent infringement lawsuit described above.

At this time, we are not
able to determine the outcome of the patent infringement lawsuit. Even if we prevail in this lawsuit, the defense of this lawsuit or similar lawsuits will be expensive and time-consuming and may distract our management from operating our business.

From time to time we are involved in litigation arising out of claims in the normal course of business. Based on the information presently available,
management believes that there are no other claims or actions pending or threatened against us, the ultimate resolution of which will have a material adverse effect on our financial position, liquidity or results of operations, although the results
of litigation are inherently uncertain, and adverse outcomes are possible.

Merger Agreement On February 10, 2006, we
entered into the Merger Agreement with Caliper and Caliper Holdings, pursuant to which we will be merged with and into Caliper Holdings and become a wholly-owned subsidiary of Caliper. A copy of the Merger Agreement and other documents relating to
the Merger are attached as exhibits to the Current Report on Form 8-K that we filed with the Securities and Exchange Commission on February 16, 2006. Our Board of Directors has approved the Merger and the Merger



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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



Agreement. On March 31, 2006, Caliper and Xenogen filed a registration statement on Form S-4 and a notice of special meeting of stockholders and
definitive proxy statement for the special meeting of stockholders pursuant to which we will ask our stockholders to adopt and approve the Merger Agreement and the Merger.

Other Contingencies We are currently discussing with Stanford the scope of products that we sell which are subject to the royalty provisions
of our Stanford license agreement. As a result of these discussions, we may amend the license agreement to change the royalties we pay to Stanford for future product sales. The amendment may also include the payment of back royalties to
Stanford for products we have already sold. We have not discussed with Stanford the specific terms and conditions of an amendment or the amount of any back royalty payments nor has Stanford made a demand for a payment of a specific back royalty
amount. Accordingly, we have not accrued for any such payments in our financial statements. If back royalties are owed to Stanford, we do not believe that they would exceed $393,000 for products sales through March 31, 2006. We do not
believe we owe Stanford any back royalties under the license agreement for prior product sales.



|10. | Stockholders Equity
|--- | --------------------

Equity Financing
under August 2005 Securities Purchase Agreement - On August 11, 2005, we entered into a Securities Purchase Agreement (the SPA) with certain institutional accredited investors (the Purchasers). Pursuant to the SPA,
on August 15, 2005, the Purchasers acquired, in the aggregate, 5,154,640 shares of our common stock, par value $0.001, at a price of $2.91 per share. The aggregate gross consideration that we received from the sale of these shares was
$15,000,002, with net proceeds amounting to $14,202,161 after issuance costs of $797,841. Investment options for the net proceeds are being contemplated, and as such, the proceeds were deposited into operating cash. On August 15, 2005, we
issued to the Purchasers warrants to purchase up to additional 1,546,392 shares of our common stock. The warrants have a term of five years and are exercisable beginning February 15, 2006 with an exercise price equal to $3.29 per share. The
fair market value of the warrants was approximately $3.2 million and was allocated from the aggregate proceeds of the financing to the warrants. The warrants were valued using the Black-Scholes method with the following assumptions: a risk-free
interest rate of 4.15%, a contractual term of 5 years, zero dividend yield, and a volatility factor of 80.2%. The registration statement registering for resale the shares issued to the Purchasers and the shares underlying the warrants was declared
effective by the SEC on November 10, 2005.



|11. | Loss Per Share
|--- | --------------

Basic net loss attributable to
common stockholders per share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. The following securities were not included in the computations of
diluted net loss attributable to common stock per share at March 31, 2006 and 2005, as their inclusion would be antidilutive:



| |  |  | warrants outstanding to purchase 1,949,942 and 395,483 shares of common stock and convertible preferred stock at March 31, 2006 and 2005, respectively;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | options to purchase common stock of 2,394,504 and 2,510,309 shares at March 31, 2006 and 2005, respectively; and
| | - |  | ----------------------------------------------------------------------------------------------------------------



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XENOGEN CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



| |  |  | common stock subject to our right to repurchase of 81,461 and 150,547 shares at March 31, 2006 and 2005, respectively.
| | - |  | ----------------------------------------------------------------------------------------------------------------------

Basic and diluted net loss attributable to common stockholders per share was calculated as follows (in thousands, except per share data):



|                                                                          |  |                              |            |   |      |   |            |  
|------------------------------------------------------------------------- |  | ---------------------------- | ---------- | - | ---- | - | ---------- | -
|                                                                          |  | Three Months Ended March 31, |           
|                                                                          |  | 2006                         |            |   | 2005 |  
|Net loss attributable to common stockholders                              |  | $                            | (5,626     | ) |      | $ | (5,145     | )
|                                                                          |  |                              |            |   |      |   |            |  
|Weighted average number of common sharesbasic and diluted                |  |                              | 20,303,013 |   |      |   | 14,821,840 |  
|                                                                          |  |                              |            |   |      |   |            |  
|Basic and diluted net loss attributable to common stockholders per share: |  | $                            | (0.28      | ) |      | $ | (0.35      | )
|                                                                          |  |                              |            |   |      |   |            |  



|12. | Comprehensive Income(in thousands)
|--- | ----------------------------------



|                                                  |  |                              |        |   |      |   |        |  
|------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                  |  | Three Months Ended March 31, |       
|                                                  |  | 2006                         |        |   | 2005 |  
|Net loss attributable to common stockholders      |  | $                            | (5,626 | ) |      | $ | (5,145 | )
|Other comprehensive income:                       |  |                              |        |   |      |   |        |  
|Unrealized gain on available for sale investments |  |                              |       |   |      |   | 3      |  
|                                                  |  |                              |        |   |      |   |        |  
|Comprehensive loss                                |  | $                            | (5,626 | ) |      | $ | (5,142 | )
|                                                  |  |                              |        |   |      |   |        |  



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|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations.
|------- | --------------------------------------------------------------------------------------

The following Managements Discussion and Analysis of our Financial Condition and Results of Operations should be read in conjunction with the
condensed consolidated financial statements and notes thereto included as part of this Quarterly Report. This report contains forward-looking statements that are based upon current expectations. We sometimes identify forward-looking statements with
such words as may, will, expect, anticipate, estimate, seek, intend, believe or similar words concerning future events. The forward-looking statements
contained herein, include, without limitation, statements concerning anticipated performance of our products, services and technologies, revenue growth, future revenue sources and concentration, achievement of revenue thresholds, gross profit
margins, selling and marketing expenses, research and development expenses, general and administrative expenses, interest expense, deferred stock-based compensation expenses, capital resources, additional financings or borrowings, additional losses,
increasing production capacity and capital expenditures. We assume no obligation to update any such forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for such forward-looking
statements. In order to comply with the terms of the safe harbor, we note that a variety of factors, risks and uncertainties could cause actual results or experience to differ materially from the anticipated results or other expectations expressed
in such forward-looking statements. Such factors, risks and uncertainties include, without limitation, those discussed below and elsewhere in this Quarterly Report, particularly in Part II, Item 1A. Risk Factors. We also urge you to
carefully review the risk factors set forth in this and other documents we file from time to time with the Securities and Exchange Commission.

All percentage amounts and ratios were calculated using the underlying data in thousands. Operating results for the three month period ended March 31, 2006, are not necessarily indicative of the results that may be expected for any
future period.

Overview

We sell integrated systems of instruments and equipment, software and reagents to biomedical and biopharmaceutical researchers that we believe improve the productivity and efficiency of the drug discovery and development process. Using the
detection and measurement of photons emitted from cells and animals that we genetically engineer to emit light, which we term biophotonic imaging, our patented and proprietary biophotonic IVIS Imaging Systems, living animal models and
research services collectively expedite in vivo data collection and analysis, a critical bottleneck in drug discovery and development. Our customers use in vivo biophotonic imaging to visually display and quantify a chosen tumor,
disease, pathogen, organ or biochemical reaction. Our products are also used to create predictive animal models, primarily rats and mice, for preclinical drug discovery and development. We believe our products enable our pharmaceutical and
biotechnology customers to generate higher-quality safety and efficacy data for drug candidates, to accelerate preclinical development and to reduce the development risk of product candidates that enter human clinical development. The sources of our
revenue are:



| |  |  | Instruments and related imaging accessories: sales of IVIS Imaging Systems and accessories;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | Long-term service contracts: custom animal production, animal phenotyping and IVIS service contracts; and
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | Recurring license fees: multi-year fees from our non-academic customers for licenses to our biophotonic imaging patents and access to reagents.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------



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We manufacture, market and sell our IVIS Imaging Systems, as well as the reagentspathogens and
tumor cells, or Bioware, and bioluminescent transgenic animals, or LPTA animal modelsthat allow our customers performing biopharmaceutical and biomedical research, discovery and development to collect safety, efficacy
and other relevant data on product candidates. Our reagent sales are comprised of genetically modified animals (mice and rats) and cell lines that are used to characterize the role of genes in the disease process, as well as to measure the efficacy
of potential drugs against certain sets of disease indications. We also provide a wide range of contract research services relating to the production of transgenic animals (in which foreign genes are incorporated) and knockout animals (in which
specific genes are functionally disabled). In addition, we provide custom animal production and phenotyping services to our customers for the purpose of target validation and compound screening. Our product offerings allow our customers to gather
data in living animals about biochemical pathways, the mechanism of action of drug candidates and how well these drug candidates work in living organisms.

On February 10, 2006, we entered into a definitive Agreement and Plan of Merger with Caliper Life Sciences, Inc. and its subsidiary, Caliper Holdings, Inc., pursuant to which we will be merged with and into
Caliper Holdings and become a wholly-owned subsidiary of Caliper. A copy of the merger agreement and other documents relating to the merger are attached as exhibits to the Current Report on Form 8-K that we filed with the Securities and Exchange
Commission on February 16, 2006. Our Board of Directors has approved the merger and the merger agreement. On March 31, 2006, Caliper and Xenogen filed a registration statement on Form S-4 and a notice of special meeting of stockholders and
definitive proxy statement for the special meeting of stockholders pursuant to which we will ask our stockholders to adopt and approve the merger agreement and the merger.

We commenced sales of our IVIS Imaging Systems in 2000 and our animal models in 2001 and our revenues have grown each year up through calendar year 2005.
Our revenue during the first quarter of 2006 was $8.7 million, a decrease of $0.5 million from the first quarter of 2005, attributed largely to a slow down in sales and marketing activity for our IVIS Systems in the first quarter of 2006 from the
comparable period last year stemming from distractions related to our pending merger with Caliper announced in February 2006. We expect our total revenues to increase for the remainder of 2006, however, although not necessarily at the same rate as
in prior years. The gross margins for our products and services vary. During the first quarter of 2006, gross margin for our IVIS Imaging Systems was 38.2%, licensing fees were 88.8% and custom animal production and phenotyping was 5.0%. We
anticipate that gross margins on our instruments and accessories as well as our custom animal production and phenotyping will improve as we increase our manufacturing capacity utilization. We sell our products and services directly to customers in
the United States and several foreign countries. In Australia/New Zealand, China, India, Israel, Japan, South Korea, Singapore, and Taiwan, we sell our IVIS Imaging Systems through independent distributors and sales agents.

We have incurred significant net losses every year since our inception. We incurred losses of $20.5 million in 2003, $21.8 million in 2004, $18.6 million
in 2005 and $ 5.6 million for the three month period ending March 31, 2006. As of March 31, 2006, we had an accumulated deficit of $191.9 million. As a company in the early stage of commercialization, our limited history of operations
makes prediction of future operating results difficult. We believe that period to period comparisons of our operating results should not be relied on as predictive of our future results.

Our revenue is subject to seasonal variations. Our customers are from the biomedical research community and the biopharmaceutical industry, and our
business is closely tied to the timing of their budget cycles. In the biomedical research community, grant proposals are due in October, February and June with funds delivered the following June, October and March, respectively. We recognize most of
our revenue from sales to biomedical institutions when we install IVIS Imaging Systems, which, due to the grant cycle,



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usually occur in the second and fourth quarters. In the biopharmaceutical industry, there are traditionally two decision making cycles: one in January or
July when budgets are planned, and the second in November or December when appropriated funds must be spent or returned to the general budget. As a result, agreements are commonly entered into in the second and fourth quarters, which follow the
beginning of the budget cycle. Therefore, historically our revenue is higher in the second and fourth quarters as compared to the first and third quarters. We generally also see a decrease in the third quarter due to vacation schedules in the
summer, especially with respect to our European and academic customers.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005 that was filed
with the Securities and Exchange Commission on March 24, 2006. Our critical accounting estimates have not changed since December 31, 2005.

Results of Operations

Three Months Ended March 31, 2006 versus Three Months Ended March 31, 2005

Revenue. Revenues by source for the three months ended March 31, 2006 and 2005 were (in thousands):



|              |  |                             |       |      |   |      
|------------- |  | --------------------------- | ----- | ---- | - | -----
|              |  | Three MonthsEnded March 31,
|              |  | 2006                        |       | 2005
|Revenue:      |  |                             |       |      |   |      
|Product       |  | $                           | 4,338 |      | $ | 5,293
|Contract      |  |                             | 2,582 |      |   | 2,271
|License       |  |                             | 1,814 |      |   | 1,710
|              |  |                             |       |      |   |      
|Total revenue |  | $                           | 8,734 |      | $ | 9,274
|              |  |                             |       |      |   |      

Total revenue during the first quarter of 2006 was $8.7 million, a decrease from the comparable
period last year of 5.8%. The revenue decrease resulted primarily from the reduction in IVIS System sales, which was largely attributed to a slow down in sales and marketing efforts stemming from distractions related to our pending merger with
Caliper announced in February 2006. The number of IVIS units sold during the first quarter of 2006 was 18 units as compared to 25 units sold during the comparable period last year. Contract revenue, on the other hand, increased in the first quarter
of 2006 by $0.3 million from the comparable period in 2005 primarily due to increased phenotyping and custom model/gene targeting activity. Lastly, license revenue increased in the first quarter of 2006 over the prior year by $0.1 million stemming
largely from the higher installed base of IVIS Imaging Systems as of March 31, 2006 versus March 31, 2005. One of our customers individually accounted for more than 10% of our revenue during the first quarter of 2006 and 2005, comprising
15.6% and 11.5% of our total revenue during those periods, respectively.

Cost of revenue. Cost of revenue decreased to $5.3 million
during the first quarter of 2006 from $6.0 million in the first quarter of 2005, or a 11.3% decrease. As a percentage of total revenues, cost of revenues was 61.1% for the first quarter of 2006 as compared to 64.9% for the comparable period in 2005.
The decrease in cost of product revenue resulted primarily from decreased IVIS Imaging System unit sales. The cost of revenue decrease was offset in part by higher stock-based compensation expense. We incurred $88,000 in stock-based compensation
expense in the first quarter of 2006 versus a credit to expense of $21,000 in the first quarter of 2005. The majority of the stock-based compensation increase was due to our adoption of Statement of Financial Accounting Standards No. 123(R),
Share-based Payment(SFAS 123(R)) on January 1, 2006. The cost of contract revenue, on the other hand, increased by 8.6% offsetting a portion of



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the product cost of revenue decrease above given the increase in phenotyping and gene targeting contractual activity in the first quarter of 2006 versus the
comparable period in 2005.

Gross Margin. Gross margins by revenue source for the three months ended March 31, 2006 and 2005
were as follows (in thousands, except percentages):



|             |  |      |       |  |      |   |  |   |       |  |      |  
|------------ |  | ---- | ----- |  | ---- | - |  | - | ----- |  | ---- | -
|Gross Margin |  | 2006 |       |  | 2005 |  
|Product      |  | $    | 1,658 |  | 38.2 | % |  | $ | 1,855 |  | 35.0 | %
|Contract     |  |      | 129   |  | 5.0  | % |  |   | 12    |  | 0.5  | %
|License      |  |      | 1,611 |  | 88.8 | % |  |   | 1,391 |  | 81.3 | %
|             |  |      |       |  |      |   |  |   |       |  |      |  
|Total        |  | $    | 3,398 |  | 38.9 | % |  | $ | 3,258 |  | 35.1 | %
|             |  |      |       |  |      |   |  |   |       |  |      |  

The gross margin percentage during the first quarter of 2006 increased from the comparable period
in 2005. All product and service lines contributed to the margin percentage improvement during the first quarter of 2006. The effect of lower unit production costs associated with a sales mix change in product revenue to IVIS 100, IVIS 50 and the
new IVIS Lumina models, greater capacity utilization of our Cranbury facility associated with our contractual projects, and higher license fees stemming from our commercial IVIS systems sales all contributed to the gross margin improvement during
the first quarter of 2006 versus the comparable period last year. From a historical perspective, gross margins on products (sales of our IVIS Imaging Systems and accessories) averaged 36.5% over the three years ended December 31, 2005 and gross
margins on licensing fees averaged 83.8% during the same period. Historical gross margins for our custom animal production and phenotyping services have varied significantly over the three years ended December 31, 2005 and averaged 4.5% over
this period.

Product Gross Margin

Despite an 18.0% decrease in product revenue during the first quarter of 2006 relative to the comparable period in 2005, our product gross margin improved by 3.1%. During the first quarter of 2006, the IVIS 50, IVIS
100 and the new IVIS Lumina Imaging Systems made up a significantly larger share of imaging system unit sales over the comparable period in 2005, serving to decrease average unit production costs by 20.8% in the first quarter of 2006 from the
comparable period last year. Offsetting a significant portion of the product unit cost decrease, however, was both the lower average selling price associated with the IVIS 100, IVIS 50 and the new IVIS Lumina units relative to our IVIS 200 and IVIS
3-D Imaging Systems, and the non-production period costs related to IVIS Imaging System installation and warranty work. For the first quarter of 2006 versus the comparable period in 2005, our average selling price based on all IVIS unit sales was
essentially flat. Despite IVIS Imaging System unit price increases ranging from 8% to 16%, the change in sales mix towards our lower-priced IVIS Imaging Systems offset the gross margin effect of the price increases such that our overall average
selling price increase was 0.3% over the comparable period last year. Sales through international distributors also comprised a greater portion of the sales mix, serving to further reduce our overall average selling price as distributor prices are
lower than our prices in other channels due to our distributors margin requirements. However, a higher proportion of IVIS Imaging System sales to commercial versus academic customers during the first quarter of 2006 over the comparable period
last year had a positive impact on our average selling price.

Contract and Licensing Gross Margins

Contract gross margin for the first quarter of 2006 improved over the comparable period in 2005. Higher contract services volume associated with a greater
number of phenotyping and gene targeting projects



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improved overall contract gross margin during the first quarter of 2006 over the comparable period last year. Our licensing gross margin percentage for the
first three months of 2006 increased over the comparable period of 2005 as well. The increase was largely the result of both higher license fees associated with imaging method patent license renewals as well as the reduction of royalty expenses on a
per license unit basis relating to reagent licensing.

Research and development. Research and development expenses include the
development of our new IVIS Imaging Systems, LPTA models and reagents. Research and development costs decreased in the first quarter of 2006 to $1.9 million from the $2.3 million in the comparable period last year. The decrease from the first
quarter of 2005 was attributed in part to reduced product development expenses associated with our IVIS 3-D Series Imaging System, with most of the development expenditures occurring in 2004 and early 2005. In addition, a reduction in personnel and
facility costs associated with reagent product development also contributed to the decrease. Allocated stock-based compensation expense, however, offset some of the cost decrease and amounted to $33,000 for the first quarter of 2006 versus a credit
to expense of $77,000 during the comparable period last year. As a percentage of total revenues, research and development expenses were 21.7% for the first quarter of 2006 as compared to 25.2% for the comparable period in 2005. The decrease is
primarily attributable to the decreased expenses described above, which decrease was partially offset by lower total revenues for the first quarter of 2006 versus the comparable period in 2005.

Selling, general and administrative. Selling, general and administrative expenses increased to $6.8 million for the first quarter of 2006 from
$5.3 million in the first quarter of 2005. General and administrative costs represented the largest component of the increase. Financial advisory fees, legal fees and other professional services fees associated with the pending merger with Caliper
accounted for $0.8 million of the increase. Other legal costs and expenses, stemming in part from our litigation with AntiCancer, contributed an additional $0.3 million of the overall cost increase from the first quarter of 2005. Accounting and
auditing fees also increased by $0.1 million during the first quarter of 2006 over the comparable period in the prior year. Offsetting these increases were reductions, on a net basis, of $0.1 million in consulting costs, directors and officers
insurance, public/investor relations expenses and other costs during the first quarter of 2006 from the comparable period in 2005.

Selling expenses
increased by $0.3 million in the first quarter of 2006 over the comparable period in 2005. Expanded marketing efforts associated with promotion of the IVIS 200 and new IVIS 3-D Imaging Systems contributed to the higher selling costs in 2006. Lastly,
allocated deferred compensation expenses increased by $0.1 million during the first quarter of 2006 from the comparable period in 2005. As a percentage of total revenues, selling, general and administrative expenses were 77.9% for the first quarter
of 2006 as compared to 57.2% for the comparable period in 2005. The increase was primarily attributable to lower total revenues and non-recurring merger-related expenses for the first quarter of 2006 versus the comparable period in 2005.

Depreciation .Depreciation expense decreased by $0.1 million in the first quarter of 2006 compared to the first quarter of 2005 due to in part
to asset acquisitions not keeping pace with the rate at which assets were becoming fully depreciated since the first quarter of 2005. The balance of the decrease was due to asset disposals and retirements.

Amortization of intangibles. We fully amortized acquisition-related intangibles by the end of first quarter of 2006. We incurred $3,000 and
$151,000 of amortization expense during the first quarter of 2006 and 2005, respectively, relating to our November 2000 acquisition of Xenogen Biosciences Corporation. There were no acquisitions or write-offs with regard to intangibles in either the
first quarter of 2006 or 2005.



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Interest expense. Interest expense was $0.3 million and $0.2 million for first quarter of 2006 and
2005, respectively. The increase was the result of a higher outstanding debt balance during the first quarter of 2006 versus the comparable last year associated with our credit line with Silicon Valley Bank.

Income tax expense (benefit). We recorded no income tax expense in either the first quarter of 2006 or 2005 due to our losses in each of these
quarters.

Expensing of Stock Awards. Beginning in the first quarter of 2006, we adopted the Statement of Financial
Accounting Standards No. 123(R), Share-based Payment(SFAS 123(R)), and elected to adopt the standard using the modified prospective transition method. Stock-based compensation cost under this transition method was based on our original
pro forma disclosures under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) for all options granted prior to 2006 that were not fully vested as of December 31, 2005. Previous
reported amounts related to these option shares have not been restated.

In November 2005, all unvested stock options with an exercise price equal to or
greater than $5.01 per share were accelerated and became fully vested at that time. The decision to accelerate the vesting of these options was made primarily to reduce compensation expense that would have been recorded in conjunction with our
adoption of SFAS 123(R), which we believe is in the best interest of stockholders. The impact of the acceleration to stock-based compensation as determined under SFAS 123 was a $2.6 million expense increase in pro forma stock-based compensation for
the fourth quarter of 2005.

We did not make any stock option grants during the first quarter of 2006, but will base the fair value and associated
compensation expense on any new stock option grant in accordance with the provisions of SFAS 123(R). The fair value of stock options that we have granted was based on the Black-Scholes model option-pricing formula and a multiple option award
approach. The fair value of our options was then amortized using the graded vesting method over the options vesting period, which is generally four years. Prior to January 1, 2006, we followed Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and interpretations as permitted by SFAS 123. Under APB 25, Stock-based compensation expense was recorded based on stock option intrinsic value which was calculated as the difference between
the stock option exercise price and the underlying stocks market value on the date of grant. Under this method, when a stock option price equaled the market price of the underlying stock on the date of grant, no compensation expense is
recognized. Since our 2004 initial public offering, all of our stock options were granted at the underlying market price of our stock.

The Black-Scholes
model requires the use of highly subjective assumptions including the options expected life, risk free interest rate, dividend yield, and the price volatility of the underlying stock. The expected option life assumed for all current stock
options was five years and was based on historical employee termination and option exercise rates. The risk free rates were based on U.S. Treasury yields for notes with comparable terms with our option life assumption. In addition, no dividend
payouts were assumed to occur for the purposes of the fair market valuation. Lastly, the volatility assumption was based on a combination of historical volatilities of both our stock and benchmarked companies. The minimum value basis for pricing
options was used for all grants made prior to Xenogen becoming a publicly traded company in July 2004.



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For the three months ended March 31, 2006 and 2005, stock-based compensation expense was $331,000 and $46,000,
respectively, and was reflected in our condensed consolidated statements of operations set forth in Item 1 of this report as follows:



|                                    |  |                             |     |      |   |     |  
|----------------------------------- |  | --------------------------- | --- | ---- | - | --- | -
|                                    |  | Three Months EndedMarch 31, |    
|                                    |  | 2006                        |     | 2005 |  
|Cost of revenue:                    |  |                             |     |      |   |     |  
|Product                             |  | $                           | 22  |      | $ | (15 | )
|Contract                            |  |                             | 55  |      |   | (4  | )
|License                             |  |                             | 11  |      |   | (2  | )
|                                    |  |                             |     |      |   |     |  
|Total cost of revenue               |  |                             | 88  |      |   | (21 | )
|Research and development            |  |                             | 33  |      |   | (77 | )
|Selling, general and administrative |  |                             | 210 |      |   | 144 |  
|                                    |  |                             |     |      |   |     |  
|TOTAL                               |  | $                           | 331 |      | $ | 46  |  
|                                    |  |                             |     |      |   |     |  

The increase in stock-based compensation expense was largely the result of the adoption of SFAS 123(R) offset in
part from the effect variable accounting treatment in 2005 on certain stock options issued in 2003 given stock market fluctuations since December 31, 2004 and the associated impact to those stock options intrinsic value.

The stock-based compensation expense in future years on options granted, but unvested as of March 31, 2006 is anticipated as follows.



|                                                |  |                      |    
|----------------------------------------------- |  | -------------------- | ---
|                                                |  | Amount (in millions)
|Deferred Compensation Amortization For the Year |  |                      |    
|April 1, 2006  December 31, 2006               |  | $                    | 0.6
|2007                                            |  |                      | 0.3
|2008 and later years                            |  |                      | 0.1
|                                                |  |                      |    
|TOTAL                                           |  | $                    | 1.0
|                                                |  |                      |    

Liquidity and Capital Resources

As of March 31, 2006, we had cash, cash equivalents and investment balances of $18.3 million. We have not achieved profitability and anticipate that
we will continue to incur net losses for the foreseeable future. We expect that our research and development expenses and selling, general and administrative expenses will increase, and as a result, we will need to generate significantly greater
revenue than we have to date to achieve profitability.

Until our initial public offering and 2005 equity financing, our operations were
funded through the proceeds from the sale of preferred stock, revenue generation, and to a lesser extent, through equipment lease lines and bank lines of credit. As of March 31, 2006, we had outstanding balances under loan and lease agreements
of $8.7 million, $8.0 million pursuant to a bank loan and $0.7 pursuant to equipment financing arrangements. On August 2, 2005, we restructured our loan and entered into an amended and restated loan facility with our primary lender and entered
into a new loan facility with a another lender that collectively provides us with access to borrowings of up to $18 million, subject to borrowing base calculations and other terms and conditions. The new loan facility with our existing lender has a
maturity date of August 2, 2007, and the amounts borrowed under the original credit agreement have been rolled into the new facility. This credit facility is secured by all our assets, excluding our intellectual property and equipment financed
through our equipment financing arrangements. As of March 31, 2006, we were in compliance with the covenants and had $8.0 million outstanding under this loan agreement. We have not borrowed any money under the loan facility with the new lender.

On August 11, 2005, we entered into a Securities Purchase Agreement with certain institutional accredited investors who have
acquired, in the aggregate, 5,154,640 shares of common stock, par value $0.001, at a price of $2.91 per share. The aggregate gross consideration received for the common stock was



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$15,000,002. The investors also received warrants to purchase up to an additional 1,546,392 shares of our common stock. The warrants have a term of five
years and are exercisable beginning six months after August 15, 2005 with an exercise price equal to $3.29 per share. The financing is described in more detail in Note 10 of the accompanying condensed consolidated financial statements set forth
in Item 1 of this report.

Operating activities. Net cash used in operating activities for the first quarter of 2006 and 2005
was $1.4 million and $5.1 million, respectively. The primary use of cash during both periods was to fund our net loss, adjusted for non cash expenses and changes in operating assets and liabilities. During the first quarter of 2006, we improved our
collections of accounts receivable, which contributed significantly to funding our net loss for the period. The receivable collections, however, were offset to some degree by inventory purchases and by payments made to suppliers. During the first
quarter of 2005, an increase in inventory purchase and a decrease in advance sales booking (deferred revenue), offset in part by increased accounts receivables collections and other items, served to increase our net cash use for the period. Deferred
revenue results primarily from invoicing customers for contracts and licenses for which revenue will be recognized over future periods.

Investing activities. Net cash used in investing activities for the first quarter 2006 was $1.3 million and was attributed essentially to leasehold improvements and purchases of equipment. During the first quarter of 2005, on the
other hand, $39,000 was provided by investing activities. During the first quarter of 2005, proceeds from investment interest were offset in part by small capital purchases.

Financing activities. Net cash provided by financing activities during the first quarter of 2006 amounted to $ 0.3 million and was attributed
to proceeds from the issuance of common stock resulting from the exercise of warrants and employee stock options, offset in part by payments made on our equipment financing obligations. During the first quarter of 2005, net cash used in financing
activities amounted to $0.3 million and was attributed to payments made on our equipment financing obligations.

We expect material capital
expenditures of approximately $3.25 million to be incurred over the next twelve months to support our sales growth and increase our imaging system manufacturing capacity. If our proposed merger with Caliper is consummated, it is possible that our
manufacturing operations will be relocated from our Alameda, California facilities. If such relocation were to occur, our capital expenditures relating to imaging system manufacturing capacity would be affected.

We currently expect our proposed merger with Caliper to be completed late in the second quarter or early in the third quarter of 2006. The merger
agreement has an outside termination date of August 31, 2006. We believe that our current cash, together with revenues from sales of IVIS imaging instruments in the second quarter, will be sufficient to funds our operations beyond the closing of the
merger with Caliper. In the event the merger is not consummated, our existing working capital at March 31, 2006 may not be sufficient to meet our operating, working capital, investing and financing requirements for the next twelve months, and we
will need to reevaluate our current plans and business operations and substantially reduce our operating expenses, raise additional capital or take other actions in order to continue as an independent company.

If we need to raise additional capital, we cannot be certain that any such financing will be available on acceptable terms, or at all. Additional equity
financing, if available, would likely be dilutive to the holders of our common stock. Borrowings from our existing lenders or new lenders, if available, would increase our debt-maintenance expenses and compliance reporting requirements, and would
likely involve restrictive covenants and a security interest in our assets.

If we need to raise additional capital and adequate funds are
not available, we will have to take measures to further reduce our operating expenses, such as reducing headcount, delaying or canceling development or commercialization of our products and services, deferring the acquisition of complimentary
products or licensing to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. Any of these results could harm our financial condition. If we need to but are not able to raise sufficient
additional capital, it would adversely affect our ability to achieve our business objectives and to continue as an independent company.



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Our contractual payment obligations have not materially changed since December 31,
2005.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk.
|------- | -----------------------------------------------------------

Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. Although limited, our exposure to market risk in
the areas of changes in United States and foreign interest rates and changes in foreign currency exchange rates are measured against the United States dollar. These exposures are directly related to our normal operating and funding activities.

We are exposed to fluctuations in interest rates under our amended and restated loan and security agreement with Silicon Valley Bank. At
March 31, 2006, our outstanding borrowings under this agreement were $8 million at weighted interest rate basis of 8.9% for the first quarter of 2006. Under the agreement, interest is assessed at the banks prime rate plus 150 basis points
on any outstanding borrowing. If the interest rate were to increase by 100 basis points, then our prevailing interest rate payment on the $8 million borrowings would be $80,000 on an annual basis.

We invest our excess cash in certificates of deposit, debt instruments of the U.S. government and its agencies and in high quality corporate issuers. Due
to the short-term nature of these investments, we concluded that there was no material exposure to interest rate risk arising from our investments as of March 31, 2006.

Currently, the majority of our revenue is denominated in United States dollars. In some circumstances, we price certain international sales to
participating European Community countries in Euros, to United Kingdom in British pounds sterling, to Switzerland in Swiss francs, to Canada in Canadian dollars, and to Sweden in Swedish krona. Increases in the value of the United States dollar
against any local currencies could cause our products to become relatively more expensive to customers in a particular country or region, leading to reduced revenue or profitability in that country or region. As we continue to expand our
international sales, we expect our non-United States dollar denominated revenue and our exposure to gains and losses on international currency transactions to increase. We currently do not engage in transactions to hedge against the risk of the
currency fluctuation, but we may do so in the future. The amount of transactions denominated in a foreign currency amounted to approximately $3,170,000 for calendar year 2005 and $390,000 for the three month period ended March 31, 2006. We
experienced a net foreign currency loss of approximately $75,000 and $27,000 for the year ended December 31, 2005 and for the three month period ended March 31, 2006, respectively.



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|Item 4. | Controls and Procedures.
|------- | ------------------------

(a) Evaluation of
Disclosure Controls and Procedures. Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures, as defined by Rule 13a-15 of the
Securities and Exchange Act of 1934, as amended, as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our chief executive officer and our chief financial officer have concluded that our disclosure
controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods
specified in SECs rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required
disclosure.

(b) Changes in Internal Control over Financial Reporting.We reported a material weakness under Item 9A(b) in our
Annual Report on Form 10-K for the fiscal year ended December 31, 2005. The material weakness identified was the failure of our financial reporting processes to timely accrue in the 2005 financial statements for a litigation settlement that we
agreed to pay on March 3, 2006. We have addressed the material weakness by establishing additional monitoring controls over the accrual of payments associated with the settlement of litigations and other items. There were no additional changes
in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

At March 31, 2006, we did not meet the definition of accelerated filer, as defined by Rule 12b-2 of the Exchange Act.
Accordingly, if we meet the definition of accelerated filer as of June 30, 2006, we will be required by the Sarbanes-Oxley Act of 2002 to include an assessment of our internal control over financial reporting and attestation from an
independent registered public accounting firm until our Annual Report on Form 10-K for our fiscal year ending December 31, 2006. However, if we do not meet the definition of accelerated filer as of June 30, 2006, we will not be
required by the Sarbanes-Oxley Act of 2002 to include an assessment of our internal control over financial reporting and attestation from an independent registered public accounting firm until our Annual Report on Form 10-K for our fiscal year
ending December 31, 2007.



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PART II  OTHER INFORMATION



|Item 1. | Legal Proceedings.
|------- | ------------------

We were named as a co-defendant
in a lawsuit filed on August 9, 2001 in the Superior Court of California, County of San Diego, Case No. GIC 772297, by plaintiff AntiCancer. The complaint sought unspecified damages and contained five causes of action against us, all of which
are based on alleged false statements regarding plaintiff and plaintiffs technology, including trade libel, defamation, intentional interference with contract, intentional interference with prospective economic advantage and unfair
competition. On March 30, 2006, we signed a Settlement Agreement and Mutual General Release with AntiCancer pursuant to which AntiCancer released us from all claims relating to this lawsuit and agreed to dismiss, with prejudice, the complaint
filed with the court in exchange for a one-time, $1 million cash payment. We paid the $1 million to AntiCancer on April 3, 2006 and the complaint was dismissed on April 7, 2006. This settlement does not affect the patent infringement
lawsuit described below.

On March 7, 2005, AntiCancer filed a lawsuit against us in the U.S. District Court for the Southern District
of California alleging infringement of five patents of AntiCancer. The complaint seeks damages and injunctive relief against the alleged infringement. On March 29, 2005, AntiCancer amended its complaint to include an additional claim seeking a
judgment that one of our imaging patents, 5,650,135, is invalid. On May 10, 2005, we filed our answer to AntiCancers amended complaint. We denied all of AntiCancers allegations and asserted various affirmative defenses, including
our position that AntiCancers patents, including some of the patents cited in its complaint, and patent claims relating to in vivo imaging of fluorescence are invalid. We are vigorously defending ourselves against AntiCancers
claims and believe AntiCancers complaint is without merit. Concurrent with filing our answer to AntiCancers complaint, we filed our own counterclaims against AntiCancer. Our counterclaims allege that AntiCancer infringes two of our U.S.
patents, 5,650,135 and 6,649,143, both relating to in vivo imaging and with a priority date before AntiCancers patents cited in its amended complaint. Both parties seek injunctive relief and an unspecified amount of damages, including
enhanced damages for willful infringement. We intend to vigorously pursue our claims against AntiCancer. The court has scheduled the Markman hearing for June 13, 2006 through June 15, 2006, and the trial is scheduled to begin is
May 14, 2007.

From time to time we are involved in litigation arising out of claims in the normal course of business. Based on the
information presently available, management believes that there are no claims or actions pending or threatened against us, the ultimate resolution of which will have a material adverse effect on our financial position, liquidity or results of
operations, although the results of litigation are inherently uncertain, and adverse outcomes are possible.



|Item 1A. | Risk Factors.
|-------- | -------------

In addition to the forward-looking
statements discussed in this report, we also provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our business. These items are factors that we believe could cause our actual results to
differ materially from expected and historical results. Other factors also could adversely affect us.



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If our proposed merger with Caliper Life Sciences, Inc. is not consummated, our stock price, business
and operations could be harmed.

On February 10, 2006, we entered into a definitive Agreement and Plan of Merger with Caliper Life
Sciences, Inc. and its subsidiary, Caliper Holdings, Inc., pursuant to which we will be merged with and into Caliper Holdings and become a wholly-owned subsidiary of Caliper. A copy of the merger agreement and other documents relating to the merger
are attached as exhibits to the Current Report on Form 8-K that we filed with the Securities and Exchange Commission on February 16, 2006. Our Board of Directors has approved the merger and the merger agreement. On March 31, 2006, Caliper
and Xenogen filed a registration statement on Form S-4 and a notice of special meeting of stockholders and definitive proxy statement for the special meeting of stockholders pursuant to which we will ask our stockholders to adopt and approve the
merger agreement and the merger.

The obligations of Caliper and Xenogen to effect the merger are subject to a number of conditions,
including approval by the Xenogen and Caliper stockholders, and the merger may not occur. If the merger is not consummated for any reason, we may be subject to a number of material risks, including the following:



| |  |  | we may be required to pay Caliper a termination fee of $3.1 million;
| | - |  | --------------------------------------------------------------------



| |  |  | the price of our common stock may decline to the extent that the current market price of our common stock reflects an assumption that the merger will be completed; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we must pay our accrued costs related to the merger, such as legal, accounting and certain financial advisory fees, even if the merger is not completed.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------

If the merger is not consummated, our existing working capital at March 31, 2006 may not be sufficient to meet our operating, working capital,
investing and financing requirements for the next twelve months, and we will need to reevaluate our current plans and business operations and substantially reduce our operating expenses, raise additional capital or take other actions in order to
continue as an independent company.

In addition, our customers may, in response to the announcement of the merger, delay or defer
purchasing decisions. Any delay or deferral in purchasing decisions by our customers would have a material adverse effect on our business, regardless of whether or not the merger is ultimately completed.

Similarly, our current and prospective employees may experience uncertainty about their future role with Caliper until Calipers strategies with
regard to us are announced or executed. This uncertainty may adversely affect our ability to attract and retain key management, marketing, technical, manufacturing, administrative, sales and other personnel. During the first quarter of 2006 through
May 5, 2006, several of our employees have resigned or announced their resignation in part as a result of uncertainty relating to the merger.

We have a history of losses and an accumulated deficit of $191.9 million as of March 31, 2006, and we may never achieve profitability.

We have incurred significant net losses every year since our inception. We incurred losses of $20.5 million in 2003, $21.8 million in 2004, $18.6 million in 2005, and $5.6 million for the three month period ended
March 31, 2006. As of March 31, 2006, we had an accumulated deficit of $191.9 million. To achieve profitability, we will need to generate and sustain substantially higher revenue than we have to date, while achieving reasonable costs and
expense levels. We may not be able to generate enough revenue to achieve profitability. We may not achieve or maintain reasonable costs and expense levels. Even if we become profitable, we may not be able to sustain or increase profitability on a
quarterly or annual basis. If we fail to achieve profitability within the timeframe expected by securities analysts or investors, the market price of our common stock will likely decline.



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If our products and services do not become widely used by pharmaceutical, biotechnology, biomedical
and chemical researchers, it is unlikely that we will ever become profitable.

Pharmaceutical, biotechnology, biomedical and chemical
researchers have historically conducted in vivo biological assessment using a variety of technologies, including a variety of animal models. Compared to these technologies, our technology is relatively new, and the number of companies and
institutions using our technology is relatively limited. The commercial success of our products will depend upon the widespread adoption of our technology as a preferred method to perform in vivo biological assessment. In order to be successful, our
products must meet the technical and cost requirements for in vivo biological assessment within the life sciences industry. Widespread market acceptance will depend on many factors, including:



| |  |  | the willingness and ability of researchers and prospective customers to adopt new technologies;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | our ability to convince prospective strategic partners and customers that our technology is an attractive alternative to other methods of in vivo biological assessment;
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| |  |  | our customers perception that our products can help accelerate efforts and reduce costs in drug development; and
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| |  |  | our ability to sell and service sufficient quantities of our products.
| | - |  | ----------------------------------------------------------------------

Additionally, to our knowledge, only one of our drug development customers has used our imaging technology to submit an investigational new drug application, or IND, to the Food and Drug Administration, or FDA, and no
drugs have been approved to date using our imaging technology. As a result, our ability to assist the drug development process in leading to the approval of drugs with commercial potential has yet to be fully proven. If commercial advantages are not
realized from the use of in vivo biophotonic imaging, our existing customers could stop using our products, and we could have difficulty attracting new customers. Because of these and other factors, our products may not gain widespread market
acceptance or become the industry standard for in vivo biological assessment.

As a company in the early stage of commercialization, our
limited history of operations makes evaluation of our business and future growth prospects difficult.

We have had a limited operating
history and are at an early stage of commercialization. While we sold our first IVIS®Imaging Systems and entered into our first commercial license in 2000, we did not begin to sell our products and services in commercial quantities until 2002. Our in vivo biophotonic imaging technology is a relatively new technology that has
not yet achieved widespread adoption. To date, we have generated revenues of $16.0 million in 2002, $20.1 million in 2003, $30.9 million in 2004, $39.7 million in 2005, and $8.7 million for the three month period ended March 31, 2006.

We do not have enough experience in selling our products at a level consistent with broad market acceptance and to know whether we can do
so and generate a profit. As a result of these factors, it is difficult to evaluate our prospects, and our future success is more uncertain than if we had a longer or more proven history of operations.

Our future revenue is unpredictable and could cause our operating results to fluctuate significantly from quarter to quarter.

Our quarterly and annual operating results have fluctuated in the past and are likely to do so in the future. In particular, our operating results in the
first and third quarters have historically been lower than those in the second and fourth quarters due to the decision-making process of our customer base. The sale of many of our



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products, including our IVIS Imaging Systems and related Bioware, typically involve a significant scientific evaluation and commitment of capital by
customers. Accordingly, the initial sales cycles of many of our products are lengthy and subject to a number of significant risks that are beyond our control, including customers budgetary constraints and internal acceptance reviews. As a
result of this lengthy and unpredictable sales cycle, our operating results have historically fluctuated significantly from quarter to quarter, and we expect this trend to continue. In addition, a large portion of our expenses, including expenses
for our Alameda, California and Cranbury, New Jersey facilities, equipment and personnel, are relatively fixed. Historically, customer buying patterns and our revenue growth have caused a substantial portion of our revenues to occur in the last
month of the quarter. Delays in the receipt of orders, our recognition of product or service revenue or the manufacture of product near the end of the quarter could cause quarterly revenues to fall short of anticipated levels. Because our operating
expenses are based on anticipated revenue levels and a high percentage of our expenses are relatively fixed, less than anticipated revenues for a quarter could have a significant adverse impact on our operating results. Accordingly, if our revenue
declines or does not increase as we anticipate, we might not be able to correspondingly reduce our operating expenses in a timely enough manner to avoid incurring additional losses. Our failure to achieve our anticipated level of revenue could
significantly harm our operating results for a particular fiscal period.

The following are among additional factors that could cause our
operating results to fluctuate significantly from period to period:



| |  |  | changes in the demand for, and pricing of, our products and services;
| | - |  | ---------------------------------------------------------------------



| |  |  | the length of our sales cycles and buying patterns of our customers, which may cause a decrease in our operating results for a quarterly period;
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| |  |  | the nature, pricing and timing of other products and services provided by us or our competitors;
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| |  |  | changes in our long term custom animal production contracts and other renewable contracts, including licenses;
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| |  |  | our ability to obtain key components for our imaging systems and manufacture and install them on a timely basis to meet demand;
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| |  |  | changes in the research and development budgets of our customers;
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| |  |  | customer reactions to the announcement of our pending merger with Caliper;
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| |  |  | acquisition, licensing and other costs related to the expansion of our operations;
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| |  |  | the timing of milestones, licensing and other payments under the terms of our license agreements, commercial agreements and agreements pursuant to which others license technology to
us;
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| |  |  | expenses related to our patent infringement litigation with AntiCancer and other litigation in which we may become involved; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | expenses related to, and the results of, patent filings and other proceedings relating to intellectual property rights.
| | - |  | -----------------------------------------------------------------------------------------------------------------------

Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter to quarter or annual comparisons of our operating results are
not a good indication of our future performance.

The termination or non-renewal of a large contract or the loss of, or a significant
reduction in, sales to any of our significant customers could harm our operating results.

We generally sell our products and often
provide our services pursuant to agreements that are renewable on an annual basis. Failure to renew or the cancellation of these agreements by any one of our significant customers, which include Pfizer Inc. and affiliates of Novartis, could result
in a significant loss of revenue.



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We currently derive, and we expect to continue to derive, a large percentage of our total revenue from a relatively small number of customers. If any of
these customers terminates or substantially diminishes its relationship with us, our revenue could decline significantly. Revenue concentration among our largest customers is as follows:



| |  |  | our ten largest customers accounted for approximately 50% of our revenue for the three month period ended March 31, 2006 and 32.8%, 41% and 53% of our revenue for the years
ended December 31, 2005, 2004 and 2003, respectively; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our largest and second largest customers accounted for approximately 16% and 5% of our revenue for the three month period ended March 31, 2006, 12% and 5% of our revenue for
the year ended December 31, 2005, 16% and 7% of our revenue for the year ended December 31, 2004, and 21% and 11% of our revenue for the year ended December 31, 2003.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The loss of significant revenue from any of our significant customers could negatively impact our results of operations or limit our ability to execute
our strategy.

We may not fully realize our revenue under long-term contracts, which could harm our business and result in higher losses
than anticipated.

We have long-term contracts for custom animal production and/or phenotyping services with two customers that are
renewed annually and are expected to generate future revenues. These two long-term contracts may not be renewed annually and may be terminated at any time during their terms. In addition, we may not be able to maintain our sublicensed rights under
certain patents relating to these contracts. Termination of these contracts for any reason would result in the loss of significant revenue would negatively impact our results of operations or limit our ability to execute our strategy.

If we are unable to meet customer demand, it would adversely impact our financial results and restrict our sales growth.

To be successful, we must manufacture our IVIS Imaging Systems in substantial quantities at acceptable costs. If we do not succeed in manufacturing
sufficient quantities of our imaging systems to meet customer demand, we could lose customers and fail to acquire new customers, if they choose a competitors product because our imaging system is not available. Increasing demand since the
launch of our IVIS Imaging System has necessitated an increase in our manufacturing capacity. We believe our current manufacturing capacity in Alameda, California is sufficient to meet our current and forecasted demand through 2006, and we are in
the planning stages for managing this capacity. We have also experienced a shift in what we believe is long-term customer demand towards our IVIS 200 systems and, more recently, our new IVIS Lumina systems, and we have altered our planned
manufacturing to increase IVIS system output in an effort to meet this demand. Certain components of our IVIS 200 systems and IVIS 50 systems are specially manufactured by our single-source suppliers and supply of these parts to us requires adequate
lead time that can result in production delays. If we experience unexpected shifts in customer demand that requires alterations to planned manufacturing, we may experience production delays that could restrict our sales growth. If, following the
closing of the merger with Caliper, manufacturing of our IVIS systems is relocated away from our Alameda, California facility, any manufacturing delays or disruptions relating to the relocation could negatively impact our ability to meet customer
demand. If we are unable to meet customer demand for IVIS Imaging Systems, it would adversely affect our financial results and restrict our sales growth.



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We depend on a limited number of suppliers, and we will be unable to manufacture or deliver our
products if shipments from these suppliers are interrupted or are not supplied on a timely basis.

We use original equipment
manufacturers, or OEMs, for various parts of our IVIS Imaging Systems, including the cameras, boxes, certain subassemblies, filters and lenses. We obtain these key components from a small number of sources. For example, the lens for our IVIS 200
system is obtained from a single source on a purchase order basis from Coastal Optical Systems Inc., and the CCD cameras for all of our IVIS Imaging Systems are obtained from two sources, Spectral Instruments, Inc. and Andor Technology Limited. We
have binding supply agreements with Spectral and Andor. From time to time, we have experienced delays in obtaining components from certain of our suppliers, which have had an impact on our production schedule for imaging systems. We believe that
alternative sources for these components in the event of a disruption or discontinuation in supply would not be available on a timely basis, which would disrupt our operations and impair our ability to manufacture and sell our products.

Our dependence upon outside suppliers and OEMs exposes us to risks, including:



| |  |  | the possibility that one or more of our suppliers could terminate their services at any time;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | the potential inability of our suppliers to obtain required components or products;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | reduced control over pricing, quality and timely delivery, due to the difficulties in switching to alternative suppliers;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | the potential delays and expense of seeking alternative suppliers; and
| | - |  | ----------------------------------------------------------------------



| |  |  | increases in prices of raw materials, products and key components.
| | - |  | ------------------------------------------------------------------

Because we receive revenue principally from biomedical research institutions and pharmaceutical, biotechnology and chemical companies, the industry conditions faced by those companies and their capital spending
policies may have a significant effect on the demand for our products.

We market our products to pharmaceutical, biotechnology and
chemical companies and biomedical research institutions, and the capital spending policies of these entities can have a significant effect on the demand for our products. These policies vary significantly between different customers and are based on
a wide variety of factors, including the resources available for purchasing research equipment, the spending priorities among various types of research companies and the policies regarding capital expenditures. In particular, the volatility of the
public stock market for biotechnology companies has at certain times significantly impacted the ability of these companies to raise capital, which has directly affected their capital spending budgets. In addition, continued consolidation within the
pharmaceutical industry will likely delay and may potentially reduce capital spending by pharmaceutical companies involved in such consolidations. During the past several years, many of our customers and potential customers, particularly in the
biopharmaceutical industry, have reduced their capital spending budgets because of these generally adverse prevailing economic conditions, consolidation in the industry and increased pressure on the profitability of such companies, due in part to
competition from generic drugs. If our customers and potential customers do not increase their capital spending budgets, because of continuing adverse economic conditions or further consolidation in the industry, we could face weak demand for our
products. Similarly, changes in availability of grant moneys may impact our sales to academic customers. Recent developments regarding safety issues for widely used drugs, including actual and/or threatened litigation, also may affect capital
spending by pharmaceutical companies. Any decrease or delay in capital spending by life sciences or chemical companies or biomedical researchers could cause our revenue to decline and harm our profitability.

In addition, consolidation within the pharmaceutical industry may not only affect demand for our products, but also existing business relationships. If
two or more of our present or future customers merge, we may not receive the same fees under agreements with the combined entities that we received under



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agreements with these customers prior to their merger. Moreover, if one of our customers merges with an entity that is not a customer, the new combined
entity may prematurely terminate our agreement. Any of these developments could materially harm our business or financial condition.

We
depend on key employees in a competitive market for skilled personnel, and without additional employees, we cannot grow or achieve profitability.

We are highly dependent on the principal members of our management team, including David W. Carter, chairman of our board and chief executive officer, and Pamela R. Contag, Ph.D., our president. With the exception of
Mr. Carter and Dr. Contag, we do not have any key person life insurance on such individuals. Additionally, while we have change of control severance arrangements in place for the principal members of our management team, as a practical
matter, such arrangements may not ensure the employees retention. One member of our management team has resigned since the announcement of our pending merger with Caliper.

Our future success also will depend in part on the continued service of our key scientific, consulting and management personnel and our ability to
identify hire and retain additional personnel. We experience intense competition for qualified personnel. We may be unable to attract and retain personnel necessary for the development of our business. Since the announcement of our pending merger
with Caliper on February 13, 2006 through May 5, 2006, several of our employees, including certain scientific personnel, have resigned or announced their resignation. Moreover, a significant portion of our work force is located in the San
Francisco Bay Area of California, where demand for personnel with the scientific and technical skills we seek is extremely high and is likely to remain high.

If we fail to properly manage our growth, our business could be adversely affected.

We have
substantially increased the scale of our operations since our initial public offering in 2004. If we are unable to manage our growth effectively, our losses could increase. The management of our growth will depend, among other things, upon our
ability to improve our operational, financial and management controls, reporting systems and procedures. In addition, we will have to invest in additional customer support resources, hire and train additional personnel for manufacturing,
installation and field support, and expand our inventory of instrumentation parts and components, which will result in additional burdens on our systems and resources and require additional capital expenditures.

We have a limited sales and marketing organization, and although we intend to increase our sales and marketing organization, we may be unable to build
an organization to meet demand for our products and services.

We currently have a limited number of people in our sales force engaged
in the direct sale of our products, many of whom were added in 2004. Because our products are technical in nature, we believe that our sales and marketing staff must have scientific or technical expertise and experience and require they be trained
in the instrumentation and reagents that they sell. Although we expanded our sales and marketing organization in 2004 and continued our expansion efforts in 2005, the number of employees with these skills is relatively small. Competition is intense
and we may not be able to continue to attract and retain sufficient qualified people or grow and maintain an efficient and effective sales and marketing department. We have recently commenced a search for sales representatives in foreign markets
that we serve directly. In several foreign countries and regions outside the U.S., including several countries in Europe and Asia, we sell our products and services primarily through third-party distributors. We are dependent upon the sales and
marketing efforts of our third-party distributors in these international markets. These distributors may not commit the necessary resources to effectively market and sell our products and services. Further, they may



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not be successful in selling our products and services. Our financial condition would be harmed if we fail to build an adequate direct and indirect sales and
marketing organization and our marketing and sales efforts are unsuccessful.

Our intellectual property rights, including one patent
that is due to expire in 2006, may not provide meaningful commercial protection for our products, which could enable third parties to use our technology, or very similar technology, and could reduce our ability to compete in the market.

We rely on patent, copyright, trade secret and trademark laws to limit the ability of others to compete with us using the same or
similar technology in the U.S. and other countries. However, these laws afford only limited protection and may not adequately protect our rights to the extent necessary to sustain any competitive advantage we may have. The laws of some foreign
countries do not protect proprietary rights to the same extent as the laws of the U.S., and many companies have encountered significant problems in protecting their proprietary rights abroad. These problems can be caused by the absence of adequate
rules and methods for defending and enforcing intellectual property rights.

We will be able to protect our technology from unauthorized
use by third parties only to the extent that they are covered by valid and enforceable patents or are effectively maintained as trade secrets. The patent positions of companies developing tools for pharmaceutical, biotechnology, biomedical and
chemical industries, including our patent position, generally are uncertain and involve complex legal and factual questions, particularly as to questions concerning the enforceability of such patents against alleged infringement. The biotechnology
patent situation outside the U.S. is even more uncertain, particularly with respect to the patentability of transgenic animals. Changes in either the patent laws or in interpretations of patent laws in the U.S. and other countries may therefore
diminish the value of our intellectual property. Moreover, our patents and patent applications may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. We also face the risk that others
may independently develop similar or alternative technologies or design around our patented technologies.

We own, or control through
licenses, a variety of issued patents and pending patent applications. However, the patents on which we rely may be challenged and invalidated, and our patent applications may not result in issued patents. AntiCancer, Inc. filed a lawsuit against us
alleging infringement of five patents and requesting that the court declare invalid one of our primary patents covering methods of in vivo biophotonic imaging. For a description of our litigation with AntiCancer, see Part II,
Item 1. Legal Proceedings.

We have taken measures to protect our proprietary information, especially proprietary information
that is not covered by patents or patent applications. These measures, however, may not provide adequate protection of our trade secrets or other proprietary information. We seek to protect our proprietary information by entering into
confidentiality agreements with employees, collaborators and consultants. Nevertheless, employees, collaborators or consultants may still disclose our proprietary information, and we may not be able to protect our trade secrets in a meaningful way.
If we lose employees, we may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by those former employees despite the existence of nondisclosure and confidentiality agreements and other
contractual restrictions to protect our proprietary technology. In addition, others may independently develop substantially equivalent proprietary information or techniques or otherwise gain access to our trade secrets.

U.S. Patent No. 4,873,191, claiming the use of certain widely accepted microinjection techniques to create transgenic animals and licensed
exclusively to our subsidiary, Xenogen Biosciences Corp., is due to expire in October 2006. Upon its expiration, we will not be able to prevent others from practicing those



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methods for commercial purposes and we may face competition from third parties seeking to provide those services on a commercial basis.

We may need to initiate lawsuits to protect or enforce our patents or other proprietary rights, which would be expensive and, if we lose, may cause us
to lose some of our intellectual property rights, which would reduce our ability to compete in the market and may cause our stock price to decline.

We rely on patents to protect a large part of our intellectual property and competitive position. Our patents, which have been or may be issued, may not afford meaningful protection for our technologies and products.
In addition, our current and future patent applications may not result in the issuance of patents in the U.S. or foreign countries. Our competitors may develop technologies and products similar to our technologies and products which do not infringe
our patents. In order to protect or enforce our patent rights, we may initiate patent litigation against third parties, such as infringement suits or interference proceedings. This risk is exacerbated by the fact that those third parties may have
access to substantially greater financial resources than we have to conduct such litigation.

These lawsuits could be expensive, take
significant time and could divert managements attention from other business concerns. These lawsuits would put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally,
we may suffer reduced instrumentation sales and/or license revenue as a result of pending lawsuits or following final resolution of lawsuits. Further, these lawsuits may also provoke these third parties to assert claims against us. Attempts to
enforce our patents may trigger third party claims that our patents are invalid. We may not prevail in any of these suits and any damage or other remedies awarded to us, if any, may not be commercially valuable. During the course of these suits,
there may be public announcements of results of hearings, motions and other interim proceedings or developments in the litigation. If securities analysts or others perceive any of these results to be negative, it could cause our stock price to
decline.

We have filed with the court our response to the AntiCancer patent infringement lawsuit. With our response, we filed
counterclaims against AntiCancer alleging that it infringes two of our U.S. patents. For a description of our litigation with AntiCancer, see Part II, Item 1. Legal Proceedings.

Our success will depend partly on our ability to operate without infringing or misappropriating the proprietary rights of others.

We may be exposed to future litigation by third parties based on claims that our products infringe the intellectual property rights of others. This risk
is exacerbated because there are numerous issued and pending patents in the life sciences industry and, as described above, the validity and breadth of life sciences patents involve complex legal and factual questions. Our competitors may assert
that their U.S. or foreign patents may cover our products and the methods we employ. For example, one of our principal competitors, Lexicon Genetics Incorporated, had been involved in litigation regarding intellectual property claims relating to the
creation of transgenic animals. In addition, we are involved in patent litigation with AntiCancer, Inc., in which it has alleged that we have infringed certain of its patents. We have counterclaimed with allegations that AntiCancer infringes our
imaging patents, as well as allegations that certain AntiCancers patents are invalid. For a description of our litigation with AntiCancer, see Part II, Item 1. Legal Proceedings. Also, because patent applications can take many
years to issue, there may be currently pending applications, of which we are unaware, which may later result in issued patents that our products may infringe. There could also be existing patents of which we are not aware that one or more of our
products may inadvertently infringe.

From time to time, we have received, and may receive in the future, letters asking us to license
certain technologies the signing party believes we may be using or would like us to use. In 2004 and 2005, we



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received letters from counsel for Lexicon Genetics Incorporated asking us to review with them one of our methods for genetically modified animal production
in relation to two patents which they exclusively license. Although we declined to do so, we are in the process of determining whether their patents may offer a more cost effective approach to certain methods of animal production.

If we do not accept a license, we may be subject to claims of infringement, or may receive letters alleging infringement. Infringement and other
intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and can divert managements attention from our core business.

If we lose a patent infringement lawsuit, we could be prevented from selling our products unless we can obtain a license to use technology or ideas covered by such patent or are able to redesign the products to avoid
infringement. A license may not be available at all or on terms acceptable to us, or we may not be able to redesign our products to avoid any infringement. If we are not successful in obtaining a license or redesigning our products, we may be unable
to sell our products and our business could suffer.

Our rights to the use of technologies licensed to us by third parties are not
within our control, and without these technologies, our products and programs may not be successful and our business prospects could be harmed.

We rely on licenses to use various technologies that are material to our business, including licenses, with sublicense rights, to in vivo imaging methods, licenses to the use of certain biologicals, and licenses to engineer and
commercialize transgenic animals. We do not own the patents that underlie these licenses. Our rights to use these technologies and employ the inventions claimed in the licensed patents are subject to the negotiation of, continuation of and
compliance with the terms of those licenses and the continued validity of these patents. In some cases, we do not control the prosecution or filing of the patents to which we hold licenses. Instead, we rely upon our licensors to prevent infringement
of those patents. Under the GenPharm International, Inc. sublicense for certain gene targeting patents we use, GenPharm retains the sole right to enforce those patent rights against infringers. Under the Promega Corporation and The Regents of the
University of California licenses for a patented form of firefly luciferase used in our LPTA animal models and certain of our Bioware, we do not have the right to enforce the patent, and neither licensor is obligated to do so on our behalf. Certain
of our licenses contain diligence obligations, as well as provisions that allow the licensor to terminate the license upon specific conditions. Some of the licenses under which we have rights, such as our licenses from Stanford University and Ohio
University, provide us with exclusive rights in specified fields, including the right to enforce the patents licensed to us from these two universities, but the scope of our rights under these and other licenses may become subject to dispute by our
licensors or third parties. We are currently discussing with Stanford the scope of products that we sell which are subject to the royalty provisions of our Stanford license agreement. As a result of these discussions, we may amend the license
agreement to change the royalties we pay to Stanford for future product sales. The amendment may also include the payment of back royalties to Stanford for products we have already sold. We have not discussed with Stanford the specific
terms and conditions of an amendment or the amount of any back royalty payments nor has Stanford made a demand for a payment of a specific back royalty amount. Accordingly, we have not accrued for any such payments in our financial
statements. If back royalties are owed to Stanford, we do not believe that they would exceed $393,000 for products sales through March 31, 2006. Any increase in the royalties we pay to Stanford would negatively impact our gross margins.

We occasionally may become subject to commercial disputes that could harm our business.

We may from time to time become engaged in commercial disputes such as claims by customers, employees, suppliers or other third parties. These disputes
could result in monetary damages or other remedies that could adversely impact our financial position or operations. For example, on August 9, 2001,



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AntiCancer, Inc. filed a lawsuit in the Superior Court of California, County of San Diego, against us and other third parties. In March 2006, we settled this
lawsuit with AntiCancer. For a description of this settlement and our patent infringement litigation with AntiCancer, see Part II, Item 1. Legal Proceedings.

On March 7, 2005, AntiCancer filed a lawsuit against us in the U.S. District Court for the Southern District of California alleging infringement of
five of its patents. The complaint seeks damages and injunctive relief against the alleged infringement as well as a judgment that one of our imaging patents, 5,650,135, is invalid. We are vigorously defending ourselves against AntiCancers
infringement claims and vigorously defending the validity of our 5,650,135 patent. In addition, we filed our own counterclaims against AntiCancer, alleging that its activities infringe three of our U.S. patents, 5,650,135, 6,217,847 and 6,649,143,
all relating to in vivo imaging and with a priority date earlier than AntiCancers patents cited against us.

Even if we
prevail in this lawsuit, the defense of this or similar lawsuits will be expensive and time-consuming and may distract our management from operating our business.

If our pending merger with Caliper is not consummated, we may need to raise additional capital to continue to grow our business and compete, which capital may not be available to us.

If our pending merger with Caliper is not consummated, our existing working capital at March 31, 2006 may not be sufficient to meet our
operating, working capital, investing and financing requirements for the next twelve months, and we will need to reevaluate our current plans and business operations and substantially reduce our operating expenses, raise additional capital or take
other actions in order to continue as an independent company. If we need to raise additional capital, we cannot be certain that any such financing will be available on acceptable terms, or at all. Additional equity financing, if available, would
likely be dilutive to the holders of our common stock. Borrowings from our existing lenders or new lenders, if available, would increase our debt-maintenance expenses and compliance reporting requirements, and would likely involve restrictive
covenants and a security interest in our assets.

If we need to raise additional capital and adequate funds are not available, we will
have to take measures to further reduce our operating expenses, such as reducing headcount, delaying or canceling development or commercialization of our products and services, deferring the acquisition of complimentary products or
licensing to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. Any of these results could harm our financial condition. If we need to but are not able to raise sufficient
additional capital, it would adversely affect our ability to achieve our business objectives and to continue as an independent company.

We face competition from companies with established technologies for in vivo biological assessment, which may prevent us from achieving significant market share for our products.

We compete with a variety of established and accepted technologies for in vivo biological assessment that several competitors and customers may be
using to analyze animal models. The most basic of these technologies have remained relatively unchanged for the past 40 years, are well established and are routinely used by researchers. We believe it may take several years for all researchers to
become fully educated about our in vivo biophotonic imaging technology.

We believe that in the near term, the market for in vivo
biological assessment will be subject to rapid change and will be significantly affected by new technology introductions and other market activities of industry participants. As other companies develop new technologies and products to conduct in
vivo biological assessment, we may be required to compete with many larger companies that enjoy several competitive advantages, including:



| |  |  | established distribution networks;
| | - |  | ----------------------------------



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| |  |  | established relationships with life science, pharmaceutical, biotechnology and chemical companies as well as with biomedical researchers;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | additional lines of products, and the ability to offer rebates or bundle products to offer higher discounts or incentives to gain a competitive advantage; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | greater resources for technology and product development, sales and marketing and patent litigation.
| | - |  | ----------------------------------------------------------------------------------------------------

Our principal competitors that use established technologies for in vivo biological assessment include Exelixis, Inc. and Lexicon Genetics
Incorporated. Each of these companies uses animal models in the area of target validation in drug discovery and utilizes methods of assessment based upon knockout mice as well as other organisms such as fruit flies, worms and yeast. We face
competition from several companies including Eastman Kodak Company, Berthold Detection Systems GmbH, Hamamatsu Photonics, Olympus Corporation, K.K. and Roper Scientific, Inc., that market systems that may be used to perform biophotonic imaging with
the appropriate licenses. These companies are larger and have greater resources than Xenogen. There are also several privately-held companies that have recently begun to market systems that may be used to perform biophotonic imaging with the
appropriate licenses. At any time, other companies may develop additional directly competitive products that could achieve greater market acceptance or render our products obsolete.

Contamination in our animal populations could damage our inventory, harm our reputation and result in decreased sales.

We offer a portfolio of transgenic animals and LPTA animal models for use by researchers in a wide range of research and drug discovery programs and also
perform breeding and model validation. We maintain animal facilities in Alameda, California and Cranbury, New Jersey. These animals and facilities must be free of contaminants, viruses or bacteria, or pathogens that would compromise the quality of
research results. Contamination of our isolated breeding rooms could disrupt our models, delay delivery to customers of data generated from phenotyping and result in decreased sales. Contamination would result in inventory loss, clean-up and
start-up costs and reduced sales as a result of lost customer orders.

In 2003, one of our animal facilities in Alameda was contaminated by
a mouse virus introduced through one of our animal vendors. We closed that facility for decontamination, and transferred our most valuable strains to third party breeders for rederivation so that we could continue to provide animals to our
customers. The decontamination process took approximately three months. We have moved all of these operations to a new barrier facility to reduce the contamination risk. Similar contamination occurred again in 2005. Neither event represented a loss
of revenue, but did affect our operational costs by increasing our animal support costs.

If a natural or man-made disaster strikes our
manufacturing facility, we would be unable to manufacture our products for a substantial amount of time and we would experience lost revenue.

We have relied to date principally on our manufacturing facility in Alameda, California to produce the IVIS Imaging Systems, our Bioware cells and microorganisms and LPTA animal models. We have also established a back-up facility for
producing our LPTA animal models in Cranbury, New Jersey and have produced some of our LPTA animal models there. Both of these facilities and some pieces of manufacturing equipment would be difficult to replace and could require substantial
replacement lead-time. Our facilities may be affected by natural disasters such as earthquakes and floods. Earthquakes are of particular significance to our Alameda facility, as it is located in an earthquake-prone area. In the event our Alameda
facility or



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equipment was affected by man-made or natural disasters, we would be forced to shift production of the IVIS Imaging Systems and many of our Bioware cells and
microorganisms and LPTA animal models to our Cranbury facility. We believe that this production shift would result in a disruption in our operations of approximately 90 to 180 days, which could harm our business. Although we currently maintain
global property insurance for damage to our property and the disruption of our business from fire and other casualties, such insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on
acceptable terms, or at all.

Terrorist acts, acts of war and natural disasters may seriously harm our business and revenues, costs and
expenses and financial condition.

Terrorist acts, acts of war and natural disasters (wherever located around the world) may cause
damage or disruption to us, our employees, facilities, partners, suppliers, distributors and customers, any and all of which could significantly impact our revenues, expenses and financial condition. The terrorist attacks that took place in the
United States on September 11, 2001 were unprecedented events that have created many economic and political uncertainties. The potential for future terrorist attacks, the national and international responses to terrorist attacks and other acts
of war or hostility have created many economic and political uncertainties that could adversely affect our business and results of operations that cannot presently be predicted. The tsunami in Asia on December 26, 2004 was unpredictable and
caused devastation of tremendous proportions and its effects are still being realized. The unpredictability of such a disaster inevitably causes uncertainty that could adversely affect our business and results of operations. We are largely uninsured
for losses and interruptions caused by terrorist acts, acts of war and natural disasters.

We use hazardous materials in our business.
Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our research and
development processes, our anesthesia systems used with our IVIS Imaging Systems to anesthetize the animals being imaged and our general biology operations involve the controlled storage, use and disposal of hazardous materials including, but not
limited to, biological hazardous materials and radioactive compounds. We are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of these materials and waste products. Although we believe
that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be completely eliminated.
In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We currently maintain a limited pollution cleanup insurance policy in the
amount of $1.0 million. We may not be able to maintain insurance on acceptable terms, or at all. We could be required to incur significant costs to comply with current or future environmental laws and regulations.

Compliance with governmental regulations could increase our operating costs, which would adversely affect the commercialization of our technology.

The Animal Welfare Act, or AWA, is the federal law that covers the treatment of certain animals used in research. The AWA currently
does not cover rats of the genus Rattus or mice of the genus Mus bred for use in research, and consequently, we are not currently required to be in compliance with this law.

Currently, the AWA imposes a wide variety of specific regulations that govern the humane handling, care, treatment and transportation of certain animals
by producers and users of research animals, most notably personnel, facilities, sanitation, cage size, feeding, watering and shipping conditions. If in the future the AWA is amended to include mice or rats bred for use in research in the scope of
regulated animals, we will become subject to registration, inspections and reporting requirements. We believe compliance with such regulations



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would require us to modify our current practices and procedures, which could require significant financial and management resources.

Furthermore, some states have their own regulations, including general anti-cruelty legislation, which establish certain standards in handling animals.
To the extent that we provide products and services overseas, we also have to comply with foreign laws, such as the European Convention for the Protection of Animals During International Transport and other anti-cruelty laws. In addition, customers
of our mice in certain countries may need to comply with requirements of the European Convention for the Protection of Vertebrate Animals Used for Experimental and Other Scientific Purposes. Additional or more stringent regulations in this area
could impact our sales of laboratory animals into signatory countries.

Since we develop animals containing changes in their genetic
make-up, we may become subject to a variety of laws, guidelines, regulations and treaties specifically directed at genetically modified organisms. The area of environmental releases of genetically modified organisms is rapidly evolving and is
currently subject to intense regulatory scrutiny, particularly overseas. If we become subject to these laws, we could incur substantial compliance costs. For example, the Biosafety Protocol, an international treaty adopted in 2000 to which the U.S.
is not a party, regulates the transit of living modified organisms, a category that includes our transgenic mice, into countries party to the treaty. As our mice are not intended for release into the environment or for use for food, feed or
processing, the treaty imposes only identification, handling, packaging and transport requirements for shipments into signatory countries. However, additional requirements may be imposed on such shipments in the future.

Additionally, exports of our IVIS Imaging Systems and biological reagents to foreign customers and distributors are governed by the International Traffic
in Arms Regulations, the Export Administration Regulations, Patriot Act and Bioterrorism Safety Act. Although these laws and regulations do not restrict our present foreign sales programs, any future changes to these regulatory regimes may
negatively affect or limit our foreign sales.

Public perception of ethical and social issues may limit or discourage the use of mice
for scientific experimentation, which could reduce our revenues and adversely affect our business.

Governmental authorities could, for
social or other purposes, limit the use of genetic modifications or prohibit the practice of our technology. Public attitudes may be influenced by claims that genetically engineered products are unsafe for use in research or pose a danger to the
environment. The subject of genetically modified organisms, like genetically altered mice and rats, has received negative publicity and aroused significant public debate. In addition, animal rights activists could protest or make threats against our
facilities, which may result in property damage. Ethical and other concerns about our methods, particularly our use of genetically altered mice and rats, could adversely affect our market acceptance.

Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees, and adoption of changes in
accounting for equity compensation could adversely affect earnings.

We have historically used stock options and other forms of
equity-related compensation as key components of our total employee compensation program in order to align employees interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages.
Effective January 1, 2006, we adopted FAS 123(R) approved by the Financial Accounting Standards Board that requires us to record a charge to earnings for employee stock option grants and other equity incentives. Moreover, applicable stock
exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant options to employees in the future. As a result, we may incur increased compensation costs,
change our equity compensation strategy or



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find it difficult to attract, retain and motivate employees, any of which could materially adversely affect our business.

We expect that our stock price will fluctuate significantly, and you may not be able to resell your shares at or above your investment price.

The stock market has experienced extreme price and volume fluctuations. The market prices of the securities of biotechnology
companies, particularly companies like ours with short operating histories and without consistent product revenues and earnings, have been highly volatile and may continue to be highly volatile in the future. This volatility has often been unrelated
to the operating performance of particular companies. Factors that could cause this volatility in the market price of our common stock include:



| |  |  | announcements of technological innovations or new products by our competitors;
| | - |  | ------------------------------------------------------------------------------



| |  |  | announcements relating to our pending merger with Caliper;
| | - |  | ----------------------------------------------------------



| |  |  | developments or disputes concerning patents or proprietary rights, or of infringement, interference or other litigation against us or our licensors;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing and development of our products and services;
| | - |  | --------------------------------------------------------



| |  |  | changes in our revenue due to contracts which are not renewed;
| | - |  | --------------------------------------------------------------



| |  |  | changes in pharmaceutical and biotechnology companies research and development expenditures;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | announcements concerning our competitors, or the biotechnology or pharmaceutical industry in general;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | new regulatory pronouncements and changes in regulatory guidelines;
| | - |  | -------------------------------------------------------------------



| |  |  | general and industry-specific economic conditions and issuance of new or changed research, reports or recommendations by industry or financial analysts about us or our business;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | actual or anticipated fluctuations in our operating results;
| | - |  | ------------------------------------------------------------



| |  |  | changes in financial estimates or recommendations by securities analysts, or termination of research coverage;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | changes in accounting principles; and
| | - |  | -------------------------------------



| |  |  | the loss of any of our key scientific or management personnel.
| | - |  | --------------------------------------------------------------

These and other external factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise negatively
affect the liquidity of our common stock. In the past, securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Whether or not meritorious, litigation brought
against us could result in substantial costs, divert managements attention and resources and harm our financial condition and results of operations.

On February 10, 2006, we entered into a merger agreement with Caliper and Calipers subsidiary, Caliper Holdings. Pursuant to the merger agreement, we will be merged with and into Caliper Holdings and become
a wholly-owned subsidiary of Caliper. We publicly announced the signing of the merger agreement on February 13, 2006. From February 13, 2006 through May 1, 2006, the per share closing prices for our common stock as reported by Nasdaq
was between $3.71 and $4.15. If the merger is not consummated, our stock price would likely decrease and would likely be highly volatile as it was prior to our announcement of the merger agreement.



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We have begun a more extensive assessment of the adequacy of our internal control system, which will
be costly and could result in the identification of deficiencies in our system of internal controls.

Section 404 of the
Sarbanes-Oxley Act of 2002 requires management to include an annual report regarding our evaluation of our internal controls in the companys annual report for the year ending December 31, 2006 if we are an accelerated filer as
defined by Rule 12b-2 of the Securities and Exchange Act of 1934, as amended, as of June 30, 2006 or December 31, 2007 if we are not an accelerated filer as of June 30, 2006. In preparation for that management report, we
will need to assess the adequacy of our internal controls, remediate any weaknesses that may be identified, validate that controls are functioning as documented and implement a continuous reporting and improvement process for internal controls. We
expect to utilize outside consultants to assist with this project, which will increase our selling, general and administrative costs in 2006 and 2007. We may also discover deficiencies that require us to improve our procedures, processes and systems
in order to ensure that our internal controls are adequate and effective, and that we are in compliance with the requirements of Section 404 of the Sarbanes-Oxley Act. If the deficiencies are not adequately addressed, or if we are unable to
complete all of our testing and any remediation in time for compliance with the requirements of Section 404 of the Sarbanes-Oxley Act and the SEC rules under it, we would be unable to conclude that our internal controls over financial reporting
are designed and operating effectively, which could adversely affect our investor confidence in our internal controls over financial reporting.

If the ownership of our common stock continues to be highly concentrated, it may prevent you and other stockholders from influencing significant corporate decisions and may result in conflicts of interest that could cause our stock price
to decline.

Our executive officers, directors and stockholders affiliated with our directors beneficially own or control approximately
42 percent of the outstanding shares of our common stock as of May 1, 2006. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors may perceive disadvantages in owning
stock in companies with controlling stockholders. These stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders, including the election and removal of directors and
any proposed merger, consolidation or sale of all or substantially all of our assets. In addition, they could dictate the management of our business and affairs. This concentration of ownership could have the affect of delaying, deferring or
preventing a change in control, or impeding a merger or consolidation, takeover or other business combination that could be favorable to you. In order to facilitate the consummation of the transactions contemplated by the merger agreement, Caliper
entered into voting agreements dated February 10, 2006, with certain of our stockholders whereby the stockholders will vote (or cause to be voted) in person or by proxy all shares of Xenogen common stock held by them in favor of the adoption of
the merger agreement and against any competing transaction, and against any other proposal properly put to a vote of our stockholders that would be reasonably likely to result in or cause a breach of Xenogens representations and warranties set
forth in the merger agreement. The stockholders that signed the voting agreements beneficially own approximately 37 percent of our outstanding shares of common stock as of May 1, 2006 and include certain of our executive officers and directors
and entities affiliates with them.

Future sales of common stock by our existing stockholders may cause our stock price to fall.

The market price of our common stock could decline as a result of sales by our existing stockholders of shares of common stock in the
market, or the perception that these sales could occur. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem appropriate. Most of our shares are freely tradable without restriction or
further regulation, other than shares purchased by our officers, directors or other affiliates within the meaning of Rule 144 under the Securities Act. Also, many of our



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employees and consultants may exercise their stock options in order to sell the stock underlying their options in the market under a registration statement
we have filed with the SEC.

We may engage in future acquisitions, which could be expensive and time consuming, and such acquisitions
could adversely affect your investment in us as we may never realize any benefits from such acquisitions.

We currently have no
commitments or agreements with respect to any material acquisitions. If we do undertake any transactions of this sort, the process of integrating an acquired business, technology, service or product may result in operating difficulties and
expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business. Moreover, we may never realize the anticipated benefits of any acquisition. Future acquisitions could result in
potentially dilutive issuances of equity securities, the incurrence of debt and contingent liabilities and amortization expenses related to other intangible assets or the impairment of goodwill, which could adversely affect our results of operations
and financial condition.

Our charter documents and Delaware law may inhibit a takeover that stockholders consider favorable and could
also limit the market price of investors stock.

Our certificate of incorporation and bylaws contain provisions that could also
delay or prevent a change in control of our company. Among these provisions are the following:



| |  |  | authorize the issuance of preferred stock which can be created and issued by the board of directors without prior stockholder approval, commonly referred to as blank
check preferred stock, with rights senior to those of common stock;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | prohibit stockholder actions by written consent; and
| | - |  | ----------------------------------------------------



| |  |  | provide for a classified board of directors.
| | - |  | --------------------------------------------

In
addition, we are governed by the provisions of Section 203 of Delaware General Corporate Law. These provisions may prohibit stockholders owning 15% or more of our outstanding voting stock from merging or combining with us. Section 203 of
Delaware General Corporate Law and other provisions in our amended and restated certificate of incorporation and bylaws and under Delaware law could reduce the price that investors might be willing to pay for shares of our common stock in the future
and result in the market price being lower than it would be without these provisions.



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

(a) Sale of Unregistered Shares

Not applicable.

(b) Use of Proceeds

On July 21,
2004, we completed our initial public offering of 4.2 million shares of our common stock at a price of $7.00 per share. The offering was made pursuant to our Registration Statement on Form S-1 (File No. 333-114152), which was declared
effective by the Securities and Exchange Commission on July 15, 2004. The offering provided net proceeds to us of approximately $24.9 million, which is net of underwriters discounts and commissions of approximately $2.1 million, and
related legal, accounting, printing and other expenses totaling approximately $2.4 million.



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We have used and intend to continue to use the proceeds from the offering for use in the operation and
expansion of our business. Through March 31, 2006, we used the following net proceeds from the offering: $5.8 million for inventory purchases, $8.7 million for employee payroll, and $10.4 million for other corporate related expenses, including
debt, facility costs, insurance premiums and supplies.



|Item 3. | Defaults Upon Senior Securities.
|------- | --------------------------------

None.



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

None.



|Item 5. | Other Information.
|------- | ------------------

Not applicable.



|Item 6. | Exhibits.
|------- | ---------



| | (a) | Exhibits.
| | --- | ---------



|              |  |                                                                                                                                                                               
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                   
|10.1         |  | Amendment, dated May 2, 2006, to Contract between Xenogen Biosciences Corporation and The National Institute of Environmental Health Sciences dated September 19, 2003        
|              | 
|31.1          |  | Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                        
|              | 
|31.2          |  | Certification by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                        
|              | 
|32            |  | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

---

| | Confidential treatment requested for portions of this exhibit.
|- | --------------------------------------------------------------



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on May 12, 2006.



XENOGEN CORPORATIONBy:

/s/ DAVID W. CARTERDavid W. CarterChairman of the Board and Chief Executive OfficerBy:

/s/ WILLIAM A. ALBRIGHT, JR.William A. Albright, Jr.Senior Vice President, Finance and Operations, and Chief Financial Officer




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EXHIBIT INDEX



|              |  |                                                                                                                                                                               
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                   
|10.1         |  | Amendment, dated May 2, 2006, to Contract between Xenogen Biosciences Corporation and The National Institute of Environmental Health Sciences dated September 19, 2003        
|              | 
|31.1          |  | Certification by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                        
|              | 
|31.2          |  | Certification by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                        
|              | 
|32            |  | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

---

| | Confidential treatment requested for portions of this exhibit.
|- | --------------------------------------------------------------



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