**UNITED
      STATES**


**SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
  **FORM
        10-Q**
 
 **(Mark
        One)**
 
 **[X]** **Quarterly
        Report Pursuant To Section 13 Or 15(d) Of The**
 **Securities
        Exchange Act Of 1934**
 **For
        the quarterly period ended September 30, 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: 0-23317**
 
 **GENE
        LOGIC INC.**
 
 (Exact
        name of registrant as specified in its charter)
 
  **Delaware**
              
              **06-1411336**(State
                  or other jurisdiction of
              
              (I.R.S.
                  Employerincorporation
                  or organization)
              
              Identification
                  No.)**610
                  Professional Drive****Gaithersburg,
                  Maryland 20879**(Address
                  of principal executive offices)**(301)
                  987-1700**(Registrant’s
                  phone number, including area code)
 
 Indicate
        by check mark whether the registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
        the
        preceding 12 months (or for such shorter period that the registrant was required
        to file such reports) and (2) has been subject to such filing requirements
        for
        the past 90 days: **** YES **** **x** NO **o**
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
 
 Large
        accelerated filer **o**  Accelerated
        filer **x** Non-accelerated
        filer **o**
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). YES **o**  NO **x**
 
 The
        number
        of shares outstanding of the Registrant’s Common Stock, $.01 par value, was
        31,819,698 as of October 31, 2006.













**GENE
        LOGIC INC.**
  **TABLE
        OF CONTENTS**
  **PART
        I F** **INANCIAL
        INFORMATION**


Item
                1.
            Financial
              Statements
            3




Consolidated
              Condensed Balance Sheets at September 30,
              2006 and December 31, 2005
            3Consolidated
              Condensed Statements of Operations for the
              Three and Nine Months Ended September 30, 2006 and 2005
            4Consolidated
              Condensed Statements of Cash Flows for the
              Nine Months Ended September 30, 2006 and 2005
            5Notes
              to Consolidated Condensed Financial
              Statements
            6


Item
                  2.
              Management’s
                  Discussion and Analysis of Results of
                  Operations and Financial Condition
              14
  Item
                  3.
              Quantitative
                    and Qualitative Disclosure about Market
                    Risk
              20
 Item
                    4.
                Controls
                        and Procedures
                21




**PART II OTHER
        I** **NFORMATION**


Item
                    1.
                Legal
                    Proceedings
                21
  Item
                    1A.
                Risk
                    Factors
                22
  Item
                    2.
                Unregistered
                    Sales of Equity Securities and Use of
                    Proceeds
                22
  Item
                    3.
                Defaults
                    Upon Senior Securities
                22
  Item
                    4.
                Submission
                    of Matters to a Vote of Security
                    Holders
                22
  Item
                    5.
                Other
                    Information
                22
  Item
                    6.
                Exhibits
                22
  Signatures
                
                23
  2.


**PART
        I****FINANCIAL
        INFORMATION**
 
 **Item
        1.****Financial
        Statements**
 **GENE
        LOGIC INC.**
 
 **CONSOLIDATED
        CONDENSED BALANCE SHEETS**
 **(in
        thousands, except share data)**
 **September
                    30,**
                
                **December
                    31,****2006**
                
                **2005****(Unaudited)****ASSETS**Current
                    assets:Cash
                    and cash equivalents
                
                $
                24,115
                
                $
                43,946Marketable
                    securities available-for-sale
                
                
                21,401
                
                
                38,179Accounts
                    receivable, net of allowance of $45 and $255 as of September
                    30, 2006 andDecember
                    31, 2005, respectively
                
                
                373
                
                
                1,779Unbilled
                    services
                
                
                329
                
                
                3,001Inventory,
                    net
                
                
                2,531
                
                
                3,091Prepaid
                    expenses
                
                
                1,830
                
                
                1,548Other
                    current assets
                
                
                959
                
                
                839Assets
                    of discontinued operations held for sale
                
                
                19,735
                
                
                32,889Total
                    current assets
                
                
                71,273
                
                
                125,272Property
                    and equipment, net
                
                
                13,636
                
                
                15,603Long-term
                    investments
                
                
                2,964
                
                
                3,239Goodwill
                
                
                2,677
                
                
                2,677Other
                    intangibles, net
                
                
                10,351
                
                
                13,399Other
                    assets
                
                
                819
                
                
                529Total
                    assets
                
                $
                101,720
                
                $
                160,719**LIABILITIES
                    AND STOCKHOLDERS' EQUITY**Current
                    liabilities:Accounts
                    payable
                
                $
                2,344
                
                $
                4,802Accrued
                    compensation and employee benefits
                
                
                4,040
                
                
                6,277Accrued
                    restructuring costs
                
                
                3,905
                
                
                -Other
                    accrued expenses
                
                
                2,630
                
                
                3,554Current
                    portion of long-term debt
                
                
                498
                
                
                497Acquired
                    technologies payable
                
                
                -
                
                
                3,492Deferred
                    revenue
                
                
                3,917
                
                
                9,613Liabilities
                    of discontinued operations held for sale
                
                
                6,513
                
                
                5,084Total
                    current liabilities
                
                
                23,847
                
                
                33,319Deferred
                  revenue
                
                
                214
                
                
                -Long-term
                    debt, net of current portion
                
                
                91
                
                
                127Deferred
                    rent
                
                
                1,635
                
                
                2,417Total
                    liabilities
                
                
                25,787
                
                
                35,863Commitments
                    and contingencies
                
                
                -
                
                
                -Stockholders'
                    equity:Preferred
                    stock, $.01 par value; 10,000,000 shares authorized; and no shares
                    issued
                    andoutstanding
                    as of September 30, 2006 and December 31, 2005
                
                
                -
                
                
                -Common
                    stock, $.01 par value; 60,000,000 shares authorized; 31,810,471
                    and
                    31,771,835 sharesissued
                    and outstanding as of September 30, 2006 and December 31, 2005,
                    respectively
                
                
                318
                
                
                318Additional
                    paid-in-capital
                
                
                386,420
                
                
                385,586Accumulated
                    other comprehensive loss
                
                
                (97
                )
                
                (78
                )Accumulated
                    deficit
                
                
                (310,708
                )
                
                (260,970
                )Total
                    stockholders' equity
                
                
                75,933
                
                
                124,856Total
                    liabilities and stockholders' equity
                
                $
                101,720
                
                $
                160,719
  See
        accompanying notes.
  3.




**GENE
        LOGIC INC.**
 
 **CONSOLIDATED
        CONDENSED STATEMENTS OF
        OPERATIONS**
 **(in
        thousands, except per share data)**
 **(Unaudited)**
  **Three
                    Months Ended**
                
                **Nine
                    Months Ended****September
                    30,**
                
                **September
                    30,****2006**
                
                **2005**
                
                **2006**
                
                **2005**Revenue:Genomics
                    services
                
                $
                3,698
                
                $
                11,719
                
                $
                17,129
                
                $
                39,125Drug
                    repositioning services
                
                
                6
                
                
                102
                
                
                36
                
                
                316Total
                    revenue
                
                
                3,704
                
                
                11,821
                
                
                17,165
                
                
                39,441Expenses
                    (1):Database
                    production
                
                
                5,978
                
                
                7,340
                
                
                21,277
                
                
                23,543Research
                    and development
                
                
                2,618
                
                
                1,818
                
                
                7,599
                
                
                4,659Selling,
                    general and administrative
                
                
                4,373
                
                
                5,823
                
                
                14,357
                
                
                16,864Restructuring
                
                
                5,377
                
                
                -
                
                
                5,377
                
                
                -Total
                    expenses
                
                
                18,346
                
                
                14,981
                
                
                48,610
                
                
                45,066Loss
                    from operations
                
                
                (14,642
                )
                
                (3,160
                )
                
                (31,445
                )
                
                (5,625
                )Interest
                    (income), net
                
                
                (633
                )
                
                (727
                )
                
                (2,162
                )
                
                (1,844
                )Other
                    (income) expense
                
                
                (66
                )
                
                (133
                )
                
                35
                
                
                (560
                )Write-down
                    of equity investment
                
                
                -
                
                
                -
                
                
                275
                
                
                -Loss
                    from continuing operations
                
                
                (13,943
                )
                
                (2,300
                )
                
                (29,593
                )
                
                (3,221
                )Loss
                    from discontinued operations (1)
                
                
                (12,712
                )
                
                (37,180
                )
                
                (20,145
                )
                
                (42,970
                )Net
                    loss
                
                $
                (26,655
                )
                $
                (39,480
                )
                $
                (49,738
                )
                $
                (46,191
                )Basic
                    and diluted net loss per share:Loss
                    from continuing operations
                
                $
                (0.44
                )
                $
                (0.07
                )
                $
                (0.93
                )
                $
                (0.10
                )Loss
                    from discontinued operations
                
                
                (0.40
                )
                
                (1.17
                )
                
                (0.63
                )
                
                (1.36
                )Net
                    loss
                
                $
                (0.84
                )
                $
                (1.24
                )
                $
                (1.56
                )
                $
                (1.46
                )Shares
                      used in computing basic and diluted net loss per
                      share
                
                
                31,810
                
                
                31,756
                
                
                31,802
                
                
                31,736(1)
                    Line items include non-cash stock compensation expense as follows
                    (see
                    Note 2):Database
                    production
                
                $
                25
                
                $
                -
                
                $
                126
                
                $
                -Research
                    and development
                
                
                16
                
                
                -
                
                
                79
                
                
                -Selling,
                    general and administrative
                
                
                49
                
                
                -
                
                
                242
                
                
                -Loss
                    from discontinued operations
                
                
                49
                
                
                -
                
                
                242
                
                
                -Total
                    non-cash stock compensation expense
                
                $
                139
                
                $
                -
                
                $
                689
                
                $
                -
 See
        accompanying notes.
  4.


**GENE
      LOGIC INC.**





**CONSOLIDATED
      CONDENSED STATEMENTS OF CASH
      FLOWS**


**(in
      thousands)**


**(Unaudited)**


**Nine
                  Months Ended****September
                  30,****2006**
              
              
              **2005**Cash
                  flows from operating activities:Loss from
                  continuing operations
              
              $
              (29,593
              )
              $
              (3,221
              )Adjustments
                  to reconcile loss from continuing operations to net cash flows
                  from continuing operating activities:Depreciation
                  and amortization
              
              
              8,067
              
              
              8,164Restructuring
              
              
              5,377
              
              
              -Non-cash
                  stock compensation expense
              
              
              447
              
              
              -Inventory
                  impairment
              
              
              675
              
              
              -Write-down
                  of equity investment
              
              
              275
              
              
              -Other
                  non-cash items
              
              
              (7
              )
              
              152Changes
                  in continuing operating assets and liabilities:Accounts
                  receivable and unbilled services
              
              
              4,078
              
              
              2,923Inventory
              
              
              (115
              )
              
              (2,587
              )Prepaids
                  and other assets
              
              
              (692
              )
              
              (392
              )Accounts
                  payable
              
              
              (2,458
              )
              
              721Accrued
                  expenses and deferred rent
              
              
              (3,683
              )
              
              3,870Accrued
                  technologies payable
              
              
              (3,492
              )
              
              -Deferred
                  revenue
              
              
              (5,482
              )
              
              3,187Net
                  cash flows from continuing operating activities
              
              
              (26,603
              )
              
              12,817Loss
                  from discontinued operations
              
              
              (20,145
              )
              
              (42,970
              )Adjustments
                  to reconcile net loss from discontinued operations to net cash
                  flows from
                  discontinued operating activities:Impairment
                  charges, depreciation and amortization and other non-cash
                  items
              
              
              14,205
              
              
              35,419Changes
                  in operating assets and liabilities
              
              
              1,613
              
              
              (125
              )Net
                  cash flows from discontinued operating activities
              
              
              (4,327
              )
              
              (7,676
              )Net
                  cash flows from operating activities
              
              
              (30,930
              )
              
              5,141Cash
                  flows from investing activities:Purchases
                  of property and equipment
              
              
              (1,845
              )
              
              (8,086
              )Purchases
                  of licenses and patent costs
              
              
              (622
              )
              
              (603
              )Software
                  development costs
              
              
              (882
              )
              
              (1,530
              )Database
                  upgrade costs
              
              
              (1,974
              )
              
              (2,920
              )Purchase
                  of marketable securities available-for-sale
              
              
              (25,256
              )
              
              (24,163
              )Proceeds
                  from sale and maturity of marketable securities
                  available-for-sale
              
              
              42,046
              
              
              39,652Net
                  investing activities of discontinued operations
              
              
              (371
              )
              
              (4,388
              )Net
                  cash flows from investing activities
              
              
              11,096
              
              
              (2,038
              )Cash
                  flows from financing activities:Proceeds
                  from issuance of common stock to employees
              
              
              145
              
              
              248Repayments
                  of an equipment loan
              
              
              (35
              )
              
              (33
              )Net
                  financing activities of discontinued operations
              
              
              (107
              )
              
              (101
              )Net
                  cash flows from financing activities
              
              
              3
              
              
              114Net
                  increase (decrease) in cash and cash equivalents
              
              
              (19,831
              )
              
              3,217Cash
                  and cash equivalents, beginning of period
              
              
              43,946
              
              
              53,237Cash
                  and cash equivalents, end of period
              
              $
              24,115
              
              $
              56,454Supplemental
                  disclosure:Interest
                  paid
              
              $
              16
              
              $
              27Non-cash
                transactions:Reclassification
                  of long-term investment to marketable securities
                  available-for-sale
              
              $
              -
              
              $
              581


See
      accompanying notes.




5.


**GENE
      LOGIC INC.**





**Notes
      to Consolidated Condensed Financial
      Statements**


**September
      30, 2006**


**(in
      thousands, except share and per share data)**


**(Unaudited)**





**Note
      1 — Organization and summary of significant accounting
      policies**





*Description
      of Business*





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





The
      Genomics Division consists of proprietary gene expression and toxicogenomics
      databases, toxicogenomics services, software tools, microarray data generation
      and analysis and other professional services and solutions. These services
      are
      designed to help customers discover and prioritize drug targets, identify
      biomarkers, predict toxicity and understand the mechanism of toxicity and obtain
      insights into the efficacy of specific compounds. The Drug Repositioning
      Division, which resulted from the acquisition of certain technologies in 2004
      that continue to be developed, consists of an integrated multi-technology
      platform used to assist customers in (i) identifying alternative indications
      for
      failed, stalled or deprioritized drug candidates, and in the future, potentially
      assist customers in (ii) expanding indications for currently marketed drugs;
      and
      (iii) prioritizing and identifying indications for compounds entering
      preclinical development. The Preclinical Division, which has now been classified
      as discontinued operations (see Note 3), consists of *in
      vivo* (in life)
      research studies and related laboratory services to enable customers primarily
      in the United States to assess the safety and pharmacologic effects of candidate
      compounds for the purpose of seeking FDA approval to initiate human trials.





The
      Company is continuing to review its strategic plan and will continue to consider
      from time to time taking actions identified in such review that could have
      a
      material impact on its business as it is presently conducted. With regard to
      its
      Genomics Division, the Company recently confirmed that its prior strategy for
      the Division would not reverse recent sales trends. Consequently, while
      retaining the core competencies required to support its current Genomics
      services and existing and future customers, the Company initiated a
      restructuring of its Genomics Division intended to reduce its use of cash.
      The
      Company terminated over 80 positions, effective October 5, 2006, accelerated
      future costs with respect to leases which were either abandoned or for which
      the
      Company has entered into sublease arrangements, recorded an impairment charge
      with respect to certain intangible assets that the Company determined were
      no
      longer needed for continuing operations and is reducing its General and
      Administrative expenses associated with the Genomics Division. Management
      concluded that the assets and technologies of its Genomics Division contribute
      significantly to the services provided by its Drug Repositioning Division and
      may also have additional value in areas such as clinical biomarker development
      and molecular diagnostics and is actively exploring these and other options
      to
      realize greater value from these assets and technologies.





The
      Company further has determined to focus its resources on those opportunities
      that it believes will have greater potential to increase stockholders’ value in
      the long-term. As a result, the Company is planning to sell its Preclinical
      Division, is in discussions regarding a sale and has engaged an investment
      banking firm to assist the Company. While it is presently the Company’s
      intention to sell the Preclinical Division, there can be no assurance that
      this
      transaction will occur or as to the terms on which such a transaction may
      occur.





*Basis
      of Presentation*





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




6.


As
      a
      result of the Company’s plan of sale with regard to its Preclinical Division and
      in accordance with Statement of Financial Accounting Standards No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”),
      the Company has classified the net assets of the Preclinical Division as assets
      and liabilities held for sale and the results of operations of the Preclinical
      Division as discontinued operations for all periods presented and has adjusted
      the carrying value of the net assets of the Preclinical Division to their fair
      value less estimated selling costs and recorded an impairment charge of $11,000
      for the Division during the three months ended September 30, 2006 which is
      included in the loss from discontinued operations. The Company will continue
      to
      evaluate the fair value less estimated selling costs of the Preclinical Division
      and any subsequent change to this value or the culmination of a sale of the
      Division could result in a gain or loss being recognized in future periods.




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




*Use
      of
      Estimates*




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




*Reclassifications*




Certain
      reclassifications have been made to the prior periods’ financial statements and
      segment information to conform to the current period presented.


*Inventory*




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


**September
                  30,**
              
              **December
                  31,****2006**
              
              **2005**Microarrays
              
              $
              2,491
              
              $
              2,199Laboratory
                  reagents
              
              
              463
              
              
              298Tissue
                  samples
              
              
              1,831
              
              
              2,2484,785
              
              
              4,745Less:Microarray
                  lower of cost or market reserve
              
              
              (561
              )
              
              -Tissue
                  sample reserves
              
              
              (1,693
              )
              
              (1,654
              )Inventory,
                  net
              
              $
              2,531
              
              $
              3,091


*Comprehensive
      Loss*





The
      Company accounts for comprehensive loss as prescribed by Statement of Financial
      Accounting Standards No. 130, “Reporting Comprehensive Income”. Comprehensive
      income (loss) is the total net income (loss) plus all changes in equity during
      the period except those changes resulting from investment by and distribution
      to
      owners. Total comprehensive loss, which includes unrealized gains or losses
      in
      the Company’s marketable securities available-for-sale, was $26,573 and $39,887
      for the three months ended September 30, 2006 and 2005, respectively, and
      $49,757 and $46,524 for the nine months ended September 30, 2006 and 2005,
      respectively.





*New
      Accounting Pronouncements*





In
      September 2006, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”).
      SFAS 157 defines fair value, establishes a framework for measuring fair value
      under generally accepted accounting principles and expands disclosures about
      fair value measurements. SFAS 157 emphasizes that fair value is a market-based
      measurement, not an entity-specific measurement, and states that a fair value
      measurement should be determined based on the assumptions that market
      participants would use in pricing the asset or liability. This Statement applies
      under other accounting pronouncements that require or permit fair value
      measurements, for which the FASB previously concluded in such accounting pronouncements
      that fair value is the relevant measurement attribute. Accordingly, this
      Statement does not require any new fair value measurements. SFAS No. 157 is
      effective for fiscal years beginning after November 15, 2007, which the Company
      intends to adopt on January 1, 2008. The Company is currently evaluating the
      impact, if any, that SFAS 157 will have on its financial position, results
      of
      operations and cash flows, but does not believe the effect will be
      material.


7.




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





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





The
      Company’s results of operations for the three and nine months ended September
      30, 2006 were impacted by the recognition of $139 and $689, respectively, in
      non-cash expense related to the fair value of the Company’s stock-based
      compensation awards. Based on outstanding share-based awards as of December
      31,
      2005, the Company estimates that non-cash stock compensation expense in 2006
      will be approximately $700 to reflect the continued vesting of outstanding
      stock
      option grants that remained unvested as of December 31, 2005. The impact of
      stock compensation expense in future periods will be dependent on the number
      and
      type of share-based payments issued to employees and non-employee directors
      and
      this estimate does not include the impact of other possible stock-based awards
      that could be made during the balance of 2006.





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





**Note
      2 — Stock-based compensation**





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





*Stock
      Plan*





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





*Directors’
      Plan*





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




8.





*ESPP*





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








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





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




As
      a
      result of adopting SFAS 123R, the Company’s net loss in the Consolidated
      Condensed Financial Statements for the three and nine months ended September
      30,
      2006 was $139 and $689 higher, respectively, than if the Company had continued
      to account for stock-based compensation under APB 25. The impact on basic and
      diluted net loss per share for the three and nine months ended September 30,
      2006 was $0.01 and $0.02 per share, respectively.





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


**Three
                  Months**
              
              **Nine
                  Months****Ended**
              
              **Ended****September
                  30,**
              
              **September
                  30,****2005**
              
              **2005**Net
                  loss, as reported
              
              $
              (39,480
              )
              $
              (46,191
              )Add:
                    Stock-based compensation expense included in reported net
                    loss
              
              
              -
              
              
              -Deduct:
                  Stock-based compensation expense determinedunder fair value-based
                  method for all awards
              
              
              (434
              )
              
              (1,579
              )Pro
                  forma net loss
              
              $
              (39,914
              )
              $
              (47,770
              )Basic
                  and diluted net loss per share:As
                  reported
              
              $
              (1.24
              )
              $
              (1.46
              )Pro
                  forma
              
              $
              (1.26
              )
              $
              (1.51
              )





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




9.


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


**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              
              **September
                  30,****2006
                  (1)**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005**Weighted
                  average fair value of grants
              
              
              --
              
              
              $1.79
              
              
              $1.11
              
              
              $1.38Expected
                  volatility
              
              
              --
              
              
              51%
              
              
              55%
              
              
              52%Risk-free
                  interest rate
              
              
              --
              
              
              3.83%
                  to 4.19%
              
              
              4.49%
                  to 5.11%
              
              
              3.41%
                  to 4.19%Expected
                  lives
              
              
              --
              
              
              3
                  years
              
              
              3
                  years
              
              
              3
                  yearsDividend
                  rate
              
              
              --
              
              
              0%
              
              
              0%
              
              
              0%(1)
                No stock option awards were granted during the three months ended
                September 30, 2006
  The
        following is a summary of option activity for the nine months ended September
        30, 2006:
 **Outstanding
                  Options****Weighted****Average****Weighted**
              
              
              **Remaining**
              
              
              **Aggregate****Average**
              
              
              **Contractual**
              
              
              **Intrinsic****Shares**
              
              
              **Exercise
                  Price**
              
              
              **Life
                  (Years)**
              
              
              **Value****Outstanding
                  at January 1, 2006**
              
              
              5,515,504
              
              $
              6.86Options
                  granted
              
              
              101,500
              
              $
              2.66Options
                  exercised
              
              
              (38,636
              )
              $
              3.77Options
                  cancelled
              
              
              (648,323
              )
              $
              6.31**Outstanding
                  at September 30, 2006**
              
              
              4,930,045
              
              $
              6.87
              
              
              5.0
              
              $
              49**Vested
                  and expected to vest at September 30, 2006**
              
              
              4,737,880
              
              $
              6.99
              
              
              4.9
              
              $
              49**Exercisable
                  at September 30, 2006**
              
              
              4,403,658
              
              $
              7.26
              
              
              4.7
              
              $
              49




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




As
      of
      September 30, 2006, $427 of total unrecognized compensation cost related to
      stock options is expected to be recognized over a weighted-average period of
      1.8
      years. This estimate does not include the impact of other possible stock-based
      awards that may be made during the balance of 2006, nor does it take into
      account the potential cancellation of stock options resulting from the
      restructuring of the Genomics Division and the possible sale of the Preclinical
      Division.




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




**Note
      3 — Discontinued Operations**




As
      previously discussed in Note 1, the Company has determined to focus its
      resources on those opportunities that it believes will have greater
      potential to increase stockholders’ value in the long-term. As a result, the
      Company is planning to sell its Preclinical Division, is in discussions
      regarding a sale and has engaged an investment banking firm to assist the
      Company. While it is the Company’s intention to sell the Preclinical Division,
      there can be no assurance that this transaction will occur or as to the terms
      on
      which such a transaction may occur.




As
      a
      result of the Company’s plan of sale with regard to its Preclinical Division and
      in accordance with SFAS 144, the Company has adjusted the carrying value of
      the
      net assets of the Preclinical Division to their fair value less estimated
      selling costs and recorded an impairment charge of $11,000 for the Division
      during the three months ended September 30, 2006 which is included in the loss
      from discontinued operations. The Company will continue to evaluate the fair
      value less estimated selling costs of the Preclinical Division and any
      subsequent change to this value or the culmination of a sale of the Division
      could result in a gain or loss being recognized in future periods. As of
      September 30, 2006, the accompanying consolidated financial statements classify
      the net assets of the Preclinical Division as assets and liabilities held for
      sale and the results of operations of the Preclinical Division as discontinued
      operations for all periods presented.


10.


Summarized
      operating results from the discontinued operations included in the Company’s
      Consolidated Condensed Statements of Operations are as follows:




**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              
              **September
                  30,****2006
                  (1)**
              
              
              **2005**
              
              
              **2006
                  (1)**
              
              
              **2005**Revenue
              
              $
              8,075
              
              $
              5,257
              
              $
              18,708
              
              $
              17,510Loss
                  from discontinued operations
              
              $
              (12,712
              )
              $
              (37,180
              )
              $
              (20,145
              )
              $
              (42,970
              )(1)
                  Includes $11,000 impariment charge during the three and nine months
                  ended
                  September 30, 2006.





Assets
      and
      liabilities of the discontinued operations are as follows as of the indicated
      periods:




**September
                  30,**
              
              **December
                  31,****2006**
              
              
              **2005**Current
                  assets
              
              $
              7,126
              
              $
              7,546Property
                  and equipment, net
              
              
              12,432
              
              
              15,079Goodwill
              
              
              -
              
              
              10,236Other
                  long-term assets
              
              
              178
              
              
              28Current
                  liabilities
              
              
              (5,540
              )
              
              (4,094
              )Noncurrent
                  liabilities
              
              
              (974
              )
              
              (990
              )Net
                  assets of discontinued operations
              
              $
              13,222
              
              $
              27,805





**Note
      4 — Restructuring Expenses**


As
      previously discussed in Note 1, during the third quarter of 2006, the Company
      initiated a restructuring of its Genomics Division, which it expects to be
      substantially completed by December 31, 2007,  and recorded total
      restructuring costs of $5,377. The components of the restructuring
      are:





·
            the
                termination of approximately 80 employees, conducted in accordance
                with
                the Worker Adjustment and Retraining Notification (WARN) Act and
                effective
                October 5, 2006, which resulted in severance costs of $1,640, of
                which
                $1,556 remains payable as of September 30, 2006 and will be paid
                in the
                fourth quarter of 2006;


·
            the
                acceleration of future costs of $2,426 for certain laboratory and
                office
                facilities that were no longer needed for continuing operations and
                which
                were either abandoned or for which the Company has entered into sublease
                arrangements, of which $2,349 remains payable as of September 30,
                2006 and
                will be paid over the next fourteen months;
                and


·
            the
                impairment of certain intangible assets of $1,311, primarily patent
                and
                license costs, which the Company determined would no longer be utilized
                by
                its Genomics Division.





**Note
      5 — Operating Leases**




In
      September 2006, the Company terminated a lease agreement for approximately
      16,400 square feet of laboratory space located at 9 West Watkins Mill Road
      in
      Gaithersburg, Maryland.





The
      Company conducts all of its operations from leased facilities, under operating
      leases with varying terms expiring through 2011, in Gaithersburg, Maryland
      and
      Cambridge, Massachusetts.





Future
      minimum lease payments under the Company’s lease agreements for continuing
      operations for the three months and years ending December 31 are as
      follows:




For
                the three months ending December 31, 2006
              
              $
              9012007
              
              
              3,4212008
              
              
              1,5032009
              
              
              1,0382010
              
              
              1,0642011
                  and thereafter
              
              
              91$
              8,018


11.


The
      Company has subleased to unrelated third parties a portion of the Company’s
      leased space, for which the income is recorded as a reduction to rent expense.
      Future minimum payments to be received under all subleases for the three months
      and years ending December 31 are as follows:


For
                the three months ending December 31, 2006
              
              $
              972007
              
              
              353$
              450





**Note
      6 — Segment information**





The
      Company’s operations were historically organized into three business segments:
      Genomics Division, Drug Repositioning Division and Preclinical Division, all
      of
      which are more fully described in Note 1. **** As
      of
      September 30, 2006, the Company’s Preclinical Division qualified for treatment
      as discontinued operations for all periods presented (see Note 3).





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





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


**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005****Genomics
                  Services**Revenue
              
              $
              3,698
              
              $
              11,719
              
              $
              17,129
              
              $
              39,125Operating
                  income (loss) (1)
              
              
              (11,221
              )
              
              27
              
              
              (21,093
              )
              
              2,539Depreciation
                  and amortization expense
              
              
              2,276
              
              
              2,341
              
              
              7,247
              
              
              7,751**Drug
                  Repositioning Services**Revenue
              
              $
              6
              
              $
              102
              
              $
              36
              
              $
              316Operating
                  income (loss) (1)
              
              
              (3,419
              )
              
              (3,121
              )
              
              (10,317
              )
              
              (8,038
              )Depreciation
                  and amortization expense
              
              
              245
              
              
              149
              
              
              820
              
              
              413





(1)
      Includes non-cash stock compensation expenses of $49 and $41 **** and
      $250
      and $197 for the three and nine months ended September 30, 2006, respectively,
      for Genomics services and Drug repositioning services.




12.


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


**Three
                  Months Ended**
              
              **Nine
                  Months Ended****September
                  30,**
              
              **September
                  30,****2006**
              
              
              **2005**
              
              
              **2006**
              
              
              **2005****Segment
                  Operating Income (Loss)**Genomics
                  services
              
              $
              (11,221
              )
              $
              27
              
              $
              (21,093
              )
              $
              2,539Drug
                  repositioning services
              
              
              (3,419
              )
              
              (3,121
              )
              
              (10,317
              )
              
              (8,038
              )(14,640
              )
              
              (3,094
              )
              
              (31,410
              )
              
              (5,499
              )Interest
                  (income), net
              
              
              (633
              )
              
              (727
              )
              
              (2,162
              )
              
              (1,844
              )Other
                  (income) expense
              
              
              (66
              )
              
              (133
              )
              
              35
              
              
              (560
              )Write-down
                  of equity investment
              
              
              -
              
              
              -
              
              
              275
              
              
              -Inter-segment
                  expenses
              
              
              2
              
              
              66
              
              
              35
              
              
              126Loss
                  from continuing operations
              
              $
              (13,943
              )
              $
              (2,300
              )
              $
              (29,593
              )
              $
              (3,221
              )





During
      the
      three months ended September 30, 2006, three customers of the Company’s Genomics
      Division accounted for 10% or more of the Company’s revenue from continuing
      operations (20.3%, 19.7% and 16.3%). During the nine months ended September
      30,
      2006, four Genomics Division customers accounted for 10% or more of the
      Company’s revenue from continuing operations (13.9%, 13.2%, 12.7% and 10.2%).
      During the three and nine months ended September 30, 2005, two Genomics Division
      customers accounted for 10% or more of the Company’s revenue from continuing
      operations (17.7% and 10.2% and 16.4% and 10.5%, respectively). The following
      table sets forth information on the composition of the Company’s total revenue
      from continuing operations by geographic region:


Geographic
                  Region**North
                  America**
              
              
              **Europe**
              
              
              **Pacific
                  Rim**For
                  the three months ended:September
                  30, 2006
              
              
              35%
              
              
              24%
              
              
              41%September
                  30, 2005
              
              
              35%
              
              
              28%
              
              
              37%For
                  the nine months ended:September
                  30, 2006
              
              
              49%
              
              
              22%
              
              
              29%September
                  30, 2005
              
              
              32%
              
              
              27%
              
              
              41%




13.


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





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





Unless
      the
      context otherwise requires, references in this Form 10-Q to “Gene Logic,” “Gene
      Logic Laboratories Inc.,” “Gene Logic Ltd.,” “Gene Logic K.K.,” the “Company,”
“we,” “us,” and “our” refer to Gene Logic Inc. and its wholly owned
      subsidiaries. Gene Logic®, GeneExpress®, BioExpress®, ToxExpress®, ASCENTA® and
      Genesis Enterprise System® are registered trademarks of Gene Logic. Drug
      Repositioning and SelectionTM, SCIANTISTM, ToxScreenTM, ToxShieldTM, ToxEdgeTM,
      ToxPlusTM and Phase R SM are
      trademarks of Gene Logic.





**Overview**





We
      currently conduct our continuing operations through two business
      segments:





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


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





We
      are
      continuing to review our strategic plan and will continue to consider from
      time
      to time taking actions identified in such review that could have a material
      impact on our business as it is presently conducted. We recently confirmed
      that
      our prior strategy for our Genomics Division would not reverse recent sales
      trends. Consequently, while retaining the core competencies required to support
      our current Genomics services and existing and future customers, we initiated
      a
      restructuring of our Genomics Division intended to reduce our use of cash.
      We
      terminated over 80 positions, effective October 5, 2006, accelerated future
      costs with respect to leases which were either abandoned or for which we
      have entered into sublease arrangements, recorded an impairment charge with
      respect to certain intangible assets that we determined were no longer needed
      for continuing operations and are reducing our General and Administrative
      expenses associated with the Genomics Division. We have concluded that the
      assets and technologies of our Genomics Division contribute significantly to
      the
      services provided by our Drug Repositioning Division and may also have
      additional value in areas such as clinical biomarker development and molecular
      diagnostics and we are actively exploring these and other options to realize
      greater value from these assets and technologies.





We
      further
      have determined to focus our resources on those opportunities that we believe
      will have greater potential to increase stockholders’ value in the long-term. As
      a result, we are planning to sell the Preclinical Division, are in
      discussions regarding a sale and have engaged an investment banking firm to
      assist us. While it is presently our intention to sell the Preclinical Division,
      there can be no assurance that this transaction will occur or as to the terms
      on
      which such a transaction may occur.





As
      a
      result of our plan of sale with regard to the Preclinical Division and
      in accordance with Statement of Financial Accounting Standards No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets”, we have
      adjusted the carrying value of the net assets of the Preclinical Division to
      their fair value less estimated selling costs and recorded an impairment charge
      of $11,000 for the Division during the three months ended September 30,
      2006 which is included in the loss from discontinued operations. We will
      continue to evaluate the fair value less estimated selling costs of the
      Preclinical Division and any subsequent change to this value or the culmination
      of a sale of the Division could result in a gain or loss being recognized in
      future periods. As of September 30, 2006, the accompanying consolidated
      financial statements classify the net assets of the Preclinical Division as
      assets and liabilities held for sale and the results of operations of the
      Preclinical Division as discontinued operations for all periods
      presented.





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




14.


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





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





Revenue
      from our Drug Repositioning Division has not been significant to date and we
      do
      not expect to receive significant revenue under any of our drug repositioning
      agreements in 2006 or 2007.





We
      have
      incurred net losses in each year since our inception, including losses of $48.3
      million in 2005, $28.5 million in 2004 and $24.8 million in 2003. At September
      30, 2006, we had an accumulated deficit of $310.7 million. Our losses have
      resulted principally from costs incurred in the development, marketing and
      sale
      of services from our Genomics and Preclinical Divisions, development of the
      Drug
      Repositioning Division, the impairment of our Preclinical Division goodwill
      and
      acquisitions of research and development. These costs have exceeded our revenue
      and we expect to incur additional losses in the future.





**Results
      of Continuing Operations**





*Three
      Months Ended September 30, 2006 and 2005*





**Total
      Revenue.** Total
      revenue from continuing operations decreased 69% to $3.7 million for the three
      months ended September 30, 2006 as compared to $11.8 million for the same period
      in 2005. Nearly all our revenue is currently derived from the operations of
      our
      Genomics Division. During the three months ended September 30, 2006, three
      customer of our Genomics Division accounted for greater than 10% of our total
      revenue. During the three months ended September 30, 2005, two Genomics Division
      customers accounted for greater than 10% of our total revenue. During the three
      months ended September 30, 2006 and 2005, 41% and 37% of our total revenue
      from
      continuing operations, respectively, was from customers in the Pacific Rim,
      and
      24% and 28% of our total revenue from continuing operations, respectively,
      was
      from customers in Europe.





***Genomics
      Services Revenue.*** Revenue
      from our Genomics services, the majority of which consists of fees from
      subscription agreements to our BioExpress and ToxExpress System databases,
      was
      $3.7 million for the three months ended September 30, 2006, a decrease of $8.0
      million, or 68%, from $11.7 million for the same period in 2005. The 2006
      decrease in revenue resulted from the absence of $6.7 million in subscription
      fees from expired agreements and $1.3 million less for perpetual license fees.
      While revenue for the fourth quarter of 2006 could be higher than that for
      the
      third quarter, we expect quarterly revenue for the first half of 2007 to be
      generally consistent with that of the third quarter of 2006.





In
      2006,
      long-term subscription agreements with five customers were to expire by their
      terms and two agreements allowed for early termination at the customer’s
      election. These agreements accounted for 28% of our 2005 Genomics services
      revenue. Also, these agreements accounted for 55% of our Genomics services
      revenue for the nine months ended September 30, 2006, of which 12% consisted
      of
      revenue from the sale of perpetual licenses to data and software. As to the
      two
      agreements that were subject to early termination at the customer’s election,
      one customer terminated its agreement early and one customer elected to continue
      its agreement. As to the remaining five agreements, three agreements have
      expired by their terms, one was terminated by mutual agreement and negotiations
      are underway for the remaining agreement. Two of these customers purchased
      perpetual licenses to data and software in connection with their respective
      terminations.





**Database
      Production Expense.** Database
      production expenses, which consist primarily of costs to provide microarray
      data
      generation and analysis services and costs related to the acquisition and
      processing of tissues and overhead expenses needed to generate the content
      of
      the BioExpress and ToxExpress System databases, decreased to $6.0 million for
      the three months ended September 30, 2006 from $7.3 million for the same period
      in 2005.  The
      decrease consisted primarily of a $1.2 million reduction in database content
      generation expenses, including $0.9 million in lower costs for agreements with
      third parties. For the remainder of 2006 and 2007, we expect database production
      expenses to decrease as we focus our efforts largely on microarray data
      generation and analysis services.




15.


**Research
      and Development Expense.** Research
      and development expenses, which consist primarily of costs associated with
      the
      evaluation of customer-supplied drug candidates and ongoing development of
      our
      drug repositioning technologies, increased to $2.6 million for the three months
      ended September 30, 2006 from $1.8 million for the same period in 2005. The
      increase was primarily a result of increased evaluations of customer-supplied
      drug candidates under the terms of our drug repositioning partnerships. For
      the
      remainder of 2006, we expect research and development expenses to increase
      modestly, as we continue to perform repositioning work on customer-supplied
      drug
      candidates and develop our drug repositioning technologies.





**Selling,
      General and Administrative Expense.** Selling,
      general and administrative expenses for continuing operations, which consist
      primarily of sales, marketing, accounting, legal, human resources and other
      general corporate expenses, decreased to $4.4 million for the three months
      ended
      September 30, 2006 from $5.8 million for the same period in 2005. The decrease
      is largely due to a reduction of $0.5 million in costs under our 2006 annual
      employee incentive compensation plan due to our Genomics Division revenue
      shortfall and other savings from general cost controls over a wide range of
      expense categories. We expect selling, general and administrative expenses
      to
      continue to be lower as a result of the reduction in our workforce.





**Restructuring
      Expense.** During
      the three months ended September 30, 2006, we initiated a restructuring of
      our
      Genomics Division, which is expected to be substantially completed by December
      31, 2007. This restructuring included the termination of approximately 80
      employees, which resulted in severance costs of $1,640; the acceleration of
      future costs of $2,426 for certain laboratory and office facilities that were
      no
      longer needed for continuing operations and were either abandoned or for which
      we have entered into sublease arrangements; and the impairment of certain
      intangible assets of $1,311, primarily patent and license costs, which we
      determined would no longer be utilized by our Genomics Division. Once fully
      implemented, we estimate that the staff reductions will reduce our annual salary
      and fringe benefits costs by approximately $8.0 million and we expect to realize
      additional savings in certain non-employee costs in connection with this
      restructuring.





**Net
      Interest Income.** Net
      interest income decreased to $0.6 million for the three months ended September
      30, 2006 from $0.7 million for the same period in 2005, due to a decline in
      the
      balance of our cash and cash equivalents and marketable securities
      available-for-sale, partially offset by increases in our rates of return on
      investments.





*Nine
      Months Ended September 30, 2006 and 2005*





**Total
      Revenue.** Total
      revenue from continuing operations decreased 56% to $17.2 million for the nine
      months ended September 30, 2006 as compared to $39.4 million for the same period
      in 2005. Nearly all our revenue is currently derived from the operations of
      our
      Genomics Division. During the nine months ended September 30, 2006, four
      customers accounted for greater than 10% of our total revenue. During the nine
      months ended September 30, 2005, two Genomics Division customers accounted
      for
      greater than 10% of our total revenue. During the nine months ended September
      30, 2006 and 2005, 29% and 41% of our total revenue, respectively, was from
      customers in the Pacific Rim, and 22% and 27% of our total revenue,
      respectively, was from customers in Europe. The decline in revenue from
      customers in the Pacific Rim reflects the impact of agreements for Genomics
      services that were terminated, renegotiated at reduced service levels or
      transitioned into perpetual licenses in 2005.





***Genomics
      Services Revenue.*** Revenue
      from our Genomics services was $17.1 million for the nine months ended September
      30, 2006, a decrease of $22.0 million, or 56%, from $39.1 million for the same
      period in 2005. The 2006 decrease in revenue resulted from declining
      subscription revenue, the absence of anticipated sales of perpetual licenses
      to
      database products and slower than anticipated sales growth for microarray data
      generation and analysis services. Specifically, the 2006 results reflect the
      absence of $18.1 million in subscription fees from expired agreements, $3.3
      million less for perpetual license fees and reduced revenue of $2.3 million
      from
      certain agreements with existing customers renegotiated at reduced service
      levels, partially offset by higher revenue of $1.7 million from increased
      microarray data generation and analysis services in 2006.





**Database
      Production Expense.** Database
      production expenses decreased to $21.3 million for the nine months ended
      September 30, 2006 from $23.5 million for the same period in 2005.  The
      decrease consisted primarily of a $2.0 million reduction in database content
      generation expenses, substantially all of which consisted of lower costs for
      agreements with third parties.





**Research
      and Development Expense.** Research
      and development expenses increased to $7.6 million for the nine months ended
      September 30, 2006 from $4.7 million for the same period in 2005. The increase
      was primarily a result of increased evaluations of customer-supplied drug
      candidates under the terms of our drug repositioning.





**Selling,
      General and Administrative Expense.** Selling,
      general and administrative expenses from continuing operations decreased to
      $14.4 million for the nine months ended September 30, 2006 from $16.9 million
      for the same period in 2005. The decrease is largely due to a reduction of
      $1.5
      million in costs under our 2006 annual employee incentive compensation plan
      due
      to our Genomics Division revenue shortfall.





**Restructuring
      Expense.** During
      the three months ended September 30, 2006, we initiated a restructuring of
      our
      Genomics Division referred to above.




16.


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




**Net
      Interest Income.** Net
      interest income increased to $2.2 million for the nine months ended September
      30, 2006 from $1.8 million for the same period in 2005, due to increases in
      our
      rates of return on investments, partially offset by a decline in the balance
      of
      our cash and cash equivalents and marketable securities
      available-for-sale.




**Other
      (Income) Expense.** Other
      (income) expense was an expense of $0.1 million for the nine months ended
      September 30, 2006 compared to income of $0.6 million for the same period in
      2005, due to foreign currency transaction losses and gains in 2006 and 2005,
      respectively, relating to our subscription agreements with our Japanese
      customers. As a result of changing our distribution arrangements in Japan,
      beginning in 2005, agreements with our Japanese customers are now denominated
      in
      Japanese Yen.




**Liquidity
      and Capital Resources**





From
      inception through September 30, 2006, we have financed our operations and
      acquisitions through the issuance and sale of equity securities and payments
      from customers. As of September 30, 2006, we had approximately $45.5 million
      in
      cash, cash equivalents and marketable securities available-for-sale, compared
      to
      $82.1 million as of December 31, 2005.





Net
      cash
      from operating activities from continuing operations decreased to a negative
      $26.6 million for the nine months ended September 30, 2006 from a positive
      $12.8
      million for the same period in 2005, primarily due to our increased net loss
      from continuing operations for the nine months ended September 30, 2006 and
      the
      timing of customer payments (including prepayments) for our services in 2005
      and
      payments under our compensation and retention plans in 2006. We presently
      anticipate that our use of cash for the fourth quarter will be significantly
      lower than that in the third quarter of 2006 due to a lower net loss from
      continuing operations and the absence of the Millennium payment described below.





During
      the
      nine months ended September 30, 2006 and 2005, our investing activities
      consisted primarily of purchases, sales and maturities of available-for-sale
      securities, capital expenditures and software development and database upgrade
      costs. Capital expenditures for the nine months ended September 30, 2006 and
      2005 were $1.8 million and $8.1 million, respectively. The decrease in capital
      expenditures was primarily due to the completion in 2005 of our facility
      renovations. For the remainder of 2006, we expect the level of capital
      expenditures to not be significant.





We
      have
      capitalized software development costs of $0.9 million and $1.5 million for
      the
      nine months ended September 30, 2006 and 2005, respectively. These costs related
      to efforts to enhance the software platform of our BioExpress and ToxExpress
      System databases. Also, we have incurred database upgrade costs of $2.0 million
      and $2.9 million for the nine months ended September 30, 2006 and 2005,
      respectively, enhancing the content of our databases using microarrays from
      Affymetrix. Any future investments in upgrades and new versions of our software
      tools are being evaluated as part of our plans for the Genomics
      Division.





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





In
      July
      2004, we purchased and licensed certain drug repositioning technologies and
      hired a research team from Millennium. During the third quarter of 2006, we
      paid
      the final purchase price payment of $3.5 million in cash. In connection with
      the
      purchase, we also had contractually agreed to spend an aggregate of $14.5
      million to develop and commercialize these technologies and we have met that
      commitment.





To
      generate our gene expression data, we use Affymetrix microarrays,
      instrumentation and software. Under the terms of our current supply and license
      agreement, as amended, we agreed to purchase a minimum of $7.1 million in
      products and services from Affymetrix in 2006. As of September 30, 2006, we
      have
      purchased $4.5 million in products and services related to this
      commitment.





Specific
      future financial commitments from continuing operations as of September 30,
      2006
      are set forth in the following table:


**Within
                  3****Total**
              
              
              **Months**
              
              
              **2007
                  & 2008**
              
              
              **2009
                  & 2010**
              
              
              **Beyond
                  2010**Long-term
                  debt
              
              
              600
              
              
              464
              
              
              109
              
              
              27
              
              
              -Payment
                  obligations to Affymetrix
              
              
              2,555
              
              
              2,555
              
              
              -
              
              
              -
              
              
              -Operating
                  leases
              
              
              8,018
              
              
              901
              
              
              4,924
              
              
              2,102
              
              
              91Total
              
              $
              11,173
              
              $
              3,920
              
              $
              5,033
              
              $
              2,129
              
              $
              91
  17.


We
      believe
      that existing cash, cash equivalents and marketable securities
      available-for-sale and anticipated payments from customers will be sufficient
      to
      support our operations for the foreseeable future. Additionally, while there
      can
      be no assurances that the sale of the Preclinical Division will occur, we
      anticipate the receipt of cash from the buyer as the result of the sale of
      our
      Preclinical Division. However, our cash requirements may change as a result
      of
      the current review of our overall business strategy, including any actions
      that
      we take as a result of that review. These estimates are forward-looking
      statements that involve risks and uncertainties. Our actual future capital
      requirements and the adequacy of our available funds will depend on many
      factors, including those discussed under “Risk Factors” in our Annual Report on
      Form 10-K for the year ended December 31, 2005 and in our subsequent filings
      with the Securities and Exchange Commission.





**Critical
      Accounting Policies**





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





***Revenue
      Recognition***





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





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





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




Periodically,
      we enter into contractual arrangements with multiple deliverables. If we are
      unable to determine objectively and reliably the fair value of individual
      undelivered elements, we recognize all revenue using the revenue recognition
      method appropriate to the predominant undelivered element. We also defer the
      direct and incremental expenses associated with the delivery of services for
      which revenue has been deferred and recognize these expenses as we recognize
      the
      related revenue. The timing of revenue recognition associated with agreements
      we
      enter into in future periods may also be dependent on our ability to objectively
      and reliably determine the fair value of deliverables included in those
      agreements.




18.


***Goodwill
      and Other Intangible Assets Impairment***





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





Under
      Statement of Financial Accounting Standards No. 142, “Goodwill and Other
      Intangible Assets”, we are required to perform an annual impairment test of our
      goodwill and periodic reviews of our other intangible assets. In addition,
      we
      are required to test for impairment at any point we have an indication that
      impairment may exist. We have elected to perform our annual impairment test
      of
      goodwill as of October 1. The goodwill impairment test that we have historically
      selected consisted of a ten-year discounted cash flow analysis, including the
      determination of a terminal value, and required management to make various
      judgments and assumptions, including revenue growth rates and discount rates,
      which management believed to be reasonable.





In
      conjunction with our review of assets held for sale of the Preclinical Division,
      we determined that the remaining value of the goodwill that resulted from the
      acquisition of TherImmune (now Gene Logic Laboratories Inc., our Preclinical
      Division) was likely impaired, due to our assessment of the possible indications
      of fair value resulting from our decision to consider the sale of the division.
      As a result, we recorded a non-cash expense of $10.2 million in the third
      quarter of 2006 representing the implied impairment of goodwill of our
      Preclinical Division. During the third quarter of 2005, we recorded a non-cash
      expense of $32.8 million  representing the implied impairment of goodwill
      of our Preclinical Division. These non-cash expenses are included in the loss
      from discontinued operations of our Preclinical Division for the respective
      periods. There is no remaining book value of goodwill for our Preclinical
      Division as of September 30, 2006.





As
      part of
      our annual testing of goodwill, we determined that no impairment existed in
      the
      carrying value of goodwill of our Genomics Division. However, due to the
      restructuring of our Genomics Division we recorded impairment charges of $1.3
      million in the third quarter of 2006 for certain intangible assets which we
      determined would no longer be utilized by our Genomics Division.





Our
      assessment of the fair value of our divisions is dependent on subjective
      estimates we make of inherently uncertain future net cash flows including
      estimates of terminal values and for the Preclinical Division, estimates of
      the
      ranges of possible sales prices. Accordingly, our estimates for future periods
      of net cash flows and the potential sale price of the Preclinical Division
      may
      change as market conditions and circumstances dictate. Future impairment tests
      of goodwill for our Genomics Division and other intangibles may result in
      additional impairment charges based on these changing estimates.





***Accounts
      Receivable and Unbilled Services***





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





***Inventory***





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





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





***Equity
      Investments***





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




19.


**Recently
      Issued Accounting Pronouncements**





In
      September 2006, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”).
      SFAS 157 defines fair value, establishes a framework for measuring fair value
      under generally accepted accounting principles and expands disclosures about
      fair value measurements. SFAS 157 emphasizes that fair value is a market-based
      measurement, not an entity-specific measurement, and states that a fair value
      measurement should be determined based on the assumptions that market
      participants would use in pricing the asset or liability. This Statement applies
      under other accounting pronouncements that require or permit fair value
      measurements, for which the FASB previously concluded in such accounting
      pronouncements that fair value is the relevant measurement attribute.
      Accordingly, this Statement does not require any new fair value measurements.
      SFAS No. 157 is effective for fiscal years beginning after November 15, 2007,
      which we intend to adopt on January 1, 2008. We are currently evaluating the
      impact, if any, that SFAS 157 will have on our financial position, results
      of
      operations and cash flows, but do not believe the effect will be material.





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





Effective
      January 1, 2006, we adopted the fair value recognition provisions of Statement
      of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”
(“SFAS 123R”), using the modified prospective transition method, and therefore
      have not restated results for prior periods. Under this method, we recognize
      compensation expense for all share-based payments granted after January 1,
      2006
      and for those that were granted prior to, but have not yet vested as of, January
      1, 2006, in accordance with SFAS 123R. For the nine months of 2006, stock-based
      compensation awards consisted of options awarded under the 1997 Equity Incentive
      Plan and the 1997 Non-Employee Directors’ Stock Option Plan. Under the fair
      value recognition provisions of SFAS 123R, we recognize stock-based compensation
      net of an estimated forfeiture rate and recognize the compensation cost for
      those shares expected to vest on a straight-line basis over the requisite
      service period of the award. Prior to SFAS 123R adoption, we accounted for
      share-based payments under Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” and accordingly, were required to
      recognize compensation expense only to the extent that the fair value of the
      underlying stock on the date of grant exceeded the exercise or acquisition
      price
      of the stock or stock-based award. Since stock options granted by us in the
      last
      several years have been granted with an exercise price equal to the fair value
      on the grant date, we did not recognize any expense for such options prior
      to
      our adoption of SFAS 123R.





Our
      results of operations for the three and nine months ended September 30, 2006
      were impacted by the recognition of $0.1 million and $0.7 million, respectively,
      in non-cash expense related to the fair value of our stock-based compensation
      awards. Based on outstanding share-based payments as of January 1, 2006, we
      estimate that non-cash stock compensation expense in 2006 will be approximately
      $0.7 million to reflect the continued vesting of outstanding stock option grants
      that remained unvested as of January 1, 2006. The impact of stock compensation
      expense in future periods will be dependent on the number and type of
      share-based payments issued to employees and non-employee directors and this
      estimate does not include the impact of other possible stock-based awards that
      could be made during the balance of 2006.





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





**Item
      3.****Quantitative
      and Qualitative Disclosure about Market Risk**





We
      have
      exposure to financial market risks, including changes in interest rates. At
      September 30, 2006, we had cash and cash equivalents of $22.9 million and
      marketable securities available-for-sale of an additional $24.1 million. We
      invest our excess cash primarily in money market funds, obligations of the
      United States Government and its agencies and marketable debt securities of
      companies with strong credit ratings. These instruments have maturities of
      twenty-four months or less when purchased. We do not utilize derivative
      financial instruments, derivative commodity instruments or other market risk
      sensitive instruments, positions or transactions in any material fashion.
      Accordingly, we believe that, while the instruments we hold are subject to
      changes in the financial standing of the issuer of such securities, we are
      not
      subject to any material risks arising from changes in foreign currency exchange
      rates, commodity prices, equity prices or other market changes that affect
      market risk sensitive instruments. Based on our cash and cash equivalents and
      marketable securities available-for-sale balances at September 30, 2006, a
      hypothetical 100 basis point adverse movement in interest rates would have
      resulted in an increase in the net loss from continuing operations of
      approximately $0.3 million for the nine months ended September 30, 2006. Actual
      changes in rates may differ from the hypothetical assumptions used in computing
      this exposure.




20.


Since
      the
      beginning of 2005 and as a result of changing our distribution arrangements
      in
      Japan, we have been subject to risk from changes in foreign exchange rates
      relating to revenue from our Japanese customers, as such agreements are now
      denominated in Japanese Yen. Such changes could result in foreign currency
      exchange gains or losses. As a policy, we convert our customer payments made
      in
      Japanese Yen to United States dollars upon receipt of such payment. Revenue
      derived from the Pacific Rim as a percentage of total revenue from continuing
      operations was 29% for the nine months ended September 30, 2006, and was
      primarily derived from our customers in Japan. Exchange rate fluctuations
      between the United States dollar and the currencies of these countries could
      result in positive or negative fluctuations in the amounts relating to revenue
      from continuing operations reported in our consolidated condensed financial
      statements. A hypothetical 10% adverse change in average foreign currency
      movements would have resulted in an increase in the net loss from continuing
      operations of approximately $0.4 million for the nine months ended September
      30,
      2006. There can be no assurance that losses related to this currency risk will
      not occur.





**Item****4.****Controls
      and Procedures**





**Evaluation
      of Disclosure Controls and Procedures**





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





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





**Changes
      in Internal Control Over Financial Reporting**





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





**PART
      II****OTHER
      INFORMATION**





**Item
      1.****Legal
      Proceedings**





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




21.


**Item
      1A.****Risk
      Factors**





In
      addition to the risk factors included in our Annual Report of Form 10-K for
      the
      year ended December 31, 2005 and subsequent filings with the SEC, we note as
      an
      additional risk factor the following:





**We
      may be Unable to Realize our Plan to Sell our Preclinical Business on Acceptable
      Terms.**




We
      have
      developed a plan to sell our Preclinical Business and are engaged in an active
      sale process. However, there is no assurance that we will be able to sell our
      business on terms that we find acceptable. In the meantime, due to uncertainty
      created by our plan of sale, we may have trouble retaining or hiring employees
      for that Division and retaining certain customers or obtaining new contracts
      from customers, which, in turn, could have an adverse effect on the Division
      and
      on our ability to sell the business on terms we find acceptable. We may have
      to
      record further losses from discontinued operations until we sell the business
      and as a result of any sale of the business, depending on the value of the
      consideration we receive.





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





None.





**Item
      3.****Defaults
      Upon Senior Securities**





None.





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





None.





**Item
      5.****Other
      Information**





None.





**Item
      6.****Exhibits**




31
              Certifications
                  pursuant to Rule 13a-14(a)/15d-14(a).32
              Certifications
                  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
                  906 of
                  the Sarbanes-Oxley Act of 2002.10.87a
              Agreement
                  for Termination of Lease and Voluntary Surrender of Premises dated
                  September 28, 2006, between Registrant and ARE-Maryland No. 23,
                  LLC.




22.


**SIGNATURES**








Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.


**GENE
                  LOGIC INC.**Date:
                  November 9, 2006
              
              By:/s/
              Philip
                  L. Rohrer, Jr.Philip
                  L. Rohrer, Jr.Chief
                  Financial Officer(*Principal
                  Financial and Accounting Officer**)*









23.