Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

OR

For the Transition Period From              to             

Commission file No. 000-30369

VIROLOGIC, INC.

(Exact name of registrant as specified in its charter)

Registrant’s Telephone Number, Including Area Code: (650) 635-1100

Securities Registered Pursuant to Section 12(b) of the Act:

None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $0.001 Par Value

(Title of class)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  x.

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004 was $86,801,043.*

The number of shares outstanding of the Registrant’s Common Stock was 117,351,121 as of March 11, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

The registrant’s Definitive Proxy Statement, to be filed with the Securities and Exchange Commission (the “Commission”) pursuant to Regulation 14A in connection with the 2005 Annual Meeting of Stockholders (the “2005 Annual Meeting”), is incorporated by reference into Part III of this Report.

Table of Contents

TABLE OF CONTENTS

2

Table of Contents

This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 including, without limitation, statements regarding development and commercialization of our proposed products and services, our anticipated rate of capital usage and the possible growth of our business into new markets. These statements, which sometimes include words such as “expect,” “goal,” “may,” “anticipate,” “should,” “continue,” or “will,” reflect our expectations and assumptions as of the date of this Annual Report based on currently available operating, financial and competitive information. Actual results could differ materially from those in the forward-looking statements as a result of a number of factors, including our ability to successfully complete the development and clinical validation of eTag assays and commercialize these assays for guiding treatment of cancer patients, the market acceptance of our products, the effectiveness of competitive products, new products and technological approaches, the ability to successfully integrate ACLARA’s operations into ours, the potential impact of the Contingent Value Rights on our financial position, the risks associated with our dependence on patents and proprietary rights, the possible infringement of the intellectual property rights of others, and our ability to raise additional capital if needed. These factors and others are more fully described in “Risk Factors Related to Our Business” and elsewhere in this Form 10-K. We assume no obligation to update any forward-looking statements.

PART I

Item 1. Business

Overview

We are a life sciences company committed to advancing personalized medicine and improving patient outcomes through the development of innovative products that guide and target the most appropriate treatments. Through a comprehensive understanding of the genetics, biology and pathology of particular diseases, we have pioneered and are developing molecular diagnostics and laboratory services that will:

We are a leader in developing and commercializing innovative products that help guide and improve the treatment of infectious diseases, cancer and other serious diseases. Our goal with personalized medicine is to enable the management of diseases at the individual patient level through the use of sophisticated diagnostics that permit the targeting of therapeutics to those patients most likely to respond to or benefit from them, thereby offering the right treatment to the right patient at the right time.

ViroLogic’s PhenoSense^™ and GeneSeq^™ products provide a practical method for measuring the impact of genetic mutations on human immunodeficiency virus, or HIV, drug resistance. This information is used to optimize various treatment options for the individual patient. We currently market several products directed at patients with HIV infection and have a number of additional assays that are in use by pharmaceutical companies in their clinical trials of new drugs that could, in time and as these new drugs are approved for use, provide additional valuable information to physicians in aiding the management of their patients’ disease progression.

Over the last several years, we have built a business based on the personalized medicine approach in HIV drug resistance testing. With our merger with ACLARA BioSciences, Inc., or ACLARA, completed in December 2004, we intend to leverage the experience and infrastructure we have built in the HIV market to the potentially larger market opportunity of cancer utilizing our proprietary eTag^™ technology, acquired through our merger with ACLARA. In the future, we plan to seek opportunities to address an even broader range of serious diseases.

3

Table of Contents

New targeted drug therapies are being introduced for the treatment of cancer. Our proprietary eTag technology provides an assay platform for analyzing very small amounts of tumor samples recovered and prepared in a variety of methods, including formalin fixation, the current standard technique in hospital pathology laboratories. This analytical platform is expected to be particularly well suited for the next generation of targeted cancer therapeutics. We believe the likelihood of a patient’s cancer responding to a given therapy can be predicted with a high degree of accuracy utilizing eTag assays, facilitating the selection of more precise and effective therapeutic options. We are developing Epidermal Growth Factor Receptor, or EGFR/Her, eTag assays that we believe will enable physicians to identify the appropriate course of treatment for cancers that have a particular molecular profile. While our initial focus is on drugs that target the EGFR/Her receptor family, we intend to develop eTag assays that target other protein drug targets and signaling pathways that are key drivers of proliferation or survival in cancer cells.

We were incorporated in the state of Delaware in November 1995 and commenced commercial operations in 1999. Our principal executive offices are located at 345 Oyster Point Blvd., South San Francisco, CA 94080. Further information can be found on our website: www.virologic.com. Information found on our website is not incorporated by reference into this report.

Background

Personalized Medicine

There is growing evidence that while many serious diseases, such as HIV and cancer, can be characterized at the molecular level, many drugs simply do not work optimally for an entire population of patients in these broad disease categories. The biopharmaceutical industry is witnessing two mutually dependent innovations:

Based on these innovations, a new approach to disease management is emerging—Personalized Medicine— in which the most effective treatment options for the individual patient can be identified using specific diagnostic tests. The ideal of personalized medicine is to move from the so-called “one size fits all” method of drug treatment, to providing “the right treatment to the right patient at the right time.”

Infectious Diseases

Viruses are microorganisms that must infect living cells to reproduce or replicate. These viruses infect human cells and replicate, making new viruses that can infect other cells. There are many different types of viruses, but all viruses share structural and functional characteristics associated with their ability to replicate. During the replication cycle, all types of virus often change slightly, or mutate. This is particularly true of viruses such as HIV and HCV. For example, in an untreated HIV-infected patient, HIV generates virus variants with genetic mutations at every possible nucleotide position, causing billions of new viruses to be produced each day. At any given time there can be many different variants of the virus present within the infected patient’s body, each with a slightly different genetic sequence. This large number of virus variants allows HIV to adapt very rapidly and develop resistance to drugs. As a consequence of drug resistance, HIV continues to cause a large number of infections and deaths despite the availability and introduction of new and effective treatments.

Viral drug resistance refers to a reduction in the ability of a particular drug or combination of drugs to block replication of the virus. Drug resistance typically occurs as a result of mutations that accumulate in the viral genome as it replicates. As the virus replicates and creates a multitude of mutations, the drug resistant mutations become more prominent. For people infected with HIV, drug resistance can render drugs less effective or even completely ineffective, thus significantly reducing treatment options. The emergence and spread of strains of virus with drug resistance means that the ability to treat infections and save lives has become increasingly difficult.

4

Table of Contents

There are approximately 40,000 new diagnoses of HIV infection in the United States each year. In time most of these progress to AIDS, which is one of the leading causes of death worldwide. It is estimated that approximately one million individuals in the United States are currently living with this disease. While once considered a fatal disease, with the advent of 20 FDA-approved anti-viral drugs for treatment of HIV and over 50 more in development, HIV infection increasingly can be treated as a chronic disease.

The Viral Drug Resistance Crisis

While more effective combination treatment regimens have been introduced for HIV, e.g. HAART (highly active antiretroviral therapy), over time the virus often develops resistance to the administered drugs, requiring a change in the combination of anti-viral agents prescribed. Selecting the right combination of drugs for optimal treatment of HIV patients is often difficult when physicians have limited information about the susceptibility of the patient’s HIV to specific anti-viral drugs. Each treatment failure increases the risk that the next drug combination will not work or work for a shorter period of time leaving the patient with fewer effective future treatment options. Physicians are faced with the challenge of tailoring therapy to individual patients numerous times over the course of the disease.

Resistance to anti-viral drugs is one of the most serious impediments to successful treatment of HIV/AIDS patients. In response to the problem of anti-viral drug resistance, physicians use combinations, or cocktails, of anti-viral drugs, attacking different targets within the virus simultaneously. However, even combination therapy eventually fails in a great majority of patients, due in large part to the fact that the virus becomes resistant to some or all of the drugs used in combination.

Anti-viral drugs approved by the U.S. Food and Drug Administration, or FDA, are generally used in various combinations to treat HIV infected patients. Combination therapy requires each drug in the combination to be active, interfering with key viral functions, for the therapy to be most effective. If any of the drugs are not active, the combination therapy will likely fail more quickly. Each treatment failure leaves the patient with fewer future treatment options. Drug resistant viruses can also be transmitted to newly infected individuals, increasing the risk that initial treatment for those individuals will not work.

There are 20 drugs approved by the FDA for treatment of HIV. These generally fall into four classes of drug. These are nucleoside reverse transcriptase inhibitors, non-nucleoside reverse transcriptase inhibitors, protease inhibitors and entry inhibitors. Most currently approved HIV therapeutics are in the first three classes. There is one approved entry inhibitor, although many are in development.

While new anti-viral drugs with increased potency and activity against drug resistant viruses are under development, the ability of HIV to mutate and replicate continues to challenge physicians, who are faced with the challenge of identifying the most appropriate therapy for the individual patient.

Viral Resistance Testing

In response to the challenge posed by drug resistant viruses and the complexity provided by multiple choices of therapeutic, tests have been developed to assess the resistance of viruses to particular drugs. Simple tests based on an analysis of the genetic composition of the virus are now quite common. In addition, more sophisticated tests are also available. The technologies available for resistance testing are:

5

Table of Contents

Both types of test can improve treatment response and can be used either to realign existing therapy or to help selection of the best initial therapy for a patient. Resistance testing has emerged as the “standard of care” in the management of patients with HIV. Current treatment guidelines from the U.S. Department of Health and Human Services, the International AIDS Society-USA and the EuroGuidelines Group recommend resistance testing to identify new potent drug combinations after therapy failure. Phenotypic testing provides the most direct measure of drug resistance and, when combined with genotypic testing, provides the most comprehensive view of a patient’s situation. The ultimate goal of resistance testing is to optimize therapies for the individual patient. Increasingly, the complexity of the virus, the sophistication of available testing, and the cost to the patient both in terms of lost future treatment options as well as funds spent on expensive but ineffective therapies, make it more and more critical that physicians have access to as much information as possible when they determine therapy for their patients.

Oncology

Over one million new cases of solid tumor cancer are diagnosed each year in the United States, with four cancer types (breast, prostate, lung and colorectal) accounting for over 700,000 of these. While the incidence of lung cancer is declining slightly, the incidence of breast and colorectal cancer is believed to be increasing at approximately five percent annually and the incidence of prostate cancer at approximately one percent annually.

Although there are often several therapeutic options for a given indication, treatment is typically expensive and accompanied by a host of adverse side effects that are detrimental to patients’ quality of life. In many cases, treatments are effective in only a small percentage of the total patient population and so multiple treatment options must be pursued sequentially until an effective one is found. Often, relatively non-specific broader acting cancer therapeutic agents, including various chemotherapies and radiotherapy are used as first-line and second-line therapies before more specific, targeted therapeutics are used. These broader agents often have serious debilitating side effects associated with them. Not until a patient has “failed” these treatments either because of intolerable or adverse side effects or because their cancer does not respond or has progressed are newer targeted therapies tried. These targeted therapies are often used in third-line treatment because the percentage of patients in the overall population for whom they are effective is relatively low (10%-20%). For patients with a life threatening disease, the sequential approach to the selection of therapies is not optimal but is a consequence of the limited information available to physicians. Despite many years of clinical studies, physicians still have inadequate information on which to base many treatment decisions and many newer targeted drugs have low levels of response in the general disease population, even though in a subset of the patient population they can be extremely effective. The consequences of suboptimal or inappropriate therapies include poor patient outcomes, both from side effects and lack of activity, as well as an economic burden on the healthcare system—the added costs of the physician’s time, wasted drugs and increased hospitalization.

Patient Selection Testing

There is growing acknowledgement that the current methods of classifying different types of cancer by the tissue of origin (e.g. breast cancer or lung cancer), are relatively crude and imprecise, and that better methods of categorizing an individual’s cancer or tumor are possible. In fact, it is now believed that individual tumors of different types (e.g. lung cancer and breast cancer) from different patients may be more closely related at the molecular level, and more likely to respond to a particular targeted therapy, than two lung tumors or two breast tumors. Separate lung cancer tissues may appear to be the same, but at the molecular level they may display very different biological processes. For a treatment to be optimally effective in killing or controlling cancer cells in an individual patient, it is desirable to have diagnostic tests that are able to “see” at this level, determine what is driving the growth of the cancer cells in that individual patient, and which drug will affect that particular process.

Cancer cells proliferate through the activation and interaction of complex biological pathways, stimulated by both extracellular signals and intracellular changes. In order to cure a patient’s cancer, or to control it and

6

Table of Contents

limit its progression, physicians must have an understanding of these complex processes, and which particular pathways have been activated and are driving cancer cell growth in each particular patient. New molecular methods and analytical techniques are attempting to provide this information. These new technologies hold the potential for revolutionizing cancer diagnosis and treatment, enabling physicians to make decisions on what treatment options are best suited for an individual patient’s “personalized medicine.”

Recently there has been scientific debate about the predictive nature of particular genetic markers or genomic structures, such as the identification of specific gene mutations present in the tumor tissue of certain patients. While this information is extremely useful in some cases, the biological patterns that result in uncontrolled cell growth and cancer are much more complex, and are influenced by many additional factors, than can be communicated in simple gene mutations. We believe that a more comprehensive understanding of the biology involved in cancer cell growth and drug response, especially at the level of proteins, protein complexes and signaling pathways, where most drugs work, is required to enable physicians to select the right therapy. Effective diagnostic tests are those that can identify the presence of the proteins and protein complexes that are the targets of the drugs in question. Even greater predictive power would likely accrue to those diagnostic tests able to measure the targets in their activated state, i.e., those target proteins actively involved in the disease process or mechanism attacked by the drug. For example, different members of the EGFR/Her receptor family are active in many types of cancer, but not in all patients with a particular type of cancer. The ability to detect activated drug targets, such as EGFR/Her receptors, is important to understanding whether particular drugs are likely to be effective.

ViroLogic’s Solution

Our solution to these challenges is based on molecular diagnostic tools that:

Infectious Diseases

Our proprietary technology identifies drug resistance in viruses that cause serious infectious diseases. Our products are used primarily in the management of patients with HIV/AIDS, and could also be applied to other serious infectious diseases. We make our tests available both to physicians to guide the management of patients’ treatment and to pharmaceutical companies to aid in the development and clinical evaluation of new drugs.

7

Table of Contents

The following table sets out the products that are offered to physicians in guiding the selection of therapy from among approved drugs and the tests available to pharmaceutical and biotechnology companies for use in drug development and clinical trial patient recruitment:

Products for HIV Testing

In addition to the HIV testing products detailed above, we have PhenoSense HCV and GeneSeq HCV assays that we make available to pharmaceutical companies for use in their drug discovery and development programs.

The products that are currently used in pharmaceutical company testing may represent potential future new products for the patient testing aspect of our business as clinical utility is established and as additional drugs are commercialized.

Physicians

Utilizing the information from the various products that we have developed, physicians are able to manage the treatment of HIV and prescribe personalized treatments for patients.

8

Table of Contents

Our GeneSeq test determines the genetic sequence of HIV and provides physicians with a prediction of expected drug resistance based on the particular mutations present in the individual patient’s virus. Our PhenoSense technology, rather than relying on known genotypic associations to make predictions of drug resistance, provides a direct measurement of the activity of each of the currently available anti-retroviral drugs against the patient’s individual virus. By directly measuring the interaction of drug with viral enzyme, it avoids the need to rely on predictions when knowledge of genotypic resistance is lacking. The quantitative nature of the phenotypic information that is provided facilitates a more useful characterization of the continuum of resistance than can be derived from basic genotypic tests. In addition, our tests can be automated and performed in large numbers, making them practical for routine use in the clinical management of patients.

We believe the information generated by our technology supports and guides the decision making process for physicians to identify optimal therapeutic treatment regimens for each patient. Through our genotypic and phenotypic tests, we provide a comprehensive report to the physician outlining the likely response of the patient’s disease to all 20 approved drugs. To provide more cost effective and timely data to the physician, we launched VLink, in March 2004, an online test reporting system for our comprehensive portfolio of HIV drug resistance assays, PhenoSense GT, PhenoSense HIV and GeneSeq HIV. Our secure online system facilitates data analysis, allowing examination of historical patient resistance data to help identify resistance patterns in patients over time, and it helps decrease the time between sample submission and reporting the results of the assays to physicians.

Pharmaceutical Companies

Pharmaceutical companies are under significant pressure to increase the productivity of their research and development functions. The most immediate impact on revenue for a pharmaceutical company can be derived from accelerating the progress of existing drugs in development through clinical trials, as opposed to enhancing drug discovery programs.

Increasing the speed and probability of success of clinical trials and accelerating the commercialization of drug candidates can be achieved through the advent of tests that are based on a personalized medicine approach. By identifying patients utilizing biomarkers that are predictive of response to the drug under investigation, clinical trials can be shorter, smaller and less costly, and have a higher probability of successful completion. In addition, the drug can be expected to have an improved economic profile because it can be prescribed with a higher degree of expected effectiveness, be brought to market more rapidly, and potentially be positioned as a first- or second-line treatment rather than a second- or third-line treatment.

Our products can be utilized by drug developers to:

Clinical trials are the most expensive part of drug development and pharmaceutical companies are now utilizing the information from pharmacogenomics, the scientific discipline focused on how genetic differences among patients determine or predict responsiveness or adverse reactions to particular drugs, to improve the outcomes of clinical trials. In a similar way, pharmaceutical companies are applying our PhenoSense technology to help select and monitor suitable patients for clinical trials. This selection process may allow pharmaceutical companies to guide important drug development decisions before large resource commitments are made. To date, we have provided testing services to almost all the pharmaceutical companies with drugs in development for treatment of HIV/AIDS and every drug approved for treatment of HIV in the past five years has benefited from the use of our tests in clinical trials. Importantly, the FDA has endorsed and emphasized the importance of resistance testing in drug development.

9

Table of Contents

Database and Virus Library

Through our products we have access to and are collecting a wealth of information on drug resistance and related clinical data that is being compiled in an interactive database and a virus library to assist our pharmaceutical customers in drug marketing and drug development. Two important components of our database include

We make this data available to pharmaceutical companies by providing defined data queries that can enhance their drug development programs. The virus library is a valuable reagent resource that facilitates novel drug characterization and clinical sample evaluations.

Oncology

Through our merger with ACLARA we plan to expand our franchise into oncology. We aim to leverage our commercial experience to develop diagnostic tests that will differentiate those patients who are likely to respond to new targeted therapies from those patients who will not respond. We are currently completing the development of our proprietary eTag assays that measure specific protein analytes and utilize tumor samples obtained from a patient’s biopsy or surgery, to aid in prescribing the new targeted cancer drugs for these patients.

Our eTag assays require only a very small amount of biological sample and can be performed directly on fresh, frozen and the standard clinical format—formalin-fixed paraffin-embedded clinically derived patient samples. This ability to utilize small amounts of human clinical samples in a wide range of formats, without extensive and time-consuming sample preparation, makes eTag assays well suited to diagnostic applications in human disease management.

Importantly, eTag assays can detect proteins and protein complexes that are not readily discernible with other technologies, especially in formalin-fixed human clinical samples. These analytes are expected to provide valuable information with respect to the activation states of key signaling pathways that drive cell proliferation and survival in tumors, and serve as biomarkers that indicate the likelihood of response to particular targeted therapeutics in individual patients and specific patient sub-groups.

Physicians

We intend to complete the development of our first commercial eTag assay product, an Epidermal Growth Factor Receptor, or EGFR, receptor assay panel that will enable physicians to identify the appropriate course of treatment for cancers that have characteristic profiles of receptors in the EGFR/Her receptor family. These assays have been developed and utilized in a research setting and have been evaluated by several pharmaceutical companies. We plan to transfer these assays into our Clinical Laboratory Improvement Amendments of 1988, or CLIA, certified clinical laboratory so that, after validation in accordance with CLIA standards, commercial tests can be launched. Retrospective clinical studies are being conducted to further evaluate and confirm the clinical utility of our assays. In these studies, we are accessing previously collected tumor samples, performing our eTag assays on those samples and comparing the results and predictions obtained from our assays with the known patient response data. A number of both retrospective and prospective studies are in progress and planned to generate this information.

Pharmaceutical Companies

Several targeted cancer drugs are already approved for marketing (e.g. Herceptin^®, Gleevec^®, Iressa^®, Tarceva^®, Erbitux^®, Avastin^®) with many more in development. As pharmaceutical companies continue to develop these targeted cancer therapies, there is an urgent need to be able to distinguish those patients who will respond to these treatments from those who will not.

10

Table of Contents

eTag assays are made available to pharmaceutical and biotechnology companies under collaborative agreements through which they can access our proprietary assay systems and development expertise for use in clinical development programs. These assays and services can be a critical aide in patient selection in clinical trials of targeted therapies that may be highly efficacious in selected patient populations while only minimally effective in the general patient population. We have conducted evaluations with several pharmaceutical and biotechnology companies and intend to develop expanded collaborations with these companies.

Reagents

Certain eTag assays used in more general pharmaceutical research and development programs are provided as research tools for multiplexed gene and protein expression analysis through the purchase of custom-made eTag assay kits, software, custom assay services, and consulting support. These assay development services and reagents are provided to pharmaceutical companies, primarily those that are significant customers or potential customers for our clinical assays in oncology.

On-Going Clinical Studies

We and independent clinical collaborators are currently conducting validation studies that are designed to show that eTag assays can be used to correctly identify patients likely to respond to particular targeted cancer therapies. For instance, in January 2005, a collaborator at Princess Margaret Hospital in Toronto presented clinical data assessing the ability of our eTag assays to accurately predict treatment outcomes for patients with metastatic colorectal cancer. The study, presented at the American Society of Clinical Oncology’s (ASCO) Gastrointestinal Cancer meeting in January, showed a correlation between the detection of EGFR/Her receptor family dimers, as measured by eTag assays, and the response as indicated by disease stability or disease progression in 18 patients being treated with erlotinib (Tarceva^®). A larger confirmatory study is underway. Several studies of this sort are in progress and planned, and are designed to provide clinical validation in support of the commercial launch of a test.

ViroLogic’s Strategy

Our objective is to be a world leader in developing and commercializing innovative products to help guide and improve the treatment of infectious diseases, cancer and other serious diseases. We have focused on developing products that meet the treatment needs for infectious diseases, primarily HIV/AIDS and believe that we have built the leading franchise in this area. Through our merger with ACLARA, we plan to expand into the area of cancer therapy and in the future will seek opportunities to address an even broader range of serious diseases. Key elements of our strategy are to:

11

Table of Contents

Sales & Marketing

We market our HIV drug resistance tests to physicians through a direct sales organization. To do so, we have built an efficient commercial infrastructure to support the industry’s most comprehensive line of drug resistance tests currently available. We currently have 26 experienced sales representatives promoting our HIV drug resistance tests in the United States. In addition, we have 11 people in our marketing, customer service and sales management functions supporting our direct sales personnel.

We also make our current products available through national, regional and hospital laboratories. In May 2004, we signed an expanded referral testing agreement with Quest Diagnostics, the nation’s leading provider of diagnostic testing, information and services. Under the terms of the agreement, Quest Diagnostics has made us its preferred provider of HIV phenotypic resistance testing. Quest Diagnostics has the largest national network of laboratories, with more than 30 full-service regional laboratories in major metropolitan areas and nearly 2,000 patient service centers, where patients’ specimens are collected. In 2004, 2003 and 2002, Quest Diagnostics, represented 12%, 9% and 10%, respectively, of our total revenue. The agreement with Quest expires in April 2005 and is subject to annual renewal on certain conditions.

We expect to leverage our existing experience and infrastructure to commercialize products for the oncology market. As we will be marketing to a separate physician group, we expect to hire sales personnel dedicated to the oncology market and are currently recruiting for a senior executive to lead this effort.

In addition we have a team of 9 employees developing and managing relationships with pharmaceutical companies related to our HIV pharmaceutical testing services, and a team of 3 employees developing relationships with pharmaceutical and biotechnology companies related to our oncology and eTag reagent products and services.

12

Table of Contents

Our marketing strategies focus on physician, patient and payor education in order to increase market awareness of our resistance testing products. We routinely sponsor and participate in conferences and scientific meetings, sponsor educational forums for physicians, and advertise in relevant journals and publications. Additionally, we target patients directly through educational programs. As part of our effort to maintain scientific leadership within the clinical community, which represents our customer base, we have a clinical advisory board consisting of leading clinicians.

We have an active reimbursement strategy, and educate both private and public payors concerning drug resistance testing in an effort to maximize reimbursement. Over an estimated 75% of HIV/AIDS patients in the United States now have access to coverage for resistance testing. At the end of 2004, 48 state Medicaid programs, including California, Florida, New Jersey and New York, the states with the largest HIV/AIDS patient populations, had favorable coverage policies for drug resistance testing. Medicare and nearly all private payors, including Aetna, the Blue Cross Blue Shield Association, Humana and United Health Care, pay for resistance testing.

Research & Development

Research and development expenditures were $7.8 million, $4.7 million and $10.4 million in 2004, 2003 and 2002, respectively. In addition, in 2004, we recorded a non-cash charge of $100.6 million as an allocation of the purchase price of ACLARA to in-process research and development programs. This reflects ACLARA’s technologies for providing eTag assays as diagnostic tools to pharmaceutical companies and physicians.

At the end of 2004 we had 49 employees in research and development, of whom 24 were focused on infectious disease programs, and 25 were focused on oncology programs and eTag-related drug discovery assays.

We maintain an active effort to seek grant funding in support of research programs. In 2003 and 2004, we were awarded a total of five grants totaling more than $5 million over three years. These grants will help support the development of analytical and database tools to facilitate the identification and characterization of drug resistant strains of HIV, and assays that will aid in the pre-clinical and clinical evaluation of the next generation of anti-viral therapeutics and vaccines. Revenue from grants in 2004 was $2.0 million.

Scientific Advisory Board

We have established an internationally renowned group of scientific advisors to provide specific expertise in areas of research and development relevant to our business. Our scientific advisors who meet periodically with our scientific and development personnel and management to discuss our present and long-term research and development activities include the following leaders in scientific and clinical research:

DAVID B. AGUS, M.D.—Research Director at the Louis Warschaw Prostate Cancer Center at Cedars-Sinai Medical Center and Assistant Professor of Medicine at UCLA.

JOSE BASELGA, M.D.—Professor of Medicine at the Universidad Autonoma de Barcelona and the Scientific Chairman of the Spanish Breast Cancer cooperative group SOLTI.

CARLOS L. ARTEAGA, M.D.—Professor of Medicine and Cancer Biology and Director of the Breast Cancer Research Program of the Vanderbilt-Ingram Cancer Center at Vanderbilt University School of Medicine.

STEPHEN P GOFF, PH.D.—Higgens Professor of Biochemistry and Molecular Biophysics at the College of Physicians and Surgeons of Columbia University, and an Investigator of the Howard Hughes Medical Institute.

ROY S. HERBST, M.D., PH.D.—Chief of the Section of Thoracic Oncology and Associate Professor at the University of Texas M. D. Anderson Cancer Center in Houston.

13

Table of Contents

MANUEL HIDALGO, M.D., PH.D.—Associate Professor of Oncology and Co-Director of the Drug Development Program at the Sidney Kimmel Comprehensive Cancer Center, Johns Hopkins University School of Medicine in Baltimore, Maryland.

DAVID D. HO, M.D.—Scientific Director and Chief Executive Officer of the Aaron Diamond AIDS Research Center, and a Professor of The Rockefeller University.

STEPHEN H. HUGHES, PH.D.—Chief of the Retroviral Replication Laboratory, HIV Drug Resistance Program at the National Cancer Institute — Frederick in Maryland.

DOUGLAS D. RICHMAN, M.D.—Professor of Pathology and Medicine at the University of California, San Diego School of Medicine and Director of the Research Center for AIDS and HIV Infection at the San Diego VA Medical Center.

ROBERT T. SCHOOLEY, M.D.—Tim Gill Professor of Medicine and Head of the Infectious Disease Division at the University of Colorado Health Sciences Center.

PJ UTZ, M.D.—Assistant Professor and directs a research laboratory in the Division of Rheumatology and Immunology at the Center for Clinical Immunology at the Stanford University School of Medicine.

OWEN N. WITTE, M.D.—Professor of Microbiology, Immunology and Molecular Genetics at UCLA. Professor Witte is also an Investigator of the Howard Hughes Medical Institute.

Competition

The markets for life science research and diagnostic products are highly competitive and are subject to rapid technological change. In particular, approaches to personalized medicine are rapidly evolving and there are many companies attempting to establish their technological approaches and products as the standard of care.

For our HIV testing products, the major competitors include manufacturers and distributors of phenotypic drug resistance technology, such as Tibotec-Virco, a division of Johnson & Johnson, and Specialty Laboratories. We also compete with makers of genotypic tests such as Applied Biosystems Group, Visible Genetics Inc., a division of Bayer Diagnostics, and laboratories performing genotypic testing as well as other genotypic testing referred to as virtual phenotyping.

For diagnostic testing for cancer therapies, we expect to compete with companies that are developing alternative technological approaches for patient testing in the cancer field. There are likely to be many competitive companies and many technological approaches in the emerging field of testing for likely responsiveness to the new class of targeted cancer therapies, including companies such as DakoCytomation A/S and Abbott Laboratories that currently commercialize testing products for guiding therapy of cancer patients. Established diagnostic product companies such as Abbott Laboratories, Roche Diagnostics and Bayer Diagnostics and established clinical laboratories such as Quest Diagnostics and LabCorp may also develop or commercialize services or products that are competitive with those that we anticipate developing and commercializing. In addition, there are a number of alternative technological approaches being developed by competitors and evaluated by pharmaceutical and biotechnology companies and being studied by the oncology community. In particular, while our anticipated oncology testing products will be based on the identification of protein-based differences among patients, there is significant interest in the oncology community in gene-based approaches that may be available from other companies.

We believe that the principal competitive factors in our markets are product capability supported by clinical validation, scientific credibility and reputation, customer service, cost effectiveness of the technology and the sales and marketing strength of the supplier.

14

Table of Contents

Many of our competitors and potential competitors in these markets have substantially greater market presence and substantially greater financial, technical and human resources than we do. We cannot assure you that they will not succeed in developing technologies and products that would render our technologies and products obsolete and noncompetitive. We also cannot assure you that we will be able to compete effectively with these competitors’ greater marketing presence and financial strength.

Operations

We perform our HIV drug resistance testing in South San Francisco, California. Our clinical laboratory is accredited by the College of American Pathologists and our facility is subject to stringent CLIA operating regulations. Patient samples for testing are delivered by courier and treated as infectious specimens. After processing of the samples with our proprietary technology, results are reported to the customer. The CLIA regulations require that we meet certain quality and personnel standards and undergo proficiency testing and inspections.

We expect to transfer our eTag assays from the research setting to our CLIA certified clinical laboratory in South San Francisco, California, during 2005. This transfer process will involve documentation, quality and validation procedures comparable to those applicable to our HIV testing products. While initial products for the cancer market will be introduced through our CLIA certified clinical laboratory, future cancer testing products may include test kits that may be subject to the regulatory authority of the Food and Drug Administration, or the FDA. The FDA regulatory framework is complicated, and we have limited experience at managing FDA compliance issues. If we develop cancer test kits, the kits could be subject to premarket FDA approval requirements, which would be expensive and time-consuming, and could delay or prevent us from marketing these tests. In addition, the production of the future cancer test kits may be subject to Good Manufacturing Practice Regulation, or GMP, under the auspices of the FDA. Our facilities are not GMP compliant. If the manufacture of the proposed kits is subject to GMP regulation, we will be required to establish a GMP compliant facility, or to enter into a relationship with a third party manufacturer that operates a GMP compliant facility. We do not have experience with GMP compliance. GMP compliance, or entry into a manufacturing relationship with a third party manufacturer, would be time-consuming and expensive.

Patents and Proprietary Rights

Our Intellectual Property Strategy

We will be able to protect our technology from unauthorized use by third parties only to the extent that our proprietary rights are covered by valid and enforceable patents or are effectively maintained as trade secrets. Patents and other proprietary rights are an essential element of our business. Our policy is to file patent applications and to protect technology, inventions and improvements to inventions that are commercially important to the development of our business. Our commercial success will depend in part on obtaining this patent protection.

With respect to our viral disease portfolio, including products and services for HIV, we currently have 27 issued patents and 128 pending applications for additional patents, including international counterparts to our U.S. patents. We have licensed and expect that we may need to license additional technology in order to continue the development and commercialization of our products. In addition, with respect to our HIV products, we have non-exclusively licensed seven patents under the Roche Molecular Systems, Inc., or Roche, license discussed below.

With respect to our planned oncology products and eTag technology, and as a result of our merger with ACLARA, we have approximately 148 granted, allowed, issued and pending patent applications in the United States and in other countries, including 15 issued or allowed patents. In addition, we have 129 granted, allowed,

15

Table of Contents

issued and pending patent applications in the United States and in other countries, including 58 issued or allowed patents, related to the historic microfluidics business of ACLARA. Our patents and patent applications related to our eTag technology and products in development address the following essential areas: Biomarkers enabled by eTag technology, including the use of selected intracellular protein-protein complexes and cell surface receptor dimers to indicate disease status, particularly in the cancer field; and eTag technology, including compositions, methods and applications in gene expression and proteomics, particularly as the latter relates to cell-based assays for measurement of receptor dimerization, analysis of signal transduction pathways, and analysis of receptor-ligand binding for receptor and ligand deorphanization and drug screening. Patents related to ACLARA’s historic microfluidics business address microfluidic and nanofluidic instruments and devices, their fabrication and their applications, particularly as they relate to high-throughput screening or diagnostic applications of eTag technology.

These patents and patent applications cover a broad range of technology applicable across our entire current and planned product line. We cannot assure you that any of the currently pending or future patent applications will be issued as patents, or that any patents issued to us will not be challenged, invalidated, held unenforceable or circumvented. Further, we cannot assure you that our intellectual property rights will be sufficiently broad to prevent third parties from producing competing products similar in design to our products.

In addition to patent protection, we also rely on protection of trade secrets, know-how and confidential and proprietary information. We generally enter into confidentiality agreements with our employees, consultants and our collaborative partners upon commencement of a relationship with us. However, we cannot assure you that these agreements will provide meaningful protection against the unauthorized use or disclosure of our trade secrets or other confidential information or that adequate remedies would exist if unauthorized use or disclosure were to occur. The exposure of our trade secrets and other proprietary information would impair our competitive advantages and could have a material adverse effect on our operating results, financial condition and future growth prospects. Further, we cannot assure you that others have not or will not independently develop substantially equivalent know-how and technology.

Further, there is a risk that some of our confidential information could be compromised during the discovery process of any litigation. During the course of any lawsuit, there may be public announcements of the results of hearings, motions and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could have a substantial negative effect on the trading price of our stock.

Intellectual Property of Others

Our commercial success also depends in part on avoiding the infringement of other parties’ patents or proprietary rights and the breach of any licenses that may relate to our technologies and products. Third parties may have patents or patent applications relating to products or processes similar to, competitive with or otherwise related to our products. These products and processes may include technologies relating to HIV, hepatitis B and C, other viruses and oncology technologies. Third parties have from time to time threatened to assert infringement or other intellectual property rights against us based on their patents or other intellectual property rights.

We have had to, and expect to continue to have to, enter into licenses covering the rights at issue. Unless we are able to expand our existing licenses and obtain additional licenses, patents covering these technologies may adversely impact our ability to commercialize one or more of our potential products. We are aware of various third-party patents that may relate to our technology. We believe that we do not infringe these patents but cannot assure you that we will not be found in the future to infringe these or other patents or proprietary rights of third parties, either with products we are currently developing or with new products that we may seek to develop in the future. If third parties assert infringement claims against us, we may be forced to enter into license arrangements with them. We cannot assure you that we could enter into the required licenses on commercially reasonably

16

Table of Contents

terms, if at all. The failure to obtain necessary licenses or to implement alternative approaches may prevent us from commercializing products under development and would impair our ability to be commercially competitive. We may also become subject to interference proceedings conducted in the U.S. Patent and Trademark Office to determine the priority of inventions.

The defense and prosecution, if necessary, of intellectual property suits, U.S. Patent and Trademark Office interference proceedings and related legal and administrative proceedings will result in substantial expense to us, and significant diversion of effort by our technical and management personnel. An adverse determination in litigation or interference proceedings to which we may become a party could subject us to significant liabilities to third parties, could put our patents at risk of being invalidated or interpreted narrowly and could put our patent applications at risk of not issuing.

License Agreements

We license polymerase chain reaction, or PCR, technology from Roche for performing a step in our PhenoSense and GeneSeq tests. This license is non-exclusive and lasts for the life of the patent term of the last to expire licensed Roche patent. We believe that the last Roche patent expires in 2005. If Roche develops or acquires additional patents covering technology related to the licensed technology, we have the option of licensing that additional technology under the terms of this agreement, which may extend the term of the license. In exchange for the license, we have agreed to pay Roche a royalty based on the net service revenues we receive from our products. At least sixty days prior to introducing a new product utilizing the Roche technology, we must notify Roche of that introduction. If we fail to notify Roche, we would have to pay a higher royalty. We also agreed to participate in proficiency testing in accordance with applicable quality assurance standards and to comply with all relevant regulations and standards. Further, we have agreed to give Roche a reasonable opportunity to negotiate for a license to use any technology we develop related to the reaction technology we license from Roche, such as the automation of the method for performing the reaction. Roche has the right to terminate this license if we fail to pay royalties, make a semi-annual royalty report or participate in proficiency testing. We believe we are in compliance with these requirements. The license allows us to use technology covered by the licensed Roche patents within a broad field that includes all of our currently planned products. If we were to expand our product line beyond the licensed field, however, we would need to negotiate an expansion of the license.

We license certain technologies from Third Wave Technologies, Inc. pursuant to a License Agreement signed by ACLARA in October 2002 and assigned to us as a result of the merger. Under the License Agreement and a related Supply Agreement, we have rights to incorporate Third Wave’s Invader technology and Cleavase enzyme with our eTag technology to offer the eTag Assay System for multiplexed gene expression applications for t