VIROLOGIC INC - 10-K Annual Report


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


o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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 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 o.

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2003 was $28,663,200.*

The number of shares outstanding of the Registrant’s Common Stock was 53,397,100 as of March 25, 2004.

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 2004 Annual Meeting of Stockholders (the “2004 Annual Meeting”), is incorporated by reference into Part III of this Report.

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 our PhenoSense and GeneSeq testing products, the growth of our pharmaceutical business, research and development expenditures, adequacy of our capital resources, and other financial matters. 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 raise additional capital, the market acceptance of our resistance testing products, the effectiveness of our competitors’ existing products and new products, the ability to effectively manage growth and the risks associated with our dependence on patents and proprietary rights. 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.

We are a biotechnology company developing, marketing and selling innovative products to guide and improve treatment of viral diseases. We incorporated in the state of Delaware on November 14, 1995 and commenced commercial operations in 1999. We developed a practical way of directly measuring the impact of genetic mutations on drug resistance and using this information to guide therapy. We have proprietary technology, called PhenoSense, for testing drug resistance in viruses that cause serious viral diseases such as HIV/ AIDS and hepatitis. Our products are used by physicians in selecting optimal treatments for their HIV patients and by industry, academia and government for clinical studies, drug screening and characterization, and basic research.


	•	PhenoSense HIV. This phenotypic test directly and quantitatively measures resistance of a patient’s HIV to anti-viral drugs. It is used by physicians in patient testing and by pharmaceutical customers in their research and development activities.

	•	GeneSeq HIV. This genotypic test examines and evaluates the genetic sequences of a patient’s HIV. It is used by physicians in patient testing and by pharmaceutical customers in their research and development activities.

	•	PhenoSense GT. This product combines our PhenoSense HIV and GeneSeq HIV tests into one integrated report to provide comprehensive drug resistance information to assist physicians in selecting optimal treatments for their HIV patients and by pharmaceutical customers in their research and development activities.

	•	Replication Capacity HIV. This test measures viral fitness, or the ability of a virus to reproduce and infect new cells. We currently include this product free of charge when a physician or pharmaceutical customer orders one of the reports generated by our PhenoSense products. In the future, we may offer this product on a stand-alone basis.

	•	PhenoScreen. This phenotypic product provides high-throughput screening for the identification of potential clinical drug candidates for pharmaceutical customers.

	•	PhenoSense HIV Entry and GeneSeq HIV Entry. We currently market both a phenotypic entry assay and a genotypic entry assay, which measure HIV resistance to entry inhibitors, to pharmaceutical customers for use in their research and drug development activities. We intend to offer these tests to physicians for patient testing after pharmaceutical drugs become available for patient use and based on demand for the product.

	•	PhenoSense HIV Co-Receptor Tropism. HIV enters and infects cells by attaching to a cellular receptor (CD4) and one of two co-receptors, either CCR5 or CXCR4. Several pharmaceutical


		companies are developing drugs to block this co-receptor attachment. We have applied our PhenoSense HIV Entry technology to develop a test to assess which co-receptor the patient’s virus uses to enter cells (tropism). This test may play an important role in defining patient eligibility for treatment with these new HIV co-receptor inhibitors and monitoring their response to therapy. In addition, data exist which suggest that co-receptor tropism may be a prognostic factor in the pace of HIV disease progression.

	•	PhenoSense HIV Antibody Neutralization for Vaccine Development. This application of the PhenoSense HIV Entry assay is available to pharmaceutical customers and researchers to aid in the development of HIV vaccines.

	•	GeneSeq HCV. This genotypic test examines and evaluates the genetic sequence of hepatitis C and is currently available for pharmaceutical customers. We also intend to offer this test to physicians for patient testing after more pharmaceutical drugs become available for patient use.

	•	GeneSeq HBV. Like our GeneSeq HIV product, this genotypic test is directed toward hepatitis B and currently available for pharmaceutical customers. We intend to offer this test to physicians for patient testing after more pharmaceutical drugs become available for patient use.

We are also developing additional products. Like our other tests, we anticipate that these tests will be used first by pharmaceutical companies in their research and drug development activities, and later by physicians for patient testing after drugs become available for patient use:


	•	PhenoSense and GeneSeq HIV Integrase. We are currently applying our PhenoSense and GeneSeq HIV technologies to develop tests to evaluate resistance to a new class of HIV drugs called integrase inhibitors, which are designed to block a critical step in the lifecycle of HIV.

	•	PhenoSense HCV. This is a phenotypic test directed toward hepatitis C.

	•	PhenoSense HBV. This is a phenotypic test directed toward hepatitis B.

We are also collecting resistance test results and related clinical data to create database products that are sold to pharmaceutical customers to assist in drug development and drug marketing. This database may be made available to physicians for use in therapy guidance in the future.

In 2003, we completed development of our GeneSeq HCV assay for use by pharmaceutical companies in their research and drug development activities. In addition, we were awarded four Small Business Innovation Research (“SBIR”) grants from the National Institute of Allergy and Infectious Diseases (“NIAID”), a division of the U.S. National Institutes of Health (“NIH”), totaling more than $4 million over three years. The 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.

Viruses are microorganisms that must infect living cells to reproduce, or replicate. Many viruses cause disease in people. 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, viruses often change slightly, or mutate. For example, in an untreated HIV patient, as many as ten billion new viruses are produced each day, and at least one quarter of the new viruses have errors, or mutations, in their genes. At any given time there can be many different variants of the virus present within the body, each with a slightly different genetic sequence.

Currently available anti-viral drugs interfere with key viral functions to prevent viruses from replicating and therefore slow the progression of disease. However, these drugs are typically effective for only a limited time because viruses develop resistance to them through mutation, making the therapy less effective and

making many serious viral diseases almost impossible to cure. A resistant virus is one that is less sensitive to the drug that is administered. Mutant viruses resistant to a particular drug therapy continue to replicate while the others are eliminated. Over time the mutant, resistant virus predominates and the drug therapy fails. In response to this effect, physicians now use anti-viral drugs in combination, attacking different targets within a virus simultaneously. Combination therapy slows replication more effectively than a single drug, further delaying the development of drug resistance. In the short term, combination therapy has helped many patients. 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.

Resistance to anti-viral drugs is the most serious impediment to successful treatment of HIV/ AIDS patients. There are currently nineteen drugs approved by the U.S. Food and Drug Administration (“FDA”) that are generally used in various combinations to treat HIV infections. Combination therapy requires each drug in the combination to be active (in other words, interfere with key viral functions) for therapy to be most effective. If any of the drugs are not active, the therapy will likely fail more quickly. Each treatment failure increases the risk that the next drug combination will not work, or work for a shorter period of time, and leaves the patient with fewer future treatment options. Additionally, drug resistant viruses can be transmitted to newly infected individuals, increasing the risk that initial treatment for those individuals will not work. New drugs with increased potency and activity against drug resistant viruses are not becoming available in time to overcome this crisis. Consequently, physicians are faced with the challenge of tailoring therapy to individual patients numerous times per year for many patients.

When anti-viral therapy does not completely suppress viral replication, drug resistant variants can emerge rapidly, within days to weeks. If left unchecked, patients may be at greater risk of becoming more seriously ill unless effective drugs are promptly administered. Until a few years ago, physicians chose drugs based on a patient’s treatment history without the benefits of information regarding drug resistance of the patient’s virus, and frequently changed all drugs in a treatment regimen even when some might have still been effective. When physicians inadvertently select ineffective drugs, patients become more seriously ill, suffer toxic side effects, and unnecessarily bear the costs of the drugs.

To achieve long-term clinical benefit, physicians must select drugs that maximally suppress viral replication and avoid drugs to which a patient’s virus is resistant. We believe that long term solutions will rely on drug resistance tests and information systems that can guide physicians in selecting the most effective drugs against the patient’s virus and avoiding drugs to which the patient’s virus is resistant. The need for resistance testing has been affirmed in guidelines from panels led by the U.S. Department of Health and Human Services, the International AIDS Society-USA and the EuroGuidelines Group, all of which have recommended that resistance tests be routinely used when treating HIV patients.

Resistance tests can also assist pharmaceutical companies in the development of drugs to target resistant viruses. In fact, a November 1999 FDA advisory committee emphatically recommended that resistance testing be used in the development of all new anti-viral drugs for HIV.

Phenotypic tests determine “phenotype,” which refers to an organism’s outward appearance or functional characteristics. For example, eye color is a phenotype. One viral phenotype is the ability to replicate in the presence of anti-viral drugs, also referred to as “drug resistance.” Phenotypic drug resistance tests directly measure the sensitivity of a patient’s virus to anti-viral drugs by adding a drug to a virus sample and determining whether the virus is able to replicate in the presence of the drug. These tests eliminate much of the guesswork in making treatment decisions by providing the physician with direct information about drug resistance of a patient’s virus.

Early phenotypic tests required culturing, or growing viruses in the laboratory. These tests were slow, labor intensive and not easily automated. Since viruses mutate while growing in culture, the process could produce inaccurate results because the virus in culture might be different from the virus in the patient. As a result, early phenotypic testing was impractical for patient management. In the absence of practical phenotypic drug resistance tests, clinicians began to use genotypic tests in an attempt to predict drug

The World Health Organization estimates that 40 million individuals are currently infected with HIV/ AIDS, which is emerging as the most important healthcare challenge in many developing countries. A preventive vaccine remains the best long-term solution to bring this epidemic under control. Over 30 candidate vaccines have been tested and dozens more are planned. Recently, many of the world’s top AIDS researchers called for the formation of a worldwide vaccine development coalition. The current strategy for vaccine design focuses on the induction of an immune response to the virus, including the generation of neutralizing antibodies. However, conventional HIV neutralization testing technologies have cost, capacity and technical constraints that often limit the extent of their application in vaccine testing protocols. We have applied our proprietary PhenoSense technology and developed an antibody neutralization assay which we believe is more rapid, reproducible and accurate.

We believe our PhenoSense technology has significantly improved viral drug resistance testing. Our technology, which we believe to be the only currently available method that eliminates all prolonged virus culture steps, uses a genetically engineered virus that replicates only once. As a result, we avoid the need to culture viruses during testing, which makes the tests more consistent and accurate than competing phenotypic tests currently available and dramatically shortens the time required to complete them. Also, our tests can be automated and performed in large numbers, making them practical for routine use in clinical management of patients. We believe that our tests and the information that we collect from these tests have the potential to significantly change the way physicians treat viral diseases.

We believe our PhenoSense technology meets the needs of physicians and patients because it is:


	•	Direct: detects drug resistance of viruses without need for complex interpretation of mutations

	•	Quantitative: measures the degree of drug resistance and susceptibility, providing more than a “yes” or “no” answer

	•	Reliable: results are accurate and reproducible

	•	Comprehensive: can evaluate drug resistance to all currently available anti-viral drugs

	•	Versatile: can be modified to evaluate new classes of anti-viral drugs

	•	User-Friendly: results are easy to read and understand

	•	Rapid: can be performed in eight to ten days, much faster than other phenotypic resistance tests

The cornerstone of our PhenoSense technology is a proprietary vector, which we call the “resistance test vector.” This vector is a strand of viral genes that replicates when introduced into a living cell. Our vector includes two key elements. The first is a gene that produces a protein that can be easily detected, which we call an “indicator.” An example of an indicator we use is luciferase, which is responsible for the glow of fireflies. The second key element is one or more specific genes derived from the patient’s virus. These genes correspond to the targets of the anti-viral drugs being tested. For example, many HIV drugs target an enzyme called protease that is needed for HIV to replicate. We incorporate the gene that makes protease into the vector for our HIV drug resistance test.


	•	Obtain a blood sample from the patient;

	•	Isolate and inactivate the virus;

	•	Copy the viral genes corresponding to the drug targets;

	•	Insert these genes into the vector;

	•	Introduce the assembled vector into living cells to produce a new virus containing the copied genes;


	•	Use the new virus to infect cells in the presence of anti-viral drugs; and

	•	Determine the ability of the virus to complete a single round of infection.

The amount of indicator we detect is used to measure drug resistance. For example, we measure the amount of light produced by luciferase in our PhenoSense HIV test. If the virus is sensitive to the drug being tested, less light is detected. If the virus is resistant to the drug, more light is detected.

We report our resistance test results using illustrative curve diagrams. We plot the amount of luciferase, which corresponds to the amount of virus replication, on the vertical axis against the amount of drug administered on the horizontal axis. We generate curves for both a patient’s virus and a drug-sensitive control virus, and compare the two curves to quantitatively measure drug resistance. Viruses with increased resistance require more drugs to inhibit replication. We produce curves for each commercially available drug as well as for novel drugs we test for pharmaceutical development.

Our objective is to be the world leader in developing and commercializing products and information systems to guide the treatment of serious diseases. Our current products are in the fields of HIV/ AIDS and hepatitis; future target therapeutic areas may include oncology. Key elements of our strategy are to:


	•	Establish ViroLogic As The World Leader In Drug Resistance. We believe we have firmly established ourselves as a prominent force in the medical and scientific community in the field of HIV drug resistance. We present important new scientific discoveries at major meetings each year and publish those findings in prominent peer-reviewed journals. A number of major pharmaceutical companies have partnered with ViroLogic in training their organizations on the topic of HIV drug resistance and in educating the physician community.

	•	Successfully Commercialize our Product Portfolio. We are currently marketing PhenoSense HIV, GeneSeq HIV, and PhenoSense GT to physicians directly and through scientific publications, clinical trials and scientific meetings. We market our products directly to physicians in the United States through our own sales force, primarily focusing on the 1,800 leading HIV physicians who treat approximately 80% of the total U.S. HIV/ AIDS patient population. We also conduct educational symposia and programs on HIV drug resistance and resistance testing for physicians, patients and treatment educators throughout the country. We work collaboratively with pharmaceutical companies to educate physicians about resistance testing.

	•	Provide Broad, Easy Access to our Products. We have created broad access to our current commercial products from both reimbursement and distribution standpoints. We have advocated and achieved established insurance coverage policies for our marketed products throughout the country with over an estimated 75% of HIV/ AIDS patients now having access to coverage. Our products are available either directly from us or through major national and regional reference labs.

	•	Apply Our Technology to Drug Discovery and Development. We are applying our technology to create tools for pharmaceutical companies to help them determine how patients will respond to particular drugs, to assist them in screening drug candidates and to use in other drug discovery efforts. We are also assembling a library of resistance test vectors for testing of drug compounds and candidates. We currently have testing agreements with numerous pharmaceutical companies to conduct clinical trial and drug characterization work. In the future we may enter into additional partnerships to jointly discover and develop drug candidates for the treatment of HIV and other viral diseases.

	•	Expand Our PhenoSense Technology to Other Serious Diseases. Using our proprietary PhenoSense technology, we intend to develop phenotypic drug resistance testing products for other diseases. We are currently developing phenotypic and genotypic resistance tests for hepatitis viruses. We also believe that as the next generation of cancer drugs gain wide acceptance and use, they may provide a promising application for our platform therapy guidance technologies.


	•	Maintain a Strong Intellectual Property Portfolio. We have patent coverage for our PhenoSense HIV product and patent applications directed to our other products. As we expand into new areas and diversify our business, we intend to build strong intellectual property positions.

PhenoSense HIV, launched commercially in 1999, is a phenotypic drug resistance test that measures the resistance of HIV to all commercially available anti-viral drugs. When a physician orders a PhenoSense HIV test, a blood sample is drawn from the patient. This sample is sent to us to perform the test in our clinical laboratory located in South San Francisco, California. We then send a report detailing the results of the test to the physician, typically within two weeks.

HIV now affects nearly one million people in the United States and over 40 million people worldwide. Nineteen anti-viral drugs are FDA-approved for treatment of HIV infection and more than an estimated 50 additional drugs are currently in development. Despite the availability of anti-viral drugs, HIV is difficult to treat because it replicates rapidly and becomes resistant to anti-viral drugs. Selecting the right combination of drugs for optimal treatment of HIV patients is often difficult when physicians have limited information about the susceptibility to specific anti-viral drugs of the HIV infecting an individual patient.

Physicians are now routinely using resistance testing because drug resistance in HIV/AIDS treatment has become a serious crisis. Guidelines for the management of patients with HIV, issued by separate panels led by the U.S. Department of Health and Human Services and the International AIDS Society-USA (“IAS-USA”) each recommend that resistance tests be routinely used for HIV patients. The IAS-USA guidelines updated in 2003 also recommend resistance testing to new patient populations, including chronically infected, untreated patients prior to initiation of therapy. In addition, the FDA Antiviral Drugs Advisory Committee in November 1999 emphatically recommended that resistance tests should be utilized in the development of new anti-viral drugs for HIV.

All currently FDA-approved HIV drugs target an important step in the replication cycle of HIV. One group of drugs, called “reverse transcriptase inhibitors,” blocks the virus from copying its genetic material. Another group, called “protease inhibitors,” blocks the formation of viral proteins that are necessary for the virus to infect other cells. The vectors used in our PhenoSense HIV test incorporate the protease and reverse transcriptase gene segments from the virus of the patient being tested. A new group of HIV drugs, called “virus entry inhibitors,” blocks HIV from entering new cells, thereby preventing the spread of the virus in the body. PhenoSense HIV has been expanded to incorporate the HIV envelope gene in order to test this new group of drugs for pharmaceutical customers. Based on our knowledge of the mechanism of action of all of the HIV drugs currently in development, we believe we will be able to incorporate appropriate gene segments corresponding to the targets of new drugs, such as HIV integrase inhibitors or assembly inhibitors, into our proprietary PhenoSense HIV technology, thereby allowing us to create resistance tests for each of these targets.

We have commercialized a genotypic test we call GeneSeq HIV. Genotypic tests identify gene sequence mutations that may be associated with resistance to commercially available drugs. We have developed GeneSeq HIV as a tool to examine and evaluate the genetic sequences of HIV in patients. We also frequently update the rules correlating genotypic and phenotypic results to improve genotypic interpretation and our understanding of drug resistance and have incorporated many of those rules into our genotypic algorithm. We sell GeneSeq HIV to physicians who request genotypic testing and pharmaceutical companies that are developing new drugs. We may use the genetic sequence information and the rules as a component of the database described below.

PhenoSense GT is the only commercially available drug resistance test using phenotypic test results supplemented by genotypic information to provide physicians with comprehensive resistance information on

one integrated, easy-to-interpret report. Launched in November 2001, it helps physicians and patients individualize treatment regimens to fight HIV. PhenoSense GT was designed in response to an increasing number of physicians ordering both phenotypic and genotypic tests for their patients.

We have applied our PhenoSense technology to measure replication capacity of a patient’s virus, which is a critical component of a broader concept known as viral fitness. Replication capacity is a measure of a virus’ ability to replicate and infect new cells. It is different from resistance in that it is a measure of the virus’ ability to replicate in the absence of anti-viral drugs, rather than a measure of drug activity against the virus. Our researchers and collaborators have published 14 studies using the PhenoSense Replication Capacity assay. The current IAS-USA guidelines also highlight replication capacity measurement, which in recent studies has been shown to be a reliable predictor of HIV disease progression, similar to viral load and CD4 T-cell counts. Several studies have demonstrated the important relationship between replication capacity and immunological outcome. We are currently conducting multiple studies to further define the clinical utility of our Replication Capacity assay. We currently offer this product free of charge when a physician or pharmaceutical customer orders one of our PhenoSense products. In the future, we may offer this product on a stand-alone basis.

This phenotypic product is intended as a secondary screening assay that can be used to determine relative potency of a larger number of compounds. This assay was designed to help drug companies screen clinical drug candidates for HIV by providing an initial drug susceptibility assessment at a very high testing capacity and throughput in order to identify “lead” compounds that will require subsequently more intensive characterization.

We have developed tests to measure phenotypic and genotypic susceptibility of HIV to a new class of anti-viral drugs called viral entry inhibitors. One entry inhibitor drug has been approved for the treatment of HIV infection and an estimated 20 drugs designed to block virus attachment or entry are being evaluated in preclinical and clinical studies. Several pharmaceutical companies have already used our tests to determine the anti-viral activity of their drugs in early or late stages of preclinical and clinical development.

HIV enters and infects cells by attaching to a cellular receptor (CD4) and one of two co-receptors, either CCR5 or CXCR4. Several pharmaceutical companies are developing drugs to block co-receptor attachment. We have applied our PhenoSense HIV Entry technology to develop a test to assess which co-receptor the patient’s virus uses to enter cells (tropism). The test may play an important role in defining patient eligibility for treatment with these new HIV co-receptor inhibitors and monitoring their response to therapy. In addition, data exist which suggest that co-receptor tropism may be a prognostic factor in the pace of HIV disease progression.

We are currently applying our PhenoSense HIV Entry technology to test patient blood samples for the presence of antibodies that neutralize the HIV virus (i.e., prevent the virus from infecting cells). This test is especially important for the development of an effective prophylactic or therapeutic HIV vaccine. Currently, numerous companies, academic and government organizations have HIV vaccine candidates in various stages of development and require a rapid high-throughput assay for accurate assessment of neutralizing antibodies. We are currently providing neutralizing antibody testing for several pharmaceutical companies, as well as government sponsored and private research groups.

We have applied our GeneSeq technologies to develop a test to analyze drug resistance of hepatitis C virus, or HCV. HCV infection causes liver disease and liver cancer. The Center for Disease Control and Prevention (“CDC”) estimates that four million people in the United States and more than 170 million

people worldwide are infected with HCV. Based on studies that show that 60% to 85% of persons infected with HCV develop chronic infection, and assuming that all such persons would benefit from anti-viral drug therapy, we estimate that 60% to 85% of patients infected with HCV may benefit from anti-viral drug therapy.

HCV replicates and mutates at extremely high rates inside an infected patient, similar to HIV. Therefore, complex combinations of drugs may then be required to increase the success of treatment. As a result, a number of major pharmaceutical companies are discovering and developing new drugs for HCV. HCV drugs are in development that target many different aspects of the virus’ life cycle. Similar to HIV drugs, there are efforts to develop HCV protease inhibitors as well as drugs that block the replication of the genetic material of HCV or the production of HCV proteins.

Our HCV genotypic test is currently being used by pharmaceutical customers in the discovery and development of new HCV drugs. As the number and use of HCV drugs increase, we expect the demand for our HCV resistance tests by physicians making treatment decisions to grow. Prior to that time, we expect our HCV resistance tests will continue to be used by pharmaceutical customers in the discovery and development of new HCV drugs.

We have applied our GeneSeq technology to develop a test to analyze drug resistance of hepatitis B virus, or HBV. HBV infection is a leading cause of liver disease and liver cancer and leads to more than one million deaths worldwide each year. The CDC estimates that there are over one million people in the United States chronically infected with HBV, and over 350 million people chronically infected worldwide, mostly in Asia. Based on research that shows that half of patients with chronic HBV have evidence of active disease, and assuming that anti-viral drug treatment is indicated for patients with active disease, we estimate that approximately half of those chronically infected would benefit from anti-viral drug therapy.

As in the case of HIV, drug resistance is a problem when treating HBV. Similar to the treatment of HIV infection, effective therapy of chronic HBV infection will likely require complex combinations of anti-viral drugs. As more drugs become available, physicians will face increasing difficulty selecting the most appropriate drug combinations for HBV patients. Therefore, we believe drug resistance testing will play a significant role in guiding HBV treatment.

The FDA has approved three drugs (alpha interferon, lamivudine, and adefovir) for the treatment of HBV infection and more than an estimated 15 drugs are in preclinical or clinical stages of development. Many of these drugs target HBV reverse transcriptase, which acts in a manner similar to HIV reverse transcriptase, to prevent the virus from copying its genes. Research efforts are ongoing to discover drugs that target other aspects of HBV’s life cycle, such as the assembly of HBV viruses, or the entry of HBV into liver cells.

As the number and use of HBV drugs increases, we expect the demand for GeneSeq HBV by physicians making treatment decisions to grow. Prior to that time, we expect our HBV resistance tests will continue to be used by pharmaceutical customers in the discovery and development of new HBV drugs.

We are currently applying our PhenoSense and GeneSeq HIV technologies to develop tests to evaluate resistance to a new class of HIV drugs called integrase inhibitors. Several integrase inhibitors, which are designed to block the reproduction of HIV once it is inside a cell, are now in development.

We plan to apply our PhenoSense technology to develop tests to analyze drug resistance of hepatitis B, or HBV, and hepatitis C, or HCV. As discussed above, hepatitis infection is a leading cause of liver disease and liver cancer, and we believe drug resistance testing will play a significant role in guiding treatment. Based on our knowledge of the mechanism of action of these drugs in research, we believe that we will be able to incorporate genes corresponding to the targets of these drugs into our PhenoSense HBV and HCV vector.

As the number and use of HBV and HCV drugs increases, we expect the demand for PhenoSense HBV and HCV by physicians making treatment decisions to grow. Prior to that time, we expect our HBV and HCV resistance tests will be used by pharmaceutical customers in the discovery and development of new HBV and HCV drugs.

We perform resistance testing for industry, academia and government for clinical studies, drug screening/characterization and basic research. Given the FDA’s endorsement of the important role of resistance testing in drug development, and the large number of drugs in development for HIV, hepatitis and other viral diseases, our pharmaceutical product and service offerings have become a significant aspect of our business.

Clinical Trials. Because clinical trials are the most expensive part of drug development, pharmaceutical companies are trying to improve the outcomes of clinical trials by using the methods of “pharmacogenomics,” the scientific discipline focused on how genetic differences among patients determine or predict responsiveness or adverse reactions to particular drugs. In a similar way, pharmaceutical companies are applying our PhenoSense technology to help select patients for clinical trials. This selection process may allow companies to guide important drug development decisions before large resource commitments are made. To date, we have signed testing agreements with most pharmaceutical companies involved in HIV/AIDS drug development, including: Abbott Laboratories, Boehringer Ingelheim, Bristol-Myers Squibb, Chiron Corporation, Gilead Sciences, GlaxoSmithKline, Hoffmann-La Roche Ltd., Merck and Co., Pfizer Pharmaceuticals, Schering-Plough, Vertex Pharmaceuticals and numerous others. We are involved in more than 100 clinical research and drug characterization studies with these pharmaceutical companies as well as other government and academic organizations evaluating a number of HIV drugs and drug regimens.

Database. We are collecting resistance test results and related clinical data in an interactive database to assist our pharmaceutical customers in drug marketing and drug development. Two important components of our database include viral resistance, replication, and co-receptor tropism data and a specimen library comprised of resistance test vectors, virus clones and site-directed mutants. We have entered into contractual relationships with pharmaceutical companies to provide defined data queries that can enhance efforts to develop and market their drugs. We have also entered into a contract with a database product company to commercialize this asset. Our database may be made available to physicians for use in therapy guidance in the future.

Drug and Vaccine Discovery. Our database of viral resistance information and our specimen library which is comprised of resistance test vectors, virus clones and site-directed mutants is the foundation of our pharmacogenomics capability for use in screening potential drugs or vaccines. We believe our drug resistance technology can provide more extensive supplemental and enhanced information about the activity of chemical compounds than conventional assays.

We currently have 21 experienced sales representatives promoting our resistance tests in the primary U.S. markets for drugs targeted at HIV/AIDS. Within these major markets, we are targeting the approximately 1,800 leading HIV physicians who treat 80% of the HIV/AIDS patients in the U.S. We may enter into relationships with other companies to serve markets outside the U.S.

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.

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 2003, 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

In addition, we have made PhenoSense HIV broadly available through numerous national and regional reference laboratories and hospitals. We currently have distribution arrangements with nearly all major national reference laboratories including Quest Diagnostics, Laboratory Corporation of America, Associated Regional and University Pathologists, Inc. (“ARUP”), Mayo Clinic, as well as multiple regional laboratories. Under these agreements, these entities perform numerous services for us including collection of samples, shipping the samples to us, billing and reporting the results to doctors.

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. We currently have 19 issued patents and 107 pending applications for additional patents, including international counterparts to our U.S. patents. We have non-exclusively licensed seven patents under the Roche Molecular Systems, Inc. (“Roche”) license discussed below. These patents cover a broad range of technology applicable across our entire current and planned product line. We have also licensed technology from other third parties, and expect that we may need to license additional technology in order to continue the development and commercialization of our products. We also seek protection through confidentiality and proprietary information agreements.

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 and hepatitis B and C and other viruses. 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 products.

We license polymerase chain reaction (“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. Currently, 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. In addition, we also license technology from other third parties. We recorded royalty expense of $1.1 million, $1.0 million and $0.7 million for the years ended December 31, 2003, 2002 and 2001, respectively.

We face, and will continue to face, competition from organizations such as other biotechnology companies and commercial laboratories, as well as academic and research institutions.

Our major competitors include manufacturers and distributors of phenotypic drug resistance technology, such as Tibotec-Virco (division of Johnson & Johnson) and Specialty Laboratory. We also compete with makers of genotypic tests such as Applied Biosystems Group, Visible Genetics Inc. (division of Bayer Diagnostics) and laboratories performing genotypic testing as well as other genotypic testing referred to as virtual phenotyping. Each of these competitors is attempting to establish its test as the standard of care among opinion leaders. However, we believe that ViroLogic is well positioned in this market as the only company focused on HIV drug resistance with:


	•	Multiple testing platforms (phenotype, genotype and combination)

	•	Rapid turnaround time (2 weeks or less)

	•	Clinical cutoffs derived using our assay

	•	Technologies developed to provide additional resistance information for new drug targets

Some of our competitors have substantially greater financial resources and larger research and development staffs than we do. In addition, they may have greater experience in developing products, obtaining the necessary regulatory approvals of products, and the processing and marketing of products.


	•	Demonstrate the degree of clinical benefit of our products relative to their costs

	•	Develop proprietary products

	•	Develop and maintain products that reach the market first

	•	Develop products that are technologically superior to other products in the market

	•	Obtain patent or other proprietary protection for our products and technologies

	•	Obtain and maintain adequate reimbursement coverage from payors

	•	Attract and retain scientific and product development personnel

The Clinical Laboratory Improvement Amendments of 1988 extends federal oversight to virtually all clinical laboratories by requiring that laboratories be certified by the federal government, by a federally approved accreditation agency or by a state that has been deemed exempt from the regulation’s requirements. Pursuant to these Federal clinical laboratory regulations, clinical laboratories must meet quality assurance, quality control and personnel standards. Labs also must undergo proficiency testing and inspections. Standards are based on the complexity of the method of testing performed by the laboratory.

These regulations categorize our laboratory as high complexity, and we believe we are in compliance with the more stringent standards applicable to high complexity testing for personnel, quality control, quality assurance and patient test management. Our clinical laboratory holds a Certificate of Registration under these regulations. Our clinical laboratory has been surveyed by the College of American Pathologists, a federally approved accreditation agency, which has accredited our clinical laboratory.

In addition to the Federal laboratory regulations, states, including California, require laboratory licensure and may adopt regulations that are more stringent than federal law. We believe we are in material compliance with California and other applicable state laws and regulations.

The sanctions for failure to comply with Federal or state clinical laboratory regulations, or accreditation requirements of federally approved agencies, may be suspension, revocation or limitation of a laboratory’s certificate or accreditation. There also could be fines and criminal penalties. The suspension or loss of a license, failure to achieve or loss of accreditation, imposition of a fine, or future changes in applicable federal

Under our current labeling and marketing plans, our phenotypic products have not been subject to FDA regulation, although we are aware of increasing activity by the FDA in regards to regulating homebrew HIV genotypic resistance testing such as ours. We cannot predict the extent of future FDA regulation, and we might be subject in the future to greater regulation, or different regulations, that could have a material effect on our finances and operations.

We are subject to licensing and regulation under federal, state and local laws relating to the handling and disposal of medical specimens and hazardous waste and radioactive materials as well as to the safety and health of laboratory employees. Our clinical laboratory is operated in material compliance with applicable federal and state laws and regulations relating to disposal of all laboratory specimens. We utilize outside vendors for disposal of specimens.

In addition to its comprehensive regulation of safety in the workplace, the Federal Occupational Safety and Health Administration has established extensive requirements relating to workplace safety for healthcare employers, including clinical laboratories, whose workers may be exposed to blood-borne pathogens such as HIV and the hepatitis virus. These regulations, among other things, require work practice controls, protective clothing and equipment, training, medical follow-up, vaccinations and other measures designed to minimize exposure to chemicals and transmission of the blood-borne and airborne pathogens. Although we believe that we are currently in compliance in all material respects with such federal, state and local laws, failure to comply could subject us to denial of the right to conduct business, fines, criminal penalties and other enforcement actions.

Regulations of the Department of Transportation, the International Air Transportation Agency, the Public Health Service and the Postal Service apply to the surface and air transportation of clinical laboratory specimens.

Revenues for clinical laboratory testing services come from a variety of sources, including Medicare and Medicaid programs; other third-party payors, including commercial insurers, Blue Cross Blue Shield plans, health maintenance and other managed care organizations; and patients, physicians, hospitals and other laboratories. We are a Medicare laboratory services provider. Medicare has issued coverage policies and payment guidelines for resistance testing, including phenotypic and genotypic testing. Currently, nearly all public and a majority of private payors have approved the reimbursement of our existing products. However, the majority of our payors are currently reimbursing our products at varying levels from 70% to 100% of our list prices. While recently issued guidelines of the Department of Health and Human Services recommend drug resistance testing for HIV patients, this does not assure coverage or level of coverage, by state, Medicare or any other payors.

Since 1984, Congress has periodically lowered the ceilings on Medicare reimbursement for clinical laboratory services from previously authorized levels. In addition, state Medicaid programs are prohibited from paying more than Medicare for clinical laboratory tests. In some instances, they pay significantly less. Similarly, other payors, including managed care organizations, have sought on an ongoing basis to reduce the costs of healthcare by limiting utilization and payment rates. Actions by Medicare or other payors to reduce reimbursement rates or limit coverage or utilization of resistance testing would have a direct adverse impact on our revenues and cash flows. We cannot predict whether reductions or limitations will occur, though we feel some reductions are likely.

Our agreements with third-party payors, including Medicare and Medicaid, require that we identify the services we perform using industry standard codes known as the Current Procedural Terminology (“CPT”)

codes, which are developed by the American Medical Association (“AMA”). Most payors maintain a list of standard reimbursement rates for each such code, and our ability to be reimbursed for our services is therefore effectively limited by our ability to describe the services accurately using the CPT codes. From time to time, the AMA changes its instructions about how our services should be coded using the CPT codes. If these changes leave us unable to accurately describe our services or are not coordinated with payors such that corresponding changes are made to the payors’ reimbursement schedules, we may have to renegotiate our pricing and reimbursement rates, the changes may interrupt our ability to be reimbursed, and/or the overall reimbursement rates for our services may decrease dramatically.

Significant uncertainty exists as to the reimbursement status of new medical products like the products we are currently developing, particularly if these products fail to show demonstrable value in clinical studies. If government and other third-party payors do not provide adequate coverage and reimbursement for our planned products, our revenues will be reduced.

Existing federal laws governing Medicare and Medicaid and other federal healthcare programs, as well as similar state laws, impose a variety of broadly described fraud and abuse prohibitions on healthcare providers, including clinical laboratories. Multiple government agencies enforce these laws. The Health Insurance Portability and Accountability Act of 1996 provides for the establishment of a program to coordinate federal, state and local law enforcement programs. Over the last several years, the clinical laboratory industry has also been the focus of major government enforcement actions.

One set of fraud and abuse laws, the federal anti-kickback laws, prohibits clinical laboratories from, among other things, making payments or furnishing other benefits intended to induce the referral of patients for tests billed to Medicare, Medicaid, or certain other federally funded programs. California also has its own Medicaid anti-kickback law, as well as an anti-kickback law that prohibits payments made to physicians to influence the referral of any patients. California laws also limit the ability to use a non-employee sales force.

Under another federal provision, known as the “Stark” law or “self-referral” prohibition, physicians who have an investment or compensation relationship with a clinical laboratory may not, unless a statutory exception applies, refer Medicare or Medicaid patients for testing to the laboratory. In addition, a laboratory may not bill Medicare, Medicaid or any other party for testing furnished pursuant to a prohibited referral. There is a California self-referral law, as well, which applies to all patient referrals.

Currently, we have a financial relationship with one referring physician, who serves as part-time medical director at our clinical laboratory. Very few of this physician’s patients, if any, are federal healthcare program patients. In addition, we do not bill for services furnished to any patients referred by this physician. The California anti-kickback law may have exceptions applicable to our relationship with this physician. We have requested a written opinion from California officials to determine whether this relationship is appropriate, but have not received any response to our request.

There are a variety of other types of federal and state anti-fraud and abuse laws, including laws prohibiting submission of false or otherwise improper claims to federal healthcare programs, and laws limiting the extent of any differences between charges to Medicare and Medicaid and charges to other parties. We seek to structure our business to comply with the federal and state anti-fraud and abuse laws. We cannot predict, however, how these laws will be applied in the future, and we cannot be sure arrangements will not be found in violation of them. Sanctions for violations of these laws may include exclusion from participation in Medicare, Medicaid and other federal healthcare programs, criminal and civil fines and penalties, and loss of license. Any of these could have a material adverse effect on our business.


	•	privacy regulations;

	•	security regulations; and

	•	standards for electronic transactions, or transaction standards.

The privacy regulations prohibit the use or disclosure of “protected health information” except for certain purposes or unless specific conditions are met. Protected health information is information transmitted or maintained in any form — by electronic means, on paper, or through oral communications that: (1) relates to the past, present, or future physical or mental health or condition of an individual, the provision of health care to an individual, or the past, present, or future payment for the provision of health care to an individual; and (2) identifies the individual or with respect to which there is a reasonable basis to believe the information can be used to identify the individual. Data that have been de-identified in accordance with the Privacy regulation’s stringent de-identification standard are not considered protected health information and are not subject to the regulation. We have implemented privacy and security changes that we believe comply with these standards. In addition, we implemented measures we believe will reasonably and appropriately meet the specifications of the security regulations and the transaction standards.

The HIPAA regulations on transaction standards establish uniform standards for electronic transactions and code sets, including the electronic transactions and code sets used for claims, remittance advices, enrollment and eligibility. These standards are complex, and subject to differences in interpretation. We cannot guarantee that our compliance measures will meet the specifications for any of these regulations. In addition, certain types of information, including demographic information not usually provided to us by physicians, could be required by certain payers. As a result of inconsistent application of requirements by payers, or our inability to obtain billing information, we could face increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and net revenues.

HHS issued additional guidance on July 24, 2003 stating that it will not penalize a covered entity for post-implementation date transactions that are not fully compliant with the transactions standards, if the covered entity can demonstrate its good faith efforts to comply with the standards. HHS’ stated purpose for this flexible enforcement position was to “permit health plans to mitigate unintended adverse effects on covered entities’ cash flow and business operations during the transition to the standards, as well as on the availability and quality of patient care.”

On September 23, 2003, the Centers for Medicare and Medicaid Services (“CMS”) announced that it will implement a contingency plan for the Medicare program to accept electronic transactions that are not fully compliant with the transaction standards after the October 16, 2003 compliance deadline. CMS’ contingency plan allows Medicare carriers to continue to accept and process Medicare claims in the traditional electronic formats now in use in order to give its healthcare providers additional time to complete the testing process, provided they are making a good faith effort to comply with the new standards. As part of its plan, CMS is expected to regularly reassess the readiness of its healthcare providers to determine how long the contingency plan will remain in effect.

In its announcement, CMS encouraged other payors to assess the readiness of their trading partners and to implement contingency plans, if appropriate. A number of other major payors have announced they intend to follow CMS’ lead, but we cannot assure you that all payors will develop similar contingency plans. At this time, we cannot estimate the potential impact of payors implementing (or failing to implement) the HIPAA transaction standards on our cash flows and results of operations.

In addition to the HIPAA provisions described above, there are a number of state laws regarding the confidentiality of medical information, some of which apply to clinical laboratories. These laws vary widely, and new laws in this area are pending, but they most commonly restrict the use and disclosure of medical information without patient consent. Penalties for violation of these laws include sanctions against a laboratory’s state licensure, as well as civil and/ or criminal penalties. Compliance with such rules could require us to spend substantial sums, which could negatively impact our profitability.

As of March 25, 2004, we had 187 employees, of whom 15 hold PhD or MD degrees and 22 hold other advanced degrees. Approximately 86 employees are engaged in clinical laboratory operations, including 33 licensed healthcare professionals. There are 22 employees in research and development, and 79 in sales, marketing, information systems, finance and other administrative functions.

In 2003, we adopted a code of ethics that applies to our principal executive officer, principal financial and accounting officer, persons performing similar functions as well as all employees. We have posted the text of our code of ethics on our website at www.virologic.com. In addition, we intend to promptly disclose (i) the nature of any amendment to our code of ethics that applies to our principal executive officer, principal financial and accounting officer, or persons performing similar functions and (ii) the nature of any waiver, including an implicit waiver, from a provision of our code of ethics that is granted to one of these specified individuals, the name of such person who is granted the waiver and the date of the waiver on our website in the future.

The following table sets forth, as of February 27, 2004, certain information concerning our executive officers:

WILLIAM D. YOUNG has served as our Chief Executive Officer since November 1999 and has served as the Chairman of the Board since May 1999. From March 1997 to October 1999, Mr. Young was Chief Operating Officer at Genentech, Inc., a biotechnology company. As COO at Genentech, Mr. Young was responsible for all of the company’s development, operations and commercial functions. Mr. Young joined Genentech in 1980 as Director of Manufacturing and Process Sciences and held various executive positions prior to becoming COO. Prior to joining Genentech, Mr. Young was employed by Eli Lilly and Company for 14 years. Mr. Young is a member of the board of directors of Biogen IDEC, Inc., Human Genome Sciences, Inc. and VaxGen, Inc. He received his bachelor’s degree in chemical engineering from Purdue University and his MBA from Indiana University.

KAREN J. WILSON has served as our Chief Financial Officer since January 2001. From November 1999 to January 2001, Ms. Wilson held the position of Chief Financial Officer and Vice President of Operations for Novare Surgical Systems, Inc., a medical device manufacturer. Prior to that, from 1987 to 1993 and from 1996 to November 1999, she worked for Deloitte & Touche LLP, a professional services firm, most recently as Senior Manager serving a diverse list of global clients in both the medical and technology fields. From 1993 to 1996, she was Controller for Lightwave Electronics Corporation, a laser manufacturer. Ms. Wilson is a certified public accountant and received her bachelor’s degree in business from the University of California at Berkeley.

TIEN T. BUI joined ViroLogic as National Sales Director in November 2000 and was named Vice President of Sales in September 2001. Before joining ViroLogic, Ms. Bui was the Virology Field Director for DuPont Pharmaceuticals’ Western Business Unit, where she was responsible for $60 million in product sales. In addition to her most recent sales management position at DuPont, she served that company for over 10 years, from 1990 to 2000, in various sales and marketing roles, including: physician and hospital sales; clinical development and education; healthcare policy and government affairs; and strategic market development. Ms. Bui received her bachelor’s degree in international business from San Francisco State University and also studied abroad at The University of Liege, Belgium.

KATHY L. HIBBS joined ViroLogic as Vice President, General Counsel in April 2001. Prior to joining ViroLogic, Ms. Hibbs was Vice President and General Counsel for Multitude, Inc., an Internet telecommunications company. Prior to that, from 1996 to 2000, she served as Senior Corporate Counsel at Varian Medical Systems, Inc., a leading manufacturer of integrated cancer therapy systems. At Varian, she was responsible for numerous legal matters including regulatory compliance, employment law, litigation and SEC reporting. Before her employment with Varian, Ms. Hibbs worked as a litigator for two California law firms and dealt with various legal issues, including civil rights and securities law. She received her JD degree from the University of California, Hastings College of Law, and her bachelor’s degree in political science from the University of California, Riverside.

KENNETH N. HITCHNER joined ViroLogic as Director of Project Management in May 1999 and was named Vice President of Pharmaceutical Collaborations in October 2003. Prior to joining ViroLogic, Mr. Hitchner was the Director of Project Management at Gilead Sciences. Prior to Gilead, he was with Genentech for fifteen years where he held a number of positions including the Director of Product Development and Global Project Leader. Mr. Hitchner received his bachelor’s degree in Zoology from DePauw University and a Masters Degree in Biology from San Francisco State University.

CHRISTOS J. PETROPOULOS, PhD has served as our Director of Research and Development since August 1996, became Senior Director of Research and Development in September 1997 and was named our Vice President, Research and Development in November 1999. From 1992 to 1996, Dr. Petropoulos was a scientist at Genentech where he headed the Molecular Virology Laboratory and the Research Virology and Molecular Detection Laboratories from 1994 to 1996. Dr. Petropoulos received his PhD in molecular and cell biology from Brown University.

JEANNETTE M. WHITCOMB, PhD joined ViroLogic as one of the first scientists in the Research and Development department in 1996, transitioned to the Operations group in 2002 and was named Vice President of Operations in June 2003. Prior to joining ViroLogic she was a Postdoctoral Fellow in Dr. Stephen H. Hughes’ lab at the National Cancer Institute — Frederick Cancer Research and Development Center. Prior to that, she was a Fogerty Fellow in Dr. Peter A. Cerutti’s lab at the Swiss Institute for Experimental Cancer Research in Lausanne, Switzerland. Dr. Whitcomb received her bachelor’s degree in Biology from Widener University in Chester, Pennsylvania and her PhD in Microbiology and Immunology from Temple University School of Medicine in Philadelphia.

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

STEPHEN P. GOFF, PhD — 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.

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

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

DOUGLAS D. RICHMAN, MD — 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, MD — Tim Gill Professor of Medicine and Head of the Infectious Disease Division at the University of Colorado Health Sciences Center.

Except for the historical information contained or incorporated by reference, this annual report on Form 10-K and the information incorporated by reference contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed here. Factors that could cause or contribute to differences in our actual results include those discussed in the following section, as well as those discussed in Part II, Item 7 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere throughout this annual report and in any other documents incorporated by reference into this annual report. You should consider carefully the following risk factors, together with all of the other information included in this annual report on Form 10-K. Each of these risk factors could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock.

We may incur future losses and may not achieve profitability as soon as expected, which may cause our stock price to fall.

We have experienced significant losses each year since our inception and may incur additional losses. We experienced losses applicable to common stockholders of approximately $9.3 million in the year ended December 31, 2003, $33.3 million in 2002 and $28.8 million in 2001. As of December 31, 2003, we had an accumulated deficit of approximately $106.3 million. We may continue to incur losses primarily as a result of spending related to:


	•	Expanding patient and pharmaceutical company sample processing capabilities

	•	Research and product development costs

	•	Sales and marketing activities

	•	Additional clinical laboratory and research space and other necessary facilities

	•	General and administrative costs

If our history of losses continues, our stock price may fall and you may lose part or all of your investment.

Our stockholders will experience substantial additional dilution if our shares of preferred stock or their related warrants are converted into or exercised for shares of common stock. As of December 31, 2003, our outstanding shares of preferred stock and related warrants were convertible into or exercisable for up to an aggregate of 15,390,497 shares of common stock, or approximately 29% of the number of shares of outstanding common stock.

As of December 31, 2003, we had 52,608,382 shares of common stock outstanding. However, as of December 31, 2003, we also had outstanding the following shares of preferred stock and related warrants:


	•	274 shares of Series A Redeemable Convertible Preferred Stock (“Series A Preferred Stock”), convertible into 2,468,468 shares of common stock (not including the conversion of accrued but unpaid premiums)

	•	warrants issued to the purchasers of our preferred stock in connection with our preferred stock financings to purchase 12,922,029 shares of common stock

Together, the common shares reserved for issuance upon conversion of the Series A Preferred Stock and upon exercise of the warrants referenced above, represent approximately 15,390,497 shares of common stock, or 29% of the outstanding shares of our common stock at December 31, 2003, all of which are issuable for an approximate weighted-average effective price of $1.15 per share.

The number of shares of common stock that we may be required to issue upon conversion of the Series A Preferred Stock, and exercise of the warrants granted to purchasers of our Series A Preferred Stock in connection with the issuance thereof, can increase substantially upon the occurrence of several events, including if:


	•	We issue shares of stock (with certain exceptions) for an effective price less than the conversion price of the Series A Preferred Stock or the related warrants (each $1.11 as of December 31, 2003)


	•	We fail to have sufficient shares of common stock reserved to satisfy conversions, exercises and other issuances

	•	We fail to honor requests for conversion, or notify any holder of Series A Preferred Stock of our intention not to honor requests for conversion

	•	We fail to issue shares upon exercise of the warrants

	•	We fail to redeem any shares of Series A Preferred Stock when required

We are also obligated to issue additional shares of common stock every six months to the holders of the Series A Preferred Stock as “premium payments.” As of December 31, 2003, these issuances equaled about 133 shares of common stock for every share of Series A Preferred Stock outstanding at the time the issuance is made. This number of shares will increase every six months, by about 27 shares of common stock for each share of Series A Preferred Stock, up to a maximum of about 186 shares of common stock for every share of Series A Preferred Stock. All of the previous share totals are based upon an assumed stock price of $3.76, which was the closing price of our stock on the Nasdaq National Market on December 31, 2003, but the actual number of shares will be based upon our stock price from time to time as of the payment dates. If the 274 shares of the Series A Preferred Stock outstanding as of December 31, 2003 remain outstanding for five years following such date, we will be required to issue as premium payments an additional 493,989 shares of common stock (again based on an assumed stock price of $3.76) to holders of the Series A Preferred Stock, which is 0.9% of the shares of common stock outstanding as of December 31, 2003. We do not receive payment or other consideration for these issuances.

All of the foregoing issuances of common stock would be substantially dilutive to the outstanding shares of common stock, especially where, as described above, the shares of common stock are issued without additional consideration. We cannot predict whether or how many additional shares of our common stock will become issuable due to these provisions.

Any dilution or potential dilution may cause our stockholders to sell their shares, which would contribute to a downward movement in the stock price of our common stock. Any downward pressure on the trading price of our common stock could encourage investors to engage in short sales, which could further contribute to a downward trend in the price of our common stock.

Holders of our Series A Preferred Stock have the right, under certain circumstances, to require us to redeem for cash all of the preferred stock that they own. The redemption price for the Series A Preferred Stock is the greater of (i) 115% of the original purchase price plus 115% of any accrued premium payment thereon and (ii) the aggregate fair market value of the shares of common stock into which such shares of Series A Preferred Stock are then convertible. As of December 31, 2003, there were 274 shares of Series A Preferred Stock outstanding, with an aggregate redemption price equal to approximately $3.3 million.

Shares of Series A Preferred Stock are redeemable by the holders of the respective series in any of the following situations:


	•	If we fail to remove a restrictive legend on any certificate representing any common stock that was issued to any holder of such series upon conversion of their preferred stock or exercise of their warrants and that may be sold pursuant to an effective registration statement or an exemption from the registration requirements of the federal securities laws

	•	If we fail to have sufficient shares of common stock reserved to satisfy conversions of the series

	•	If we fail to honor requests for conversion, or if we notify any holder of such series of our intention not to honor future requests for conversion

	•	If we institute voluntary bankruptcy or similar proceedings

	•	If we make an assignment for the benefit of creditors, or apply for or consent to the appointment of a receiver or trustee for us or for a substantial part of our property or business, or such a receiver or trustee shall otherwise be appointed


	•	If we sell all or substantially all of our assets

	•	If we merge, consolidate or engage in any other business combination (with some exceptions), provided that such transaction is required to be reported pursuant to Item 1 of Form 8-K

	•	If we commit a material breach under, or otherwise materially violate the terms of, the transaction documents entered into in connection with the issuance of such series

	•	If the registration statements covering shares of common stock underlying the Series A Preferred Stock and related warrants cannot be used by the respective selling security holders for the resale of all the underlying shares of common stock for an aggregate of more than 30 days

	•	If our common stock is not tradable on the NYSE, the AMEX, the Nasdaq National Market or the Nasdaq SmallCap market for an aggregate of twenty trading days in any nine month period

	•	If 35% or more of our voting power is held by any one person, entity or group

	•	If we fail to pay any indebtedness in excess of $350,000 when due, or if there is any event of default under any agreement that is likely to have a material adverse effect on us

	•	Upon the institution of involuntary bankruptcy proceedings

Upon the occurrence of any of the events described above, individual holders of the Series A Preferred Stock would have the option, while such event continues, to require us to purchase some or all of the then outstanding shares of Series A Preferred Stock held by such holder. If we receive any notice of redemption, we are required to immediately (no later than one business day following such receipt) deliver a written notice to all holders of the same series of preferred stock stating the date when we received the redemption notice and the amount of preferred stock covered by the notice. Redemption of the Series A Preferred Stock in any event described above would require us to expend a significant amount of cash that could exceed our total available cash and cash equivalents and could negatively impact our ability to operate our business or raise additional capital. See the notes to the financial statement for further details.

In the event that we need to raise additional capital, our stockholders could experience substantial additional dilution. If such financing is not available on commercially reasonable terms, we may have to significantly curtail our operations or sell significant assets and may be unable to continue as a going concern.

As of December 31, 2003, we had available cash and cash equivalents, short-term investments and short-term restricted cash of $9.9 million. We anticipate that our existing capital resources together with funds from the sale of our products, contract revenue and borrowing under equipment financing arrangements will enable us to maintain currently planned operations through at least December 31, 2004. However, we may need additional funding sooner than that. To the extent operating and capital resources are insufficient to meet our obligations, including lease payments and future requirements, we will have to raise additional funds to continue the development, commercialization and expansion of our technologies. Our inability to raise capital would seriously harm our business and product development efforts. In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. However, we cannot guarantee that additional financing, in any form, will be available at all, or on terms acceptable to us. If we sell equity or convertible debt securities to raise additional funds, our existing stockholders may incur substantial dilution and any shares so issued will likely have rights, preferences and privileges superior to the rights, preferences and privileges of our outstanding common and preferred stock. In the event financing is not available in the time frame required, we will be forced to reduce our operating expenses, curtail sales and marketing activities, reschedule research and development projects or delay, scale back or eliminate some or all of our activities. Further, we might be required to sell certain of our assets or obtain funds through arrangements with third parties that require us to relinquish rights to certain of our technologies or products that we would seek to develop or commercialize ourselves. These actions, while necessary for the continuance of operations during a time of cash constraints and a shortage of working capital, could make it difficult or impossible to implement our long-term business plans or could affect our ability to continue as a going concern.

Our testing products may not achieve market acceptance, which could limit our future revenue.

Our ability to establish phenotypic resistance testing as the standard of care to guide and improve the treatment of viral diseases will depend on physicians’ and clinicians’ acceptance and use of phenotypic resistance testing. Phenotypic resistance testing is still relatively new. We cannot predict the extent to which physicians and clinicians will accept and use phenotypic resistance testing. They may prefer competing technologies and products. The commercial success of phenotypic resistance testing will require demonstrations of its advantages and potential economic value in relation to the current standard of care, as well as to competing products. We have introduced two products using our proprietary PhenoSense technology, PhenoSense HIV and PhenoSense GT, which we began actively marketing in November 1999 and November 2001, respectively. We are still in the early stages of development of new products applying our PhenoSense technology to other viral diseases. If PhenoSense HIV or PhenoSense GT is not accepted in the marketplace, our ability to sell other PhenoSense products would be undermined. Market acceptance will depend on:


	•	Our marketing efforts and continued ability to demonstrate the utility of PhenoSense in guiding anti-viral drug therapy, for example, through the results of retrospective and prospective clinical studies

	•	Our ability to demonstrate the advantages and potential economic value of our PhenoSense testing products over current treatment methods and other resistance tests

If the market does not accept phenotypic resistance testing, or our PhenoSense products in particular, our ability to generate revenue will be limited.

Our revenues will be diminished if changes are made to the way that our products are reimbursed, or if government or third-party payors limit the amounts that they will reimburse for our current products, or do not authorize reimbursement for our planned products.

Government and third-party payors, including Medicare and Medicaid require that we identify the services we perform using industry standard codes known as the Current Procedural Terminology (“CPT”) codes, which are developed by the American Medical Association (“AMA”). Most payors maintain a list of standard reimbursement rates for each such code, and our ability to be reimbursed for our services is therefore effectively limited by our ability to describe the services accurately using the CPT codes. From time to time, the AMA changes its instructions about how our services should be coded using the CPT codes. If these changes leave us unable to accurately describe our services or are not coordinated with payors such that corresponding changes are made to the payors’ reimbursement schedules, we may have to renegotiate our pricing and reimbursement rates, the changes may interrupt our ability to be reimbursed, and/or the overall reimbursement rates for our services may decrease dramatically. In addition, we may spend significant time and resources to minimize the impact of these changes on reimbursement.

Government and third-party payors are attempting to contain or reduce the costs of healthcare and are challenging the prices charged for medical products and services. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of healthcare products. This could in the future limit the price that we can charge for our products. This could also hurt our ability to generate revenues. Significant uncertainty exists as to the reimbursement status of new medical products like the products we are currently developing, particularly if these products fail to show demonstrable value in clinical studies. Currently, nearly all public and a majority of private payors have approved the reimbursement of our existing products. However, the majority of our payors are currently reimbursing our products at varying levels from 70% to 100% of our list prices. If government and other third-party payors do not continue to provide adequate coverage and reimbursement for our testing products or do not authorize reimbursement for our planned products, our revenues will be reduced.

Billing complexities associated with health care payors may result in increased bad debt expense, which could impair our cash flow and limit our ability to reach profitability.

Billing for laboratory services is complex. Laboratories must bill various payors, such as Medicare, Medicaid, insurance companies, doctors, employer groups and patients, all of whom have different requirements. Billing difficulties often result in a delay in collecting, or ultimately an inability to collect, the related receivable. This impairs cash flow and ultimately reduces profitability if we are required to record bad debt

expense for these receivables. Most of the bad debt expense is the result of noncredit related issues, primarily missing or incorrect billing information on requisitions. We perform the requested tests and report test results regardless of incorrect or missing billing information. We subsequently attempt to obtain any missing information and rectify incorrect billing information received from the healthcare provider. Missing or incorrect information on requisitions slows the billing process, creates backlogs of unbilled requisitions and generally increases the aging of accounts receivable. Among many other factors complicating billing are:


	•	Pricing differences between our fee schedules and those of the payors

	•	Changes in or questions about how products are to be identified in the requisitions

	•	Disputes between payors as to which party is responsible for payment

	•	Disparity in coverage among various payors

	•	Difficulties of adherence to specific compliance requirements and procedures mandated by various payors

Ultimately, if all issues are not resolved in a timely manner, the related receivables are charged to the allowance for doubtful accounts.

We may encounter problems or delays in processing tests, or in expanding our automated testing systems, which could impair our ability to grow our business, generate revenue and achieve and sustain profitability.

In order to meet future projected demand for our products and fully utilize our current clinical laboratory facilities, we estimate that we will have to continue to expand the volume of patient samples that we are able to process. We are also continuing to develop our quality-control procedures and to establish more consistency with respect to test turnaround so that results are delivered in a timely manner. Thus, we need to continue to develop and implement additional automated systems to perform our tests. We have installed several information systems over the past few years, including enterprise resource and laboratory information systems, to support the automated tests, analyze the data generated by our tests and report the results. If these systems do not work effectively as we scale up our processing of patient samples, we may experience processing or quality-control problems and we may experience delays or failures in our operations. These problems, delays or failures could adversely impact the promptness and accuracy of our transaction processing, which could impair our ability to grow our business, generate revenue and achieve and sustain profitability. We have experienced periods during which processing of our test results was delayed, resulting in a temporary backlog of tests to be performed, as was the case in the fourth quarter of 2003. While we take steps to minimize the likelihood of any delays, future delays and backlog may nevertheless occur.

We face intense competition, and if our competitors’ existing products or new products are more effective than our products, the commercial opportunity for our products will be reduced or eliminated.

The commercial opportunity for our products will be reduced or eliminated if our competitors develop and market new testing products that are superior to, or are less expensive than, our phenotypic and/or genotypic resistance testing products we develop using our proprietary technology. The biotechnology industry evolves at a rapid pace and is highly competitive. Our major competitors include manufacturers and distributors of phenotypic drug resistance technology, such as Tibotec-Virco (division of Johnson & Johnson) and Specialty Laboratory. We also compete with makers of genotypic tests such as Applied Biosystems Group, Visible Genetics Inc. (division of Bayer Diagnostics) and laboratories performing genotypic testing as well as other genotypic testing referred to as virtual phenotyping. Each of these competitors is attempting to establish its test as the standard of care. Tibotec-Virco’s phenotypic and genotypic tests have been commercially available for a longer time than has PhenoSense HIV or GeneSeq HIV. Genotypic tests are cheaper and generally faster than phenotypic resistance tests. Our competitors may successfully develop and market other testing products that are either superior to those that we may develop or that are marketed prior to marketing of our testing products. Some of our competitors have substantially greater financial resources and research and development staffs than we do. In addition, some of our competitors have significantly greater experience in developing products, and in obtaining the necessary regulatory approvals of products and processing and marketing products.

We derive a significant portion of our revenues from a small number of customers and our revenues may decline significantly if any major customer cancels or delays a purchase of our products.

Our revenues to date and for the foreseeable future consist largely of sales of our PhenoSense products. It is likely that we will continue to have significant customer concentration. Our customers are not typically required to purchase tests from us under long-term contracts, and may stop ordering tests from us at any time. The loss of any major customer, a slowdown in the pace of increasing physician and physician group sales as a percentage of sales, or the delay of significant orders from any significant customer, even if only temporary, could have a significant negative impact on our revenues and our ability to fund operations from revenues, generate cash from operations or achieve profitability.

Various testing materials that we use are purchased from single qualified suppliers, which could result in our inability to secure sufficient materials to conduct our business.

We purchase some of the testing materials used in our laboratory operations from single qualified suppliers. Although these materials could be purchased from other suppliers, we would need to qualify the suppliers prior to using their materials in our commercial operations. Although we believe we have ample inventory stock to allow validation of another source, in the event of a material interruption of these supplies, the quantity of our stock may not be adequate. Any extended interruption, delay or decreased availability of the supply of these materials could prevent us from running our business as contemplated and result in failure to meet our customers’ demands. If significant customer relationships were harmed by our failure to meet customer demands, our revenues may decrease. We might also face significant additional expenses if we are forced to find alternate sources of supplies, or change materials we use. Such expenses could make it more difficult for us to attain profitability, offer our tests at competitive prices and continue our business as currently conducted or at all.

We are dependent on licenses for technology we use in our resistance testing, and our business would suffer if these licenses were terminated.

We license technology that we use in our PhenoSense and GeneSeq tests from Roche. We hold a non-exclusive license for the life of the patent term of the last licensed Roche patent. Currently, the last Roche patent expires in 2005. However, if additional patents are identified that would be necessary or useful for our operations, such patents could be added to the license at our option, which may extend the term of the license. We believe that many of our competitors, including Tibotec-Virco (division of Johnson & Johnson) and other resistance testing companies, also license this technology on non-exclusive terms. 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. In addition, we also license technology from other third parties. If these licenses were to be terminated, we would likely have to change a portion of our testing methodology, which would halt our testing, at least temporarily, and cause us to incur substantial additional expenses.

The intellectual property protection for our technology and trade secrets may not be adequate, allowing third parties to use our technology or similar technologies, and thus reducing our ability to compete in the market.

The strength of our intellectual property protection is uncertain. In particular, we cannot be sure that:


	•	We were the first to invent the technologies covered by our patent or pending patent applications

	•	We were the first to file patent applications for these inventions

	•	Others will not independently develop similar or alternative technologies or duplicate any of our technologies

	•	Any of our pending patent applications will result in issued patents

	•	Any patents issued to us will provide a basis for commercially viable products or will provide us with any competitive advantages or will not be challenged by third parties

We currently have 19 issued patents and 107 pending applications for additional patents, including international counterparts to our U.S. patents. We have licensed seven patents under the Roche license discussed above. These patents cover a broad range of technology applicable across our entire current and planned product line. Other companies may have patents or patent applications relating to products or processes similar to, competitive with or otherwise related to our products. Patent law relating to the scope of claims in the technology fields in which we operate, including biotechnology and information technology, is still evolving and, consequently, patent positions in our industry are generally uncertain. We cannot assure you that we will prevail in any lawsuits regarding the enforcement of patent rights or that, if successful, we will be awarded commercially valuable remedies. In addition, it is possible that we will not have the required resources to pursue offensive litigation or to otherwise protect our patent rights. We also rely on unpatented trade secrets to protect our proprietary technology. Other companies may independently develop or otherwise acquire equivalent technology or gain access to our proprietary technology.

Our products could infringe on the intellectual property rights of others, which may cause us to engage in costly litigation and, if we are not successful defending any such litigation or we cannot obtain necessary licenses, could cause us to pay substantial damages and prohibit us from selling our products.

Our commercial success depends upon our ability to develop, manufacture, market and sell our products and use our proprietary technologies without infringing the proprietary rights of others. Companies in our industry typically receive a higher than average number of claims and threatened claims of infringement of intellectual property rights, and numerous U.S. and foreign issued patents and pending patent applications owned by others exist in HIV, HCV, HBV and the other fields in which we are selling and/or developing products. We may be exposed to future litigation by third parties based on claims that our products, technologies or activities infringe the intellectual property rights of others. Because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that our products or technologies may infringe. There also may be existing patents, of which we are not aware, that our products or technologies may inadvertently infringe. Further, there may be issued patents and pending patent applications in fields relevant to our business, of which we may become aware from time to time, that we believe we do not infringe or that we believe are invalid or relate to immaterial portions of our overall business. We cannot assure you that third parties holding any of these patents or patent applications will not assert infringement claims against us for damages or seeking to enjoin our activities. We also cannot assure you that, in the event of litigation, we will be able to successfully assert any belief we may have as to non-infringement, invalidity or immateriality, or that any infringement claims will be resolved in our favor. Third parties have from time to time threatened to assert infringement or other intellectual property claims against us based on their patents or other intellectual property rights or inform us that they believe we required one or more licenses in order to perform certain of our tests. For instance, we recently entered into a license agreement with the NIH covering certain intellectual property rights. To date, we have not had to incur and do not expect to incur significant costs to defend against or settle threatened claims. However, in the future we may have to pay substantial damages, possibly including treble damages, for infringement if it is ultimately determined that our products infringe a third party’s patents. Further, we may be prohibited from selling our products before we obtain a license, which, if available at all, may require us to pay substantial royalties. Even if infringement claims against us are without merit, defending a lawsuit will take significant time, and may be expensive and divert management attention from other business concerns.

If we do not successfully introduce new products using our technology, we may not sustain long-term revenue growth.

We may not be able to develop and market new resistance testing products for HIV and other serious diseases, including hepatitis. Demand for these products will depend in part on the development by others of additional anti-viral drugs to fight these diseases. Physicians will likely use our resistance tests to determine which drug is best for a particular patient only if there are multiple drug treatment options. Several anti-viral drugs currently are in development but we cannot assure you that they will be approved for marketing, or if these drugs are approved that there will be a need for our resistance tests. If we are unable to develop and market resistance test products for other viral diseases, or if an insufficient number of anti-viral drugs are approved for marketing, we may not sustain long-term revenue growth.

Our business operations and the operation of our clinical laboratory facility are subject to stringent regulations and if we are unable to comply with them, we may be prohibited from accepting patient samples or may incur additional expense to attain and maintain compliance.

The operation of our clinical laboratory facility is subject to a stringent level of regulation under the Clinical Laboratory Improvement Amendments of 1988. Laboratories must meet various requirements, including requirements relating to quality assurance, quality control and personnel standards. Our laboratory is also subject to regulation by the state of California and various other states. We have received accreditation by the College of American Pathologists and therefore are subject to their requirements and evaluation. Our failure to comply with applicable requirements could result in various penalties, including loss of certification or accreditation, and we may be prevented from conducting our business as we do now or as we may wish to in the future.

The FDA may impose medical device regulatory requirements on our tests, including possibly premarket approval requirements, which could be expensive and time-consuming and could prevent us from marketing these tests.

In the past, the FDA has not required that genotypic or phenotypic testing conducted at a clinical laboratory be subject to premarketing clearance or approval, although the FDA has stated that it believes its jurisdiction extends to tests generated in a clinical laboratory. We received a letter from the FDA in September 2001 that asserted such jurisdiction over in-house tests like ours, but which also stated the FDA is not currently requiring premarket approval for HIV monitoring tests such as ours provided that the promotional claims for such tests are limited to its analytical capabilities and do not mention the benefit of making treatment decisions on the basis of test results. The FDA letter also asserted that our GeneSeq test had been misbranded due to the use of purchased analyte specific reagents (ASRs), if test reports do not include a statement disclosing that the test has not been cleared or approved by the FDA. We now utilize in-house prepared ASRs in our products. The FDA has indicated in discussions that the focus of the letter was our genotypic tests and not our phenotypic tests, but there is no certainty its focus will remain narrow.

We have had several discussions with the FDA related to its positions set forth in the letter. We do not at this point believe the FDA will require us to take steps that materially affect our business or financial performance, but we cannot guarantee this will remain the case.

We cannot be sure that the FDA will accept the steps we take, or that the FDA will not require us to alter our promotional claims or undertake the expensive and time-consuming process of seeking premarket approval with clinical data demonstrating the sensitivity and specificity of our tests. If premarket approval is required, we cannot be sure that we will be able to obtain it in a timely fashion or at all; and in such event the FDA would have authority to require us to cease marketing tests until such approval is granted.

In general, we cannot predict the extent of future FDA regulation of our business. We might be subject in the future to greater regulation, or different regulations, that could have a material effect on our finances and operations. If we fail to comply with existing or additional FDA regulations, it could cause us to incur civil or criminal fines and penalties, increase our expenses, prevent us from increasing revenues, or hinder our ability to conduct our business.

If we do not comply with laws and regulations governing the confidentiality of medical information, we may lose the state licensure we need to operate our business, and may be subject to civil, criminal or other penalties. Compliance with such laws and regulations could be expensive.

The Department of Human Health and Services, or HHS, has issued final regulations under the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”), designed to improve the efficiency and effectiveness of the health care system by facilitating the electronic exchange of information in certain financial and administrative transactions, while protecting the privacy and security of the information exchanged. Three principal regulations have been issued:

We have implemented the HIPAA privacy regulations. In addition, we implemented measures we believe will reasonably and appropriately meet the specifications of the security regulations and the transaction standards.

These standards are complex, and subject to differences in interpretation. We cannot guarantee that our compliance measures will meet the specifications for any of these regulations. In addition, certain types of information, including demographic information not usually provided to us by physicians, could be required by certain payors. As a result of inconsistent application of requirements by payors, or our inability to obtain billing information, we could face increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and net revenues. At this time, we cannot estimate the potential impact of payors implementing (or failing to implement) the HIPAA transaction standards on our cash flows and results of operations.

In addition to the HIPAA provisions described above, there are a number of state laws regarding the confidentiality of medical information, some of which apply to clinical laboratories. These laws vary widely, and new laws in this area are pending, but they most commonly restrict the use and disclosure of medical information without patient consent. Penalties for violation of these laws include sanctions against a laboratory’s state licensure, as well as civil and/or criminal penalties. Compliance with such rules could require us to spend substantial sums, which could negatively impact our profitability.

We may be unable to build brand loyalty because our trademarks and trade names may not be protected.

Our registered or unregistered trademarks or trade names such as the name PhenoSense, PhenoSense GT, PhenoScreen and GeneSeq may be challenged, canceled, infringed, circumvented or declared generic or determined to be infringing on other marks. We may not be able to protect our rights to these trademarks and trade names, which we need to build brand loyalty. Brand recognition is critical to our short-term and long-term marketing strategies especially as we commercialize future enhancements to our products.

Clinicians or patients using our products or services may sue us and our insurance may not sufficiently cover all claims brought against us, which will increase our expenses.

Clinicians, patients and others may at times seek damages from us if drugs are incorrectly prescribed for a patient based on testing errors or similar claims. Although we have obtained liability insurance coverage, we cannot guarantee that liability insurance will continue to be available to us on acceptable terms or that our coverage will be sufficient to protect us against all claims that may be brought against us. We may incur significant legal defense expenses in connection with a liability claim, even one without merit or for which we have coverage.

We may have difficulty managing our growth and attracting and retaining skilled personnel, which could hinder our commercial efforts and impair our ability to compete.

If our management is unable to manage our growth effectively, it is possible that our systems and our facilities may become inadequate. Our success also depends on our continued ability to attract and retain highly qualified management and scientific personnel. If we cannot successfully attract and retain qualified personnel, our research and development efforts could be hindered and our ability to run our business effectively and compete with others in our industry will be harmed. With the exception of Bill Young, our CEO, we do not have employment agreements with any of our employees, and we do not maintain “key man” insurance for any employee. If any of our key employees were to leave, we may incur significant costs searching for a replacement. In addition, we have entered into severance agreements with our officers that would, in some instances, require us to pay severance to such officers upon the termination of their employment. We are not aware that any key employee has plans to retire or leave in the near future.

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

We have historically used stock options and other forms of equity-related incentives as a key component of our employee compensation packages. We believe that stock options and other long-term equity incentives

directly motivate our employees to maximize long-term stockholder value and, through the use of long-term vesting, encourage employees to remain with us. The Financial Accounting Standards Board and other agencies have proposed, and are currently considering, changes to accounting principles generally accepted in the U.S. that would require us to record a charge to earnings for employee stock option grants and other equity incentives. Moreover, applicable stock exchange listing standards related to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant options to employees in the future, which may result in changes in our equity compensation strategy. These and other developments in the provision of equity compensation to employees could make it more difficult to attract, retain and motivate employees, and such a change in accounting rules may adversely impact our future financial condition and operating results.

We may be subject to litigation, which would be time consuming and divert our resources and the attention of our management.

In November 2002, we implemented a business restructuring plan. With the exception of one, all of the employees terminated in connection with the business restructuring signed a release of claims. We have received correspondence from the former employee that did not sign a release threatening to bring claims against us that stem from termination. We do not have employee practices liability insurance to cover any potential claims by employees terminated in the reduction of force. Even if we are eventually successful in our defense of this or any other similar claims, the time and money spent may prevent us from operating our business effectively or profitably or may distract our management.

Compliance with changing regulation of corporate governance, public disclosure and accounting matters may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new rules subsequently implemented by the SEC and The Nasdaq Stock Market, as well as new accounting pronouncements, are creating uncertainty and additional complexities for companies such as ours. To maintain high standards of corporate governance and public disclosure, we intend to invest all reasonable necessary resources to comply with evolving standards. This investment may result in increased general and administrative expenses and a diversion of management time and attention from strategic revenue-generating and cost management activities.

Our operating results may fluctuate from quarter to quarter, making it likely that, in some future quarter or quarters, we will fail to meet estimates of operating results or financial performance, causing our stock price to fall.

If revenue declines in a quarter, our losses will likely increase or our earnings will likely decline because many of our expenses are relatively fixed. Though our revenues may fluctuate significantly as we continue to build the market for our products, expenses such as research and development, sales and marketing and general and administrative are not affected directly by variations in revenue. In addition, our cost of product revenue could also fluctuate significantly due to variations in the demand for our product and the relatively fixed costs to produce it. We are contractually obligated for rental payments under a building lease assignment through 2011 in the event of default by the assignee. We cannot accurately predict how volatile our future operating results will be because our past and present operating results, which reflect moderate sales activity, are not indicative of what we might expect in the future. As a result it is very difficult for us to forecast our revenues accurately and it is likely that in some future quarter or quarters, our operating results will be below the expectations of securities analysts or investors. In this event, the market price of our common stock may fall abruptly and significantly. Because our revenue and operating results are difficult to predict, period-to-period comparisons of our results of operations may not be a good indication of our future performance.

If a natural disaster strikes our clinical laboratory facility and we are unable to receive and or process our customers’ samples for a substantial amount of time, we would lose revenue.

We rely on a single clinical laboratory facility to process patient samples for our tests, which are received via delivery service or mail, and have no alternative facilities. We will also use this facility for conducting other tests we develop, and even if we move into different or additional facilities they will likely be in close proximity

to our current clinical laboratory. Our clinical laboratory and some pieces of processing equipment are difficult to replace and could require substantial replacement lead-time. Our processing facility may be affected by natural disasters such as earthquakes and floods. Earthquakes are of particular significance since our clinical laboratory is located in South San Francisco, California, an earthquake-prone area. Our laboratory and equipment are insured up to $15.3 million against loss or damage in the event of a fire but not in the event of a flood or an earthquake. We also have business interruption insurance that provides coverage up to $25 million for business losses related to fire. Our insurance coverage may not be adequate to cover total losses incurred in a fire. However, even if covered by insurance, in the event our existing clinical laboratory facility or equipment is affected by natural disasters, we would be unable to process patient samples and meet customer demands or sales projections. If our patient sample processing operations were curtailed or ceased, we would not be able to perform our tests, which would reduce our revenues, and may cause us to lose the trust of our customers or market share.

Terrorist acts and acts of war may seriously harm our business and financial condition.

Terrorists acts or acts of war (wherever located around the world) may cause damage or disruption to our company, employees, facilities, partners, suppliers, distributors and resellers, and customers, which could significantly impact our revenues, costs and expenses and financial condition. In addition, as our headquarters and our significant patient populations are located in major metropolitan areas of the United States, we may be impacted by actions against the United States. Depending on severity and location, such acts could impact our ability to receive shipments of patient samples or result in a substantial reduction in the number of ordered tests due to the inability of patients to get to their physicians. We will be predominantly uninsured for losses and interruptions caused by terrorist acts and acts of war.

Concentration of ownership among some of our stockholders may prevent other stockholders from influencing significant corporate decisions.

At December 31, 2003, approximately 33% of our common stock was beneficially held by a small number of stockholders including an affiliate of Pfizer, our directors, entities affiliated with our directors and former directors, and our executive officers. In addition, our Series A Preferred Stock is held by a small number of stockholders, some of who also own shares of our common stock and could acquire significant additional shares of common stock by converting shares of preferred stock. Consequently, a small number of our stockholders may be able to substantially influence our management and affairs. If acting together, they would be able to influence most matters requiring the approval by our stockholders, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets and any other significant corporate transaction. The concentration of ownership may also delay or prevent a change in our control at a premium price if these stockholders oppose it. There are also certain approval rights of the Series A Preferred Stock, and the few holders of those shares could prevent certain important corporate actions by not approving those actions.

The market prices for securities of biotechnology companies in general have been highly volatile and may continue to be highly volatile in the future. Our stock price has fluctuated widely during the last two years from a low of $0.72 per share in September 2002 to a high of $4.40 per share in January 2004. The following factors, in addition to other risk factors described in this section, may have a significant negative impact on the market price of our common stock:


	•	Period-to-period fluctuations in financial results

	•	Financing activities

	•	Litigation

	•	Delays in product introduction, launches or enhancements

	•	Announcements of technological innovations or new commercial products by our competitors

	•	Results from clinical studies


	•	Developments concerning proprietary rights, including patents

	•	Publicity regarding actual or potential medical results relating to products under development by our competitors or our own products or products under development

	•	Regulatory developments in the United States and foreign countries

	•	Changes in payor reimbursement policies

	•	Economic and other external factors or other disaster or crisis

A low or volatile stock price may negatively impact our ability to raise capital and to attract and maintain key employees.

We may be required to obtain the consent of the holders of our preferred stock before taking corporate actions, which could harm our business.

Our charter documents require us to obtain the consent of the holders of the Series A Preferred Stock before we may issue securities that have senior or equal rights to the respective series, incur unsecured indebtedness for borrowed money, or take other actions with respect to the respective series or other securities. We are also required to obtain the consent of the holders of the Series A Preferred Stock before we amend or modify our certificate of incorporation or bylaws to change any of the rights of such series. To obtain these consents, we would need to get consent from holders of a majority of the outstanding shares of the Series A Preferred Stock.

These obligations, and our complicated capitalization structure in general, might frustrate attempts to remove our board or management by making it difficult to find suitable replacements willing to spend substantial amounts of time and efforts on company matters. Moreover, these obligations may deter a potential acquirer from completing a transaction with us. They may also prevent us from taking corporate actions that would be beneficial to our stockholders and us, such as raising capital. Even if we are not prevented from taking such actions, they might be more expensive to us. This was the case when we issued our Series B Preferred Stock in March 2002, because we had to grant additional warrants to holders of Series A Preferred Stock as consideration in order to secure their consent and waiver concerning the financing and the resulting impact on the Series A Preferred Stock. This was also the case when we issued our Series C Convertible Preferred Stock in November 2002, because we had to agree to exchange the shares of Series B Preferred Stock for notes that were convertible into our Series C Convertible Preferred Stock, and to exchange the warrants associated with shares of Series B Preferred Stock for new warrants as consideration to secure the consent and waiver of the Series B Preferred Stock holders concerning the financing and the resulting impact on their respective preferred stock.

If our stockholders sell substantial amounts of our common stock, the market price of our common stock may fall.

If our stockholders sell substantial amounts of our common stock, including shares issued upon the exercise of outstanding options and warrants and upon the conversion of the Series A Preferred Stock, the market price of our common stock may fall. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. Sales of a substantial number of shares could occur at any time. This may decrease the price of our common stock and may impair our ability to raise capital in the future.

Provisions of our charter documents and Delaware law may make it difficult for our stockholders to replace our management and may inhibit a takeover, either of which could limit the price investors might be willing to pay in the future for our common stock.

Provisions in our certificate of incorporation and bylaws may make it difficult for our stockholders to replace or remove our current management, and may delay or prevent an acquisition or merger in which we are not the surviving company. In particular:


	•	Our Board of Directors is classified into three classes, with only one of the three classes elected each year, so that it would take at least two years to replace a majority of our directors


	•	Our bylaws contain advance notice provisions that limit the business that may be brought at an annual meeting and place procedural restrictions on the ability to nominate directors

	•	Our stockholders are not permitted to call special meetings or act by written consent

The holders of Series A Preferred Stock also have voting rights relating to many types of transactions, such as the creation or issuance of senior or pari passu equity or debt securities and the payment of dividends or distributions, and are subject to redemption at the option of the holder upon certain mergers, consolidations or other business combinations. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions could discourage changes of our management and acquisitions or other changes in our control and otherwise limit the price that investors might be willing to pay in the future for our common stock.

As of March 25, 2004, we leased one building of laboratory and office space of approximately 41,000 square feet in South San Francisco, California. The lease expires in April 2010 and provides an option to extend the term for an additional ten years. We also subleased office space of approximately 14,000 square feet in another building in South San Francisco, California. This sublease expires on December 31, 2004.

Since May 2, 2000, our common stock has been traded on the Nasdaq National Market under the symbol “VLGC.” The following table sets forth, for the periods indicated, the high and low sales prices per share of common stock on the Nasdaq National Market:

The last reported sale price of our common stock on the Nasdaq National Market on March 25, 2004 was $2.92. As of March 25, 2004, there were approximately 10,000 stockholders of record of our common stock.

We have never declared or paid any cash dividends on our common stock. We currently intend to retain any future earnings for funding growth and, therefore, do not anticipate paying any cash dividends on our common stock in the foreseeable future. Any future determination to pay cash dividends on our common stock will be at the discretion of the board of directors and will be dependent upon our financial condition, results of operations, capital requirements and other such factors as the board of directors deems relevant. In addition, as long as any Series A Preferred Stock is outstanding, we may not, without first obtaining the written approval of the holders of such stock, declare or pay any cash dividends to common stockholders.

In addition, we are obligated to pay dividends to the Series A preferred stockholders. See “Capital Stock” note to the financial statements for further discussion.

The following sets forth the number of shares of our common and preferred stock issued in the fourth quarter of 2003. For these issuances, we relied on the exemption provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”):

In October 2003, we issued 3,479,849 shares of our common stock to four holders of our Series C Preferred Stock upon such holders’ conversion of certain shares of Series C Preferred Stock held by such holders. Additionally, we issued 420 shares of our common stock to one holder of our warrants upon such holder’s exercise of warrants for an aggregate cash exercise price of $0.02.

In November 2003, we issued 2,419,889 and 1,863,437 shares of our common stock to one holder of our Series A Preferred Stock and four holders of our Series C Preferred Stock, respectively, upon such holders’ conversion of certain shares of Series A and Series C Preferred Stock held by such holders. Additionally, we issued 420 and 250,000 shares of our common stock to three holders of our warrants upon such holders’ exercise of warrants for an aggregate cash exercise price of $0.02 and $1.11 per share, respectively.

In December 2003, we issued 4,203,089 shares of our common stock to twelve holders of our Series C Preferred Stock upon conversion of certain shares of Series C Preferred Stock held by such holders. Additionally, we issued 946,079 shares of our common stock to two holders of our warrants upon such holders’ exercise of warrants for an aggregate cash exercise price of $1.11. We also issued 124,493 shares of

In December 2003, we issued 53,820 shares of common stock with a market value of $0.2 million as of the date of such issuance, to the ViroLogic, Inc. 401(k) Profit Sharing Plan as a matching contribution under the terms of the plan.

Information about our equity compensation plans is included in Item 12 of Part III of this Annual Report.

The following selected financial information has been derived from our audited financial statements. The information below is not necessarily indicative of results of future operations, and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes thereto included in Item 8 of this Form 10-K in order to fully understand factors that may affect the comparability of the information presented below.

See notes to the financial statements for a description of the number of shares used in the computation of the basic and diluted loss per common share.


(a)	At December 31, 2002, short-term liabilities include $12.05 million of Series C Convertible Secured Promissory Notes (“Notes”). On February 4, 2003, our stockholders ratified the Series C Private Placement resulting in the conversion of the Notes into stockholders’ equity. See notes to financial statements for further details.

The following discussion of the financial condition and results of operations should be read in conjunction with the financial statements and the notes thereto included in this Form 10-K. The estimates and certain other statements below are forward-looking statements that involve risks and uncertainties. Our actual future capital requirements and the adequacies of our available funds will depend on many factors, including those under “Risk Factors Related to Our Business.”

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the financial statements describes the significant accounting policies used in the preparation of the financial statements. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.

A critical accounting policy is defined as one that is both material to the presentation of our financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on our financial condition and results of operations. Specifically, critical accounting estimates have the following attributes: 1) we are required to make assumptions about matters that are highly uncertain at the time of the estimate; and 2) different estimates we could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on our financial condition or results of operations.

Estimates and assumptions about future events and their effects cannot be determined with certainty. We base our estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as our operating environment changes. These changes have historically been minor and have been included in the financial statements as soon as they became known. Based on a critical assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe that our financial statements are fairly stated in accordance with accounting principles generally accepted in the United States, and present a meaningful presentation of our financial condition and results of operations.

We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our financial statements:

data. If the government and other third-party payors significantly change their reimbursement policies, an adjustment to the allowance may be necessary. Revenue generated from our database of resistance test results is recognized when earned under the terms of the related agreements, generally upon shipment of the requested reports. Contract revenue consists of revenue generated from National Institutes of Health (“NIH”) grants and commercial assay development, and other non-product revenue. NIH grant revenue is recorded on a reimbursement basis as grant costs are incurred. The costs associated with contract revenue are included in research and development expenses. Deferred revenue relates to cash received in advance of meeting the revenue recognition criteria described above.

In addition, we review and estimate the collectibility of our receivables based on the period of time they have been outstanding. Historical collection and payor reimbursement experience is an integral part of the estimation process related to reserves for doubtful accounts. In addition, we assess the current state of our billing functions in order to identify any known collection or reimbursement issues in order to assess the impact, if any, on our reserve estimates, which involves judgment. We believe that the collectibility of our receivables is directly linked to the quality of our billing processes, most notably those related to obtaining the correct information in order to bill effectively for the services we provide. As such, we have implemented procedures to reduce the number of requisitions that we receive from healthcare providers with missing or incorrect billing information. Revisions in reserve for doubtful accounts estimates are recorded as an adjustment to bad debt expense within general and administrative expenses. We believe that our collection and reserves processes, along with our close monitoring of our billing processes, helps to reduce the risk associated with material revisions to reserve estimates resulting from adverse changes in collection and reimbursement experience and billing operations.

We record a valuation allowance to reduce our deferred tax assets to the amount that we believe is more likely than not to be realized. Due to our lack of earnings history, the net deferred tax assets at December 31, 2003 have been fully offset by a valuation allowance.

We estimate a beneficial conversion feature for our convertible preferred stock in accordance with Emerging Issues Task Force Consensus No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features” and No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments” based on the difference between the estimated conversion price and common stock fair market value at the date of issuance. We use the Black-Scholes option valuation model to estimate the conversion price at the date of issuance, which considers a number of factors requiring judgment including the weighted-average expected life of stock options from grant date and the volatility factor of the expected market price of the Company’s common stock. We record the beneficial conversion feature as a deemed dividend on the Statement of Operations, resulting in an increase to the loss applicable to common stockholders in the calculation of basic and diluted loss per common share.

We have elected to continue to follow Accounting Principles Board Opinion No. 25 “Accounting for Stock-Based Compensation” (“APB 25”) to account for employee stock options. Under APB 25, no compensation expense is recognized because the exercise price of our employee stock options equals the

market price of the underlying stock on the date of grant. Deferred compensation, if recorded, is amortized using the graded vesting method. Statement of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by Statement of Financial Accounting Standards Board Statement No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123” (“SFAS 148”) requires the disclosure of pro forma information regarding net loss and net loss per share as if we had accounted for stock options under the fair value method. See “Summary of Significant Accounting Policies” note to the financial statements for further discussion.

We account for stock option grants to non-employees in accordance with the Emerging Issues Task Force Consensus No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires the options subject to vesting to be periodically re-valued and expensed over their vesting periods. We estimate the fair value of these stock options and stock purchase rights at the date of grant using the Black-Scholes option valuation model, which considers a number of factors requiring judgment.

Year Ended December 31, 2003 Compared to Years Ended December 31, 2002 and 2001.

Revenue. Revenue was $33.4 million, $25.3 million and $18.3 million in 2003, 2002 and 2001, respectively. The increase of $8.1 million in 2003 as compared to 2002 and $7.0 million in 2002 as compared to 2001 was primarily attributable to growth in the HIV resistance testing market and increased demand for our PhenoSense HIV, PhenoSense GT and GeneSeq HIV products for patient and pharmaceutical testing. In addition, contract revenue, which primarily consists of revenue from NIH research grants and commercial assay development contributed to increases year over year due to new projects being approved and initiated. In 2003, we were awarded four Small Business Innovation Research (“SBIR”) grants from the National Institute of Allergy and Infectious Diseases (“NIAID”), a division of the U.S. National Institutes of Health, totaling more than $4 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. In 2001, we were awarded NIH research grants to develop new technologies to measure HIV resistance to entry inhibitors and viral replication capacity.

We believe increased demand for existing products and new product launches will be the primary factors contributing to a projected increase in the level of sales in 2004 as compared to 2003. The Company anticipates quarterly differences in the revenue growth rate relating to the timing of various clinical studies and seasonal effects observed in patient testing, which in keeping with the historical trend we expect to be most noticeable in the first quarter.

Cost of product revenue. Cost of product revenue was $16.7 million, $14.6 million and $11.8 million in 2003, 2002 and 2001, respectively. The increase of $2.1 million in 2003 as compared to 2002 and $2.7 million in 2002 as compared to 2001 was due to the higher volume of testing. Included in these costs are materials, supplies, labor and overhead related to product revenue. Gross margins increased to 48% in 2003 from 41% in 2002 and 34% in 2001. The increase was primarily due to improved operational efficiency and economies of scale and implementation of the 2002 business restructuring plan as discussed below. We anticipate that gross

Research and development. Research and development costs were $4.7 million, $10.4 million and $11.7 million in 2003, 2002 and 2001, respectively. The decrease of $5.7 million in 2003 as compared to 2002 and $1.3 million in 2002 as compared to 2001 was primarily the result of reallocating certain research and development personnel and resources to revenue generating activities, and implementation of the 2002 business restructuring plan as discussed below. Total research and development expenses included costs associated with contract revenue as follows:

Because our resistance tests target viral diseases and our product lines overlap, most of our core research and development activities are advancing multiple potential product lines. Due to this substantial overlap, we do not track costs on a project by project basis, except for the costs reimbursed by the NIH as discussed above. We expect research and development spending in the future to trend with the level of NIH grants and/or other research and development cost reimbursement arrangements under contract.

Below is a summary of products and products in development. The information in the column labeled “Estimated Completion” contains forward-looking statements regarding completion of products in development and is dependent on securing NIH grants and/or other research and development funding as well as demand for the products. The actual timing of completion of those products could differ materially from the estimates provided in the table.

General and administrative. General and administrative expenses were $9.3 million, $10.6 million and $11.4 million in 2003, 2002 and 2001, respectively. The decrease of $1.3 million in 2003 as compared to 2002 and $0.8 million in 2002 as compared to 2001 was primarily due to the implementation of the 2002 business restructuring plan as discussed below and a reduction in non-cash compensation expenses related to granting stock and options prior to our initial public offering, and was partially offset by an increase in professional services fees and costs associated with facilities marketed for sublease. We expect general and administrative expenses in 2004 to increase from 2003 levels but at a substantially lower growth rate than the projected revenue growth rate primarily due to continued leveraging of existing infrastructure.

Stock Based Compensation. Deferred compensation for options granted to employees is the difference between the exercise price and the deemed fair value for financial reporting purposes of our common stock on the date certain options were granted and is a component of stockholders’ equity. In 2003, 2002 and 2001, all options were granted at fair value and no deferred compensation was recorded. Stock based compensation, recorded in connection with the grant of stock options to employees prior to our initial public offering, was amortized over the vesting period for the individual options. We recorded related amortization of $0.2 million, $0.7 million and $1.5 million in 2003, 2002 and 2001, respectively.

We determined compensation for options granted to non-employees in accordance with the Emerging Issues Task Force Consensus No. 96-18 as the fair value of the equity instruments issued. We record compensation for options granted to non-employees as the related services are rendered, and the value of the compensation may be periodically remeasured and the expense adjusted accordingly as the underlying options vest. We recorded $0.3 million, $0.2 million and $0.2 million of stock based compensation for non-employees in 2003, 2002 and 2001, respectively. At December 31, 2003, the aggregate value of the unvested options subject to remeasurement was $0.1 million, calculated based on the deemed fair value of our common stock. The related amortization will be recorded over the remaining service, which is generally one to four years.

Sales and marketing. Sales and marketing expenses were $8.3 million, $11.7 million and $10.3 million in 2003, 2002 and 2001, respectively. The decrease of $3.4 million in 2003 as compared to 2002 was primarily due to continued effective utilization of our sales and marketing capabilities and implementation of the 2002 business restructuring plan as discussed below. The increase of $1.4 million in 2002 as compared to 2001 was primarily attributable to increased sales and marketing programs related to the commercialization of our existing and new products, including PhenoSense GT. We expect sales and marketing expenses in 2004 to increase from 2003 levels but at a lower growth rate than the projected revenue growth rate primarily due to continued effective utilization of our sales and marketing capabilities.

Interest income. Interest income was $0.1 million, $0.3 million and $1.1 million in 2003, 2002 and 2001, respectively. The decrease of $0.2 million in 2003 as compared to 2002 and $0.8 million in 2002 as compared to 2001 was primarily due to lower average cash balances and lower interest rates.

Interest expense. Interest expense was $0.1 million, $0.4 million and $0.5 million in 2003, 2002 and 2001, respectively. The decrease of $0.3 million in 2003 as compared to 2002 and $43,000 in 2002 as compared to 2001 was primarily due to the payoff of several equipment loans which expired.

Other income. Other income was $0.2 million, $0.3 million and $0.1 million in 2003, 2002 and 2001, respectively, which represents residual income from one of our subleases. For further discussion, see Liquidity and Capital Resources below.

Deemed dividend. In 2001, we sold 1,625 shares of Series A Preferred Stock with warrants to purchase an aggregate of 3.2 million shares of common stock, for an aggregate purchase price of $16.25 million. We determined that the issuance of the Series A Preferred Stock resulted in a beneficial conversion feature with a value of $2.3 million that was recorded in 2001.

In the first quarter of 2002, we sold 1,005 shares of Series B Preferred Stock with warrants to purchase an aggregate of 2.2 million shares of common stock, for an aggregate purchase price of $10.05 million. In connection with this financing, we also granted warrants to purchase an aggregate of 637,261 shares of common stock to holders of Series A Preferred Stock as a payment in order to secure their consent and waiver concerning the financing and the resulting impact on the Series A Preferred Stock. In the fourth quarter of

2002, we sold 706 shares of Series C Preferred Stock with warrants to purchase an aggregate of 4.4 million shares of common stock, for an aggregate purchase price of $7.06 million. We determined that the issuance of the Series B and Series C Preferred Stock resulted in a beneficial conversion feature of $2.9 million and $7.7 million, respectively, for a total of $10.6 million in 2002.

On February 4, 2003, our stockholders approved the conversion of certain convertible secured promissory notes (“Notes”) issued to prior Series B preferred stockholders into Series C Preferred Stock and the issuance of warrants to purchase shares of our common stock in exchange for warrants originally issued in connection with Series B Preferred Stock. The warrant exchange resulted in a beneficial conversion feature of $2.2 million that was recorded at the time of the exchange in the first quarter of 2003.

The beneficial conversion features were calculated in accordance with Emerging Issues Task Force Consensus No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features” and Emerging Issues Task Force Consensus No. 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments.” The beneficial conversion features were reflected as deemed dividends in the Statement of Operations of $2.2 million, $10.6 million and $2.3 million in 2003, 2002 and 2001, respectively, and are included in stockholders’ equity as offsetting charges and credits to additional paid-in capital.

Preferred stock dividend. We recorded a preferred stock dividend of $1.6 million, $1.0 million and $0.3 million in 2003, 2002 and 2001, respectively. The Series A Preferred Stock issued in 2001 bore an initial 6% annual dividend rate, payable twice a year in shares of common stock, which increased to an 8% annual rate on the fourth such payment, and then increases by 2 percentage points every six months thereafter up to a maximum annual rate of 14%. The Series B Preferred Stock issued in 2002 received cash dividends based on a 6% annual dividend rate until November 2002 when the Series B Preferred Stock was exchanged for secured convertible promissory notes and converted to Series C Preferred Stock. The Series C Preferred Stock bore an initial 8% annual dividend rate, payable quarterly, which increases to a 9% annual dividend rate on June 30, 2004, then increases by one percentage point every quarter thereafter up to a maximum annual rate of 14%. The Series C Preferred Stock dividend was paid in cash in 2002 and was paid in shares of common stock in 2003. In December 2003, we elected to convert all Series C Convertible Preferred Stock then outstanding into common stock.

Business restructuring. In the fourth quarter of 2002, we implemented a business restructuring plan to reallocate certain personnel and resources to revenue maximizing activities and reduce cash consumption. The plan included a reduction in force of approximately 17% or 35 employees: 8 employees in laboratory operations; 6 employees in research and development; 8 employees in sales and marketing; and 13 employees in administration. In the fourth quarter of 2002, we recorded a charge for salaries, severance and other personnel related costs to the respective departments totaling $286,000: cost of product revenue of $61,000; research and development expense of $54,000; general and administrative expense of $96,000 and sales and marketing expense of $75,000. All amounts related to this restructuring were paid in 2002.

We expect our available cash and cash equivalents, short-term investments and short-term restricted cash of $9.9 million at December 31, 2003, funds provided by the sale of our products, contract revenue, and borrowing under equipment financing arrangements will be adequate to fund our operations through at least December 2004, assuming revenue reaches projected levels and cost containment measures continue to be effective. In addition, we plan to continue to evaluate various strategic opportunities, including among others, research and development collaborations, international alliances and marketing partnerships.

We have funded our operations since inception primarily through public and private sales of common and preferred stock, equipment financing arrangements, product revenue and contract revenue. In particular, we have completed three private financings since our initial public offering in May 2000. Although we expect our operating and capital resources will be sufficient to meet future requirements through at least December 2004, we may have to raise additional funds to continue the development and commercialization of future technologies and our business operations in general. These funds may not be available on favorable terms, or at all. If adequate funds are not available on commercially reasonable terms, we may be required to curtail

operations significantly or sell significant assets and may not be able to continue as a going concern. In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe that we have sufficient funds for current or future operating plans.

Net cash used in operating activities was $3.6 million, $19.3 million and $24.1 million in 2003, 2002 and 2001, respectively. Cash used in operating activities decreased primarily due to a reduction of operating losses as discussed above. Cash flows from operating activities can vary significantly due to various factors including changes in accounts receivable and deferred revenue related to new arrangements with customers. The average collection period of our accounts receivable as measured in days sales outstanding (DSO) can vary and is dependent on various factors, including the type of revenue (i.e. patient testing, pharmaceutical company testing or contract revenue) and the payment terms related to those revenues and whether the related revenue was recorded at the beginning or ending of a period.

Net cash used in investing activities of $1.0 million in 2003 resulted primarily from capital expenditures of $0.5 million and costs associated with acquiring other assets of $0.4 million. Net cash provided by investing activities of $10.7 million in 2002 resulted primarily from the net proceeds from maturities and sales of short-term investments, a lease assignment of $3.8 million and a tenant improvement reimbursement of $1.3 million, partially offset by capital expenditures of $1.4 million. Net cash used in investing activities of $2.2 million in 2001 resulted primarily from capital expenditures of $7.8 million offset by the receipt of an advance from subtenant of $2.6 million and net proceeds from maturities and sales of short-term investments.

Net cash provided by financing activities was $2.9 million, $17.8 million and $15.1 million in 2003, 2002 and 2001, respectively. The net cash provided by financing activities in 2003 resulted primarily from warrant exercises for proceeds of $4.3 million, partially offset by payments on loans and capital lease obligations. Net cash provided by financing activities in 2002 resulted primarily from our issuance of Series B and Series C Preferred Stock and an equity investment from Pfizer Ireland Pharmaceuticals for net proceeds of approximately $19.0 million. Net cash provided by financing activities in 2001 resulted primarily from our issuance of Series A Preferred Stock for net proceeds of approximately $14.7 million and equipment financing of approximately $1.3 million.

At December 31, 2003, the Company leased two buildings totaling approximately 66,000 square feet in South San Francisco, California. The lease for the Company’s primary facility, which covers 41,000 square feet, expires in April 2010 and provides an option to extend the term for an additional ten years. The lease for the Company’s original facilities, which covers approximately 25,000 square feet, was scheduled to expire in November 2004. On March 22, 2004, Company and the lessor agreed to terminate this lease. The lease termination enabled the Company to decrease the present value of its remaining lease obligations for this facility by approximately 50%. Under the terms of this agreement, the Company will make cash payments to the lessor totaling $0.4 million as follows: $0.2 million in March 2004 and $0.2 million in April 2004. As a result, the Company will record a charge in the first quarter of 2004 of approximately $0.4 million primarily related to the termination payment and the write-off of the net carrying value of the related leasehold improvements.

In addition, at December 31, 2003, the Company subleased approximately 14,000 square feet in South San Francisco, California. This sublease expires on December 31, 2004.

In June 2002, we assigned a lease of excess laboratory and office space and transferred ownership through the sale of related leasehold improvements and equipment to a third party. We received net proceeds from the lease assignment of $3.8 million, resulting in a net gain of $0.3 million, which was recognized as other income over the initial sublease term. In the event of default by the assignee, we would be contractually obligated for payments under the lease of: $1.0 million in 2004; $1.4 million in 2005; $1.5 million in 2006; $1.5 million in 2007; $1.5 million in 2008; and $3.9 million from 2009 through 2011.

In July 2001, we sublet approximately 12,000 square feet of one of our existing facilities to a third party for a term of 18 months, which ended in January 2003. The rental income generated from this sublease was $0.1 million, $0.6 million and $0.3 million in 2003, 2002 and 2001, respectively, and is recorded as a partial offset to rental expense.

At December 31, 2003, our contractual obligations for the next five years and thereafter are as follows:

In addition, the Company is obligated to pay dividends to the Series A preferred stockholders. See “Capital Stock” note to the financial statements for further discussion.

The contractual obligations discussed above are fixed costs. If we are unable to generate sufficient cash from operations to meet these contractual obligations, we may have to raise additional funds. These funds may not be available on favorable terms or at all.

Income taxes. We have incurred net operating losses since inception. At December 31, 2003, we had federal and state net operating loss carryforwards of approximately $96.9 million and $39.5 million, respectively. The federal net operating loss and credit carryforwards will expire at various dates between the years 2010 and 2023, if not utilized. The state of California net operating losses will expire at various dates between the years 2005 and 2014, if not utilized. Utilization of the federal and state net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net operating losses and credits before utilization.

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 established standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The provisions of SFAS 150 were effective for instruments entered into or modified after May 31, 2003. The adoption of SFAS 150 did not have a material effect on the Company’s results of operations or financial position.

In November 2002, the FASB issued Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21 addresses certain aspects of the accounting by a company for arrangements under which it will perform multiple revenue-generating activities. EITF 00-21 addresses when and how an arrangement involving multiple deliverables should be divided into separate units of accounting. EITF 00-21 provides guidance with respect to the effect of certain customer rights due to company nonperformance on the recognition of revenue allocated to delivered units of accounting. EITF 00-21 also addresses the impact on the measurement and/or allocation of arrangement consideration of customer cancellation provisions and consideration that varies as a result of future actions of the customer or the company. Finally, EITF 00-21 provides guidance with respect to the recognition of the cost of certain deliverables that are excluded from the revenue accounting arrangement. The provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material effect on the Company’s results of operations or financial position.

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the

securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the fair value of the investment to fluctuate and result in an unrealized loss on the instrument equal to the difference between the fair value and our carrying value of the instrument. To minimize this risk in the future, we intend to continue to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. Due to the short-term nature of our investments, which have an effective maturity of approximately 180 days as of December 31, 2003, we believe we do not have a material exposure to interest rate risk arising from our investments. Therefore we have not included quantitative tabular disclosure in this Form 10-K.

We do not enter into financial investments for speculation or trading purposes and are not a party to financial or commodity derivatives.

We have operated primarily in the United States and all sales to date have been made in U.S. Dollars. Accordingly, we have not had any material exposure to foreign currency rate fluctuations.

We have audited the accompanying balance sheets of ViroLogic, Inc. as of December 31, 2003 and 2002, and the related statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ViroLogic, Inc. at December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

ViroLogic, Inc. (“ViroLogic” or the “Company”) is a biotechnology company developing, marketing and selling innovative products to guide and improve treatment of viral diseases. The Company incorporated in the state of Delaware on November 14, 1995 and commenced commercial operations in 1999. The Company developed a practical way of directly measuring the impact of genetic mutations on drug resistance and using this information to guide therapy. The Company has proprietary technology, called PhenoSense, for testing drug resistance in viruses that cause serious viral diseases such as HIV/ AIDS and hepatitis. The Company’s products are used by physicians in selecting optimal treatments for their HIV patients and by industry, academia and government for clinical studies, drug screening and characterization, and basic research.

The Company expects available cash and cash equivalents, short-term investments and short-term restricted cash of $9.9 million at December 31, 2003, funds provided by the sale of products, contract revenue and borrowing under equipment financing arrangements will be adequate to fund operations through at least December 2004, assuming revenue reaches projected levels and cost containment measures continue to be effective. In addition, management plans to continue to evaluate various strategic opportunities, including among others, research and development collaborations, international alliances and marketing partnerships.

The Company has funded operations since inception primarily through public and private sales of common and preferred stock, equipment financing arrangements, product revenue and contract revenue. In particular, the Company completed three private financings since its initial public offering in May 2000. Although management expects operating and capital resources will be sufficient to meet future requirements through at least December 2004, the Company may have to raise additional funds to continue the development and commercialization of future technologies and business operations in general. These funds may not be available on favorable terms, or at all. If adequate funds are not available on commercially reasonable terms, the Company may be required to curtail operations significantly or sell significant assets and may not be able to continue as a going concern. In addition, management may choose to raise additional capital due to market conditions or strategic considerations even if management believes that the Company has sufficient funds for current or future operating plans.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

The carrying value of cash and cash equivalents, short-term investments, accounts receivable, accounts payable, other accrued expenses and short-term obligations approximates fair value based on the highly liquid, short-term nature of these instruments.

ViroLogic considers all highly liquid investments with original maturities of three months or less from the date of purchase to be cash equivalents. Management determines the appropriate classification of its cash

equivalents and investment securities at the time of purchase and reevaluates such determination as of each balance sheet date.

Management has classified ViroLogic’s marketable securities as available-for-sale securities in the accompanying financial statements. Available-for-sale securities are carried at market value with unrealized gains and losses included in accumulated other comprehensive income within stockholders’ equity. Realized gains and losses are included in interest income. The cost of securities sold is based on the specific identification method.

ViroLogic invests its excess cash in United States government and agency securities, debt instruments of financial institutions and corporations, and money market funds with strong credit ratings. ViroLogic has established guidelines regarding diversification of its investments and their maturities, which should maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates while maintaining adequate safety and liquidity.

Inventory is stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market. If inventory costs exceed expected market value due to obsolescence or lack of demand, reserves are recorded for the difference between the cost and the market value. These reserves are based on estimates. Inventory consists of the following:

Property and equipment are recorded at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, generally five years. Capitalized software includes software and external consulting costs incurred to implement new information systems. Computer hardware and capitalized software are depreciated over three to five years. Leasehold improvements are amortized over the shorter of the estimated useful life of the assets or the lease term.

Intangible assets with definite lives are amortized over their estimated useful lives. Included in intangible assets are costs of patents and patent applications related to products and products in development, which are capitalized and amortized on a straight-line basis over their estimated useful lives of approximately 15 years. Other intangible assets are generally amortized on a straight-line basis over their estimated useful lives.

The Company reviews long-lived assets, including property, equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows

expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is determined using discounted cash flows.

Product revenue is recognized upon completion of tests made on samples provided by customers and the shipment of test results to those customers. Services are provided to certain patients covered by various third-party payor programs, such as Medicare and Medicaid. Billings for services under third-party payor programs are included in revenue net of allowances for differences between the amounts billed and estimated receipts under such programs. The Company estimates these allowances based on historical payment information and current sales data. If the government and other third-party payors significantly change their reimbursement policies, an adjustment to the allowance may be necessary. Revenue generated from the Company’s database of resistance test results is recognized when earned under the terms of the related agreements, generally upon shipment of the requested reports. Contract revenue consists of revenue generated from National Institutes of Health (“NIH”) grants and commercial assay development, and other non-product revenue. NIH grant revenue is recorded on a reimbursement basis as grant costs are incurred. The costs associated with contract revenue are included in research and development expenses. Deferred revenue relates to cash received in advance of meeting the revenue recognition criteria described above.

The process for estimating the ultimate collection of receivables involves significant assumptions and judgments. Billings for services under third-party payor programs are recorded as revenue net of allowances for differences between amounts billed and the estimated receipts under such programs. Adjustments to the estimated receipts, based on final settlement with the third-party payors, are recorded upon settlement as an adjustment to net revenue. In addition, the Company reviews and estimates the collectibility of receivables based on the period of time they have been outstanding. Historical collection and payor reimbursement experience is an integral part of the estimation process related to the allowance for doubtful accounts. Revisions to the allowance for doubtful accounts estimate are included in general and administrative expenses.

The Company expenses research and development costs as incurred. Research and development expenses consist primarily of salaries and related personnel costs, materials, supply costs for prototypes, and include costs associated with contract revenue. In addition, research and development expenses include costs related to clinical trials and validation of the Company’s testing processes and procedures and related overhead expenses.

The Company pays royalties under licensing agreements. These royalties are directly related to revenue and are expensed to cost of product revenue at the time revenue is recognized. For further discussion, see “Equipment Financing and Commitments” note below.

The Company expenses the costs of advertising, which include promotional expenses, as incurred. Advertising expenses were $2.2 million, $4.2 million and $4.5 million and for the years ended December 31, 2003, 2002 and 2001, respectively, and were recorded as sales and marketing expenses.

The Company estimates a beneficial conversion feature for its convertible preferred stock in accordance with Emerging Issues Task Force Consensus No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features” and No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments” based on the difference between the estimated conversion price and underlying common stock fair market value at the date of issuance. The Company records the beneficial conversion feature as a deemed dividend on the Statement of Operations, resulting in an increase to the loss applicable to common stockholders in the calculation of basic and diluted loss per common share.

Basic loss per share is calculated based on the weighted-average number of common shares outstanding during the periods presented, less the weighted-average shares outstanding which are subject to the Company’s right of repurchase. Diluted earnings per common share would give effect to the dilutive impact of potential common shares which consists of convertible preferred stock (using the as-if converted method), and stock options and warrants (using the treasury stock method). Potentially dilutive securities have been excluded from the diluted loss per common share computations in all years presented as such securities have an anti-dilutive effect on loss per common share due to the Company’s net loss.

The following outstanding options and warrants, prior to the application of the treasury stock method, and convertible preferred stock, on an as-converted basis, were excluded from the computation of diluted loss per common share as these potentially dilutive securities had an anti-dilutive effect:

In addition to the securities listed above, at December 31, 2002 the Company had convertible promissory notes (“Notes”) outstanding with an aggregate principal amount of $12.05 million. On February 4, 2003, the Company’s stockholders ratified and approved the conversion of the Notes into an aggregate of 1,204.6 shares of Series C Convertible Preferred Stock, which on an as-if converted basis, is equivalent to 10.0 million shares

of common stock. The Notes also included warrants which are included in the table above. See the “Convertible Promissory Notes” note below for further discussion.

The Company has elected to continue to follow Accounting Principles Board Opinion No. 25 “Accounting for Stock-Based Compensation” (“APB 25”) to account for employee stock options. Under APB 25, no compensation expense is recognized when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant. Deferred compensation, if recorded, is amortized using the graded vesting method. Statement of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) as amended by Statement of Financial Accounting Standards Board Statement No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123” (“SFAS 148”) requires the disclosure of pro forma information regarding net loss and net loss per share as if the Company had accounted for its stock options under the fair value method.

The information regarding net loss applicable to common stockholders and net loss per share prepared in accordance with SFAS 123 has been determined as if the Company had accounted for its employee stock option and employee stock purchase plans using the fair value method prescribed by SFAS 123. The resulting effect on loss applicable to common stockholders and loss per share pursuant to SFAS 123 as amended by SFAS 148 is not likely to be representative of the effects in future years, due to subsequent years including additional grants and years of vesting.

At December 31, 2003, the Company had two stock-based employee compensation plans: the 2000 Equity Incentive Plan and the 2000 Employee Stock Purchase Plan. The Company estimates the fair value of these stock options and stock purchase rights at the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions in 2003, 2002 and 2001: risk-free interest rate of 3.3%, 2.9% and 4.0% in 2003, 2002 and 2001, respectively; a weighted-average expected life of stock options from grant date of four years; a weighted-average expected stock purchase right of six months; volatility factor of the expected market price of ViroLogic’s common stock of 100% for each of 2003 and 2002, and 65% for 2001; and a dividend yield of zero. The weighted-average fair value of stock options granted in 2003, 2002 and 2001 was $1.39, $1.83 and $2.89, respectively.

For purposes of disclosures pursuant to SFAS 123 as amended by SFAS 148, the estimated fair value of the stock options and stock purchase rights are amortized to expense over the vesting period. The Company’s pro forma information is as follows:

The Company accounts for stock option grants to non-employees in accordance with the Emerging Issues Task Force Consensus No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires the options subject to vesting to be periodically re-valued and expensed over their vesting periods, which approximates the period over which services are rendered or goods are received.

Comprehensive income (loss) is comprised of net loss and other comprehensive income (loss). Other comprehensive income (loss) includes certain changes in equity that are excluded from net income (loss). Specifically, unrealized gains and losses on our available-for-sale securities, which are reported separately in stockholders’ equity, are included in accumulated other comprehensive income. Comprehensive income (loss) and its components are as follows:

Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of cash equivalents and marketable securities. For further discussion, see “Short-Term Investments” note below.

In 2003, there were no customers representing over 10% of total revenue. In 2002, one customer represented 10% of total revenue. In 2001, two customers represented 15% and 14% of total revenue, respectively.

The Company purchases various testing materials from single qualified suppliers. Any extended interruption in the supply of these materials could result in the Company’s inability to secure sufficient materials to conduct business and meet customer demand.

The Company has determined that it operates in only one segment under Statement of Financial Accounting Standards No. 131, “Disclosure about Segments of an Enterprise and Related Information” (“SFAS 131”). SFAS 131 establishes annual and interim reporting standards for an enterprise’s operating segments and related disclosures about its products, services, geographic areas and major customers.

The amortized cost, gross unrealized gains and losses, and estimated fair value for available-for-sale securities by major security type and class of security are as follows:

Depreciation expense was $2.0 million, $2.6 million and $2.1 million in 2003, 2002 and 2001, respectively. Accumulated amortization related to leased assets was $3.8 million and $2.6 million at December 31, 2003 and 2002, respectively.

On November 14, 2002, the Company entered into an exchange agreement with all of the holders of Series B Redeemable Convertible Preferred Stock (“Series B Preferred Stock”) in order to secure their consent to the sale of Series C Convertible Preferred Stock (the “Financing”) and the resulting impact on the Series B Preferred Stock, and to increase the number of shares of common stock available for issuance upon conversion of the Series C Convertible Preferred Stock (“Series C Preferred Stock”) and the exercise of the warrants included in the Financing. Pursuant to the exchange agreement, on November 19, 2002, the Company repurchased all of the outstanding Series B Preferred Stock in exchange for convertible secured promissory notes (“Notes”). The aggregate principal amount of the Notes was $12.05 million. In addition, the Notes bore an interest rate of 8%, had a maturity date of March 19, 2003 and were secured by substantially all of the Company’s assets. On February 4, 2003, the Company’s stockholders’ ratified and approved the conversion of the Notes into Series C Preferred Stock and the issuance of warrants to purchase shares of the Company’s common stock. Promptly following this approval, (i) the principal amount of the Notes was automatically converted into an aggregate of 1,204.6 shares of Series C Preferred Stock, (ii) an amount equal to the accrued interest on the Notes from November 19, 2002 through December 31, 2002 was paid to the holders of the Notes in cash, (iii) all other accrued and unpaid interest was forgiven and, (iv) the warrants attached to such preferred stock were issued. See the “Capital Stock” note below for further details.

In addition, at December 31, 2003, the Company subleased approximately 14,000 square feet in South San Francisco, California. This sublease expires on December 31, 2004.

In June 2002, the Company assigned a lease of excess laboratory and office space and transferred ownership through the sale of related leasehold improvements and equipment to a third party. The Company received net proceeds from the lease assignment of $3.8 million, resulting in a net gain of $0.3 million which was recognized as other income over the initial sublease term. In the event of default by the assignee, the

Company would be contractually obligated for payments under the lease of: $1.0 million in 2004; $1.4 million in 2005; $1.5 million in 2006; $1.5 million in 2007; $1.5 million in 2008; and $3.9 million from 2009 to 2011.

In July 2001, the Company sublet approximately 12,000 square feet of one of its existing facilities to a third party for a term of 18 months, which ended in January 2003. The rental income generated from this sublease was $0.1 million, $0.6 million and $0.3 million in 2003, 2002 and 2001, respectively, and is recorded as a partial offset to rental expense.

As of December 31, 2003 and 2002, the Company had capitalized leases, which bear interest at weighted-average fixed rates of approximately 10.7% and 11.6% for 2003 and 2002, respectively, and are due in monthly installments through June 2008. Some of these equipment financing agreements require a balloon payment at the end of their respective terms. The carrying amount of the equipment approximates the corresponding loan balance.

As of December 31, 2003, future minimum payments, excluding the lease assignment guarantee described above, are as follows:

Rental expense, net of sublease rental income, was approximately $2.5 million, $1.7 million and $2.4 million in 2003, 2002 and 2001, respectively.

As of December 31, 2003, the Company had purchase commitments for material and service contracts totaling approximately $0.3 million. In addition, the Company is obligated to pay dividends to the Series A preferred stockholders as discussed in the “Capital Stock” note below.

The Company licenses polymerase chain reaction (“PCR”) technology from Roche Molecular Systems, Inc. (“Roche”) for performing a step in its 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. Currently, the last Roche patent expires in 2005. If Roche develops or acquires additional patents covering technology related to the licensed technology, the Company has 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, the Company has agreed to pay Roche a royalty based on the net service revenues the Company receives from its products. Roche has the right to terminate this license if the Company fails to pay royalties, make a semi-annual royalty

report or participate in proficiency testing. The Company believes it is currently in compliance with these requirements. The license allows the Company to use technology covered by the licensed Roche patents within a broad field that includes all of the Company’s currently planned products. If the Company was to expand its product line beyond the licensed field, however, the Company would need to negotiate an expansion of the license. In addition, the Company also licenses technology from other third parties. The Company recorded royalty expense of $1.1 million, $1.0 million and $0.7 million for the years ended December 31, 2003, 2002 and 2001, respectively.

In 2003, ViroLogic’s stockholders approved an increase to the number of authorized shares of the Company’s common stock from 60,000,000 shares to 100,000,000 shares.

In November 2002, the Company entered into a Stock Purchase Agreement with Pfizer Ireland Pharmaceuticals (an affiliate of Pfizer, Inc.) in which the Company agreed to issue and sell an aggregate of 2.6 million shares of its common stock for gross proceeds of $3.0 million. Concurrently, the Company and Pfizer, Inc. entered into a master services agreement and a non-exclusive license agreement for the Company’s HIV drug resistance tests and services.

In 2001, the Company issued and sold, in a private placement, an aggregate of 1,625 shares of the Company’s Series A Redeemable Convertible Preferred Stock (“Series A Preferred Stock”) and warrants to purchase an aggregate of 3.2 million shares of common stock, for an aggregate purchase price of $16.25 million.

Of the 1,625 shares issued in the financing, 274 shares remain outstanding as of December 31, 2003, and the remainder was converted into an aggregate of approximately 7.4 million shares of the Company’s common stock. As a result of the Company’s sale of Series C Preferred Stock, which is described below, the conversion price of the Series A Preferred Stock and the exercise price of the warrants issued to the purchasers of the Series A Preferred Stock has each been reduced to $1.11. Accordingly, the 274 shares of Series A Preferred Stock outstanding are convertible into approximately 2.5 million shares of common stock, and the outstanding warrants are exercisable for approximately 4.0 million shares of common stock.

The Series A Preferred Stock bears dividends payable in common stock semi-annually. The dividends were initially at an annual rate of 6% but increased to an 8% annual rate on the fourth such payment, which was made in 2003, and will increase by 2 percentage points every six months up to a maximum annual rate of 14%. This dividend is paid as a stock dividend semi-annually. Subject to the limitations described below, the holders of Series A Preferred Stock may elect to convert their shares into the Company’s common stock at any time, just as they may choose to exercise their warrants at any time. Also subject to the limitations described below, the Company may, at its option, convert the Series A Preferred Stock into common stock at any time after June 21, 2002 for Series A Preferred Stock issued at the first closing and after July 9, 2002 for Series A Preferred Stock issued at the second closing, but only if the Company’s stock price exceeds $5.10 for 20 consecutive trading days. The Company may also, at its option, convert the Series A Preferred Stock into common stock upon a sale of common stock in a firm commitment underwritten offering to the public if the

public offering price exceeds $5.10, the aggregate gross proceeds exceed $40 million and the registration statements covering shares underlying the Series A Preferred Stock are effective.

The holders are not subject to any limitations on the number of conversions of Series A Preferred Stock or subsequent sales of the corresponding common stock, that they can effect, other than a prohibition on any holder acquiring beneficial ownership of more than 4.99% of the outstanding shares of the Company’s common stock. This limitation also applies to the Company’s ability to convert Series A Preferred Stock.

The holders of Series A Preferred Stock have the right to require the Company to redeem all of the Series A Preferred Stock for cash equal to the greater of (i) 115% of their original purchase price plus 115% of any accrued and unpaid dividend or (ii) the aggregate fair market value of the shares of common stock into which such shares of Series A Preferred Stock are then convertible. Series A Preferred Stock is redeemable by the holders in any of the following situations:


	•	If the Company fails to remove a restrictive legend on any certificate representing any common stock that was issued to any holder of such series upon conversion of their preferred stock or exercise of their warrant and that may be sold pursuant to an effective registration statement or an exemption from the registration requirements of the federal securities laws

	•	If the Company fails to have sufficient shares of common stock reserved to satisfy conversions of the series

	•	If the Company fails to honor requests for conversion, or if the Company notifies any holder of such series of its intention not to honor future requests for conversion

	•	If the Company institutes voluntary bankruptcy or similar proceedings

	•	If the Company makes an assignment for the benefit of creditors, or applies for or consents to the appointment of a receiver or trustee for the Company or for a substantial part of the Company’s property or business, or such a receiver or trustee shall otherwise be appointed

	•	If the Company sells all or substantially all of its assets

	•	If the Company merges, consolidates or engages in any other business combination (with some exceptions), provided that such transaction is required to be reported pursuant to Item 1 of Form 8-K

	•	If the Company commits a material breach under, or otherwise materially violates the terms of, the transaction documents entered into in connection with the issuance of such series

	•	If the registration statements covering shares of common stock underlying the Series A Preferred Stock and related warrants cannot be used by the respective selling security holders for the resale of all the underlying shares of common stock for an aggregate of more than 30 days

	•	If the Company’s common stock is not tradable on the NYSE, the AMEX, the Nasdaq National Market or the Nasdaq SmallCap market for an aggregate of twenty trading days in any nine month period

	•	If 35% or more of the Company’s voting power is held by any one person, entity or group

	•	If the Company fails to pay any indebtedness in excess of $350,000 when due, or if there is any event of default under any agreement that is likely to have a material adverse effect on the Company

	•	Upon the institution of involuntary bankruptcy proceedings

Upon the occurrence of any of the redemption events described above, individual holders of the Series A Preferred Stock would have the option, while such event continues, to require the Company to purchase some

or all of the then outstanding shares of Series A Preferred Stock held by such holder. If the Company receives any notice of redemption, the Company is required to immediately (no later than one business day following such receipt) deliver a written notice to all holders of the same series of preferred stock stating the date when the Company received the redemption notice and the amount of preferred stock covered by the notice. If holders of the Series A Preferred Stock were to exercise their rights to redeem a material number of their shares as a result of any of the events described above, such a redemption could have a material adverse effect on the Company.

Subject to certain conditions, the Company may redeem the Series A Preferred Stock at any time after June 29, 2003, for Series A Preferred Stock issued at the first closing and after September 27, 2003 for Series A Preferred Stock issued at the second closing. Due to the nature of the redemption features of the Series A Preferred Stock, such stock has been excluded from permanent equity in the Company’s financial statements.

The Company initially recorded the Series A Preferred Stock at its fair value on the date of issuance. In accordance with EITF Topic D-98: Classification and Measurement of Redeemable Securities (“EITF Topic D-98”), the Company has elected not to adjust the carrying value of the Series A Preferred Stock to the redemption value of such shares, since it is uncertain whether or when the redemption events described above will occur. Subsequent adjustments to increase the carrying value to the redemption value will be made when it becomes probable that such redemption will occur. As of December 31, 2003, the redemption value of the Series A Preferred Stock was $3.3 million.

In 2002, the Company issued and sold, in a private placement, an aggregate of 1,005 shares of Series B Preferred Stock and warrants to purchase an aggregate of 2.2 million shares of common stock, for an aggregate purchase price of $10.05 million. In connection with this financing, the Company also granted warrants to purchase an aggregate of 637,261 shares of common stock to holders of Series A Preferred Stock, as a payment in order to secure their consent and waiver concerning the financing and the resulting impact on the Series A Preferred Stock.

The Company recorded a deemed dividend of $2.9 million in the first quarter of 2002 relating to the beneficial conversion feature of the Series B Preferred Stock and the additional warrants issued to the holders of the Series A Preferred Stock in connection with the Series B Preferred Stock financing. The net proceeds of $2.6 million attributable to the fair value of warrants are included in additional paid-in capital.

In connection with the sale of Series C Preferred Stock, described below, on November 19, 2002, the Company repurchased all of the outstanding Series B Preferred Stock in exchange for Notes. The aggregate principal amount of the Notes was $12.05 million. In addition, the Notes bore an interest rate of 8%, had a maturity date of March 19, 2003 and were secured by substantially all of the Company’s assets. On February 4, 2003, the Company’s stockholders approved the conversion of the Notes into an aggregate of 1,204.6 shares of Series C Preferred Stock. In addition, the Company’s stockholders approved the issuance of warrants to purchase approximately 5.0 million shares of the Company’s common stock at an exercise price of $1.11 per share in exchange for warrants originally issued in connection with Series B Preferred Stock.

On November 14, 2002, the Company entered into a securities purchase agreement with several investors to issue and sell, in a private placement, an aggregate of 706 shares of Series C Preferred Stock and warrants to purchase an aggregate of 4.4 million shares of common stock, for an aggregate purchase price of $7.06 million. The transaction closed on November 19, 2002. On February 4, 2003, the Company issued an

aggregate of 1,204.6 additional shares of Series C Preferred Stock upon conversion of the Notes. The rights, preferences and privileges of the Series C Preferred Stock are set forth in the Certificate of Designations, Preferences and Rights of Series C Preferred Stock (“Certificate”), as amended on February 4, 2003 to (a) provide that any dividend payments due thereunder may be paid in either cash or shares of common stock at the option of the Company, and (b) include anti-dilution provisions substantially identical to those applicable with respect to Series A Preferred Stock. The Series C Preferred Stock bore an initial 8% annual dividend rate. The warrants are subject to the terms and conditions of the stock purchase warrants issued by the Company and evidencing the warrants. The warrants were exercisable beginning May 20, 2003 and expire November 19, 2007. The exercise price of the warrants is $1.11 per share. In December 2003 the Company elected to convert all 378 shares of the Series C Convertible Preferred Stock then outstanding into 3,123,967 shares of the Company’s common stock.

The holders of the Series A Preferred Stock are entitled to receive an amount equal to $10,000 per share of Series A Preferred Stock plus all accrued and unpaid premiums thereon. Any assets remaining for distribution following the payment of the preferences to the holders of the Series A Preferred Stock shall be distributed to the holders of the common stock. As of December 31, 2003, the liquidation preference of the Series A Preferred Stock was $2.8 million.

In 2001, ViroLogic sold 1,625 shares of Series A Preferred Stock, or 6.4 million shares of common stock as converted, for net proceeds of approximately $14.7 million. In accordance with Emerging Issues Task Force Consensus No. 98-5 and No. 00-27, ViroLogic determined that the issuance of the Series A Preferred Stock resulted in a beneficial conversion feature of approximately $2.3 million recorded in 2001.

In the first quarter of 2002, ViroLogic sold 1,005 shares of Series B Preferred Stock, or 4.4 million shares of common stock as converted, for an aggregate purchase price of $10.05 million. In connection with this financing, ViroLogic also granted warrants to purchase an aggregate of 637,261 shares of common stock to holders of Series A Preferred Stock as a payment in order to secure their consent and waiver concerning the financing and the resulting impact on the Series A Preferred Stock. In the fourth quarter of 2002, ViroLogic sold 706 shares of Series C Preferred Stock, or 5.8 million shares of common stock as converted, for an aggregate purchase price of $7.06 million. In accordance with Emerging Issues Task Force Consensus No. 98-5 and No. 00-27, ViroLogic determined that the issuance of the Series B and Series C Preferred Stock resulted in a beneficial conversion feature of approximately $2.9 million and $7.7 million, respectively, for a total of $10.6 million recorded in 2002.

On February 4, 2003, the Company’s stockholders approved the conversion of certain convertible secured promissory notes issued to prior Series B preferred stockholders into Series C Preferred Stock and the issuance of warrants to purchase shares of the Company’s common stock in exchange for warrants originally issued in connection with Series B Preferred Stock. The warrant exchange resulted in a beneficial conversion feature of $2.2 million that was recorded at the time of the exchange.

In connection with the loan agreement signed in January 1998, ViroLogic issued the lender a warrant to purchase an aggregate of 34,833 shares of common stock at a price of $8.00 per share. The warrant expires in January 2008. The value of the warrant was deemed to be insignificant and, therefore, no value was recorded.

In connection with the Series B Preferred Stock issuance in August 1998, ViroLogic issued to Series B investors warrants to purchase up to 15,890 shares of common stock at a price of $0.02 per share. The warrant term is 10 years and was valued at $85,000. There are 12,596 warrants outstanding as of December 31, 2003. ViroLogic issued warrants to purchase 365,000 shares of Series B Preferred Stock, or as converted, 227,232 shares of common stock, at a price of $3.68 per share, or $5.91 per converted common share. The warrant term is 10 years and was valued at $383,000. There are 225,256 warrants outstanding as of December 31, 2003. The fair values of these warrants were determined using the Black-Scholes option valuation model.

In connection with loan agreements signed in 2000, ViroLogic issued the lender warrants to purchase an aggregate of 26,792 shares of ViroLogic’s common stock for $4.24 per share. The warrant terms are 10 years and were valued at $318,000. The fair values of these warrants were determined using the Black-Scholes option valuation model. There are 26,792 warrants outstanding as of December 31, 2003.

In connection with the July 2001 sale of Series A Preferred Stock, ViroLogic issued warrants to purchase 11,800 and 1.3 million shares of common stock at a price of $2.66 and $2.805, respectively, per share. As a result of the sale of Series C Preferred Stock, the exercise price of the warrants with an exercise price of $2.805 is now $1.11, and such warrants are exercisable to purchase 3.3 million shares of our common stock. The warrant term is four years expiring July 2005 and was valued at $1.3 million using the Black-Scholes option valuation model. The fair value of the warrants is included in additional paid-in capital. There are approximately 2.0 million warrants outstanding as of December 31, 2003.

In connection with the September 2001 sale of Series A Preferred Stock, ViroLogic issued warrants to purchase 18,200 and 1.9 million shares of common stock at a price of $2.178 and $2.805, respectively, per share. As a result of the sale of Series C Preferred Stock, the exercise price of the warrants with an exercise price of $2.805 is now $1.11, and such warrants are exercisable to purchase 4.8 million shares of our common stock. The warrant term is four years expiring September 2005 and the warrants were valued at $1.5 million using the Black-Scholes option valuation model. The fair value of the warrants is included in additional paid-in capital. There are approximately 2.0 million warrants outstanding as of December 31, 2003.

In connection with the March 2002 sale of Series B Preferred Stock, ViroLogic issued warrants to purchase 0.7 million and 2.2 million shares of common stock at a price of $2.28 and $2.508, respectively, per share. The warrant term is 4.5 years expiring September 2006 and the warrants were valued at $2.6 million using the Black-Scholes option valuation model. The fair value of the warrants is included in additional paid-in capital. On February 4, 2003, ViroLogic stockholders approved the terms of the Company’s Series C Preferred Stock financing including the issuance of warrants to purchase 5.0 million shares of the Company’s common stock (at an exercise price of $1.11 per share) in exchange for the foregoing warrants to purchase 2.2 million shares of common stock. See “Series B Redeemable Convertible Preferred Stock” discussion above for further discussion. There are approximately 4.9 million warrants outstanding as of December 31, 2003.

In connection with a service agreement signed in 2002, ViroLogic issued warrants to purchase an aggregate of 100,000 shares of ViroLogic’s common stock for $2.03 per share. The warrant term is five years and was valued at $117,000. The fair values of these warrants were determined using the Black-Scholes option valuation model. There are 100,000 warrants outstanding as of December 31, 2003.

In connection with the November 2002 sale of Series C Preferred Stock, ViroLogic issued warrants to purchase 4.8 million shares of common stock at a price of $1.11 per share. The warrant term is five years expiring November 2007 and was valued at $2.5 million using the Black-Scholes option valuation model. The fair value of the warrants is included in additional paid-in capital. There are approximately 4.3 million warrants outstanding as of December 31, 2003.

In 1999, pursuant to an employment agreement, the Chief Executive Officer was granted incentive and non-statutory stock options to purchase 650,000 shares of common stock at an exercise price of $3.14 per share. Deferred compensation relating to these options of $4.7 million was recorded on the date of grant and amortized over the vesting period of the option using the graded vesting method. Compensation expense relating to these options was $0.1 million, $0.5 million and $1.1 million in 2003, 2002 and 2001, respectively.

In 1996, ViroLogic’s board of directors and stockholders adopted the 1996 Stock Plan, which was amended and renamed the 2000 Equity Incentive Plan in February 2000 (the “Plan”). The Plan provides for the granting of options to purchase common stock and other stock awards to employees, officers, directors and consultants of ViroLogic. ViroLogic generally grants shares of common stock for issuance under the Plan at no less than the fair value of the stock on the grant date; however, management is permitted to grant non-statutory stock options at a price not lower than 85% of the fair value of common stock on the date of grant. Options granted under the Plan generally vest over four years at a rate of 25% one year from the grant date and ratably monthly thereafter. The Plan was amended in May 2002 to increase the total authorized shares reserved for issuance to 6,200,000 shares.

In 2003, 2002 and 2001, all employee options were granted at fair value on the date of grant, therefore no deferred stock-based compensation was recorded. In connection with options granted in 2000, ViroLogic recorded deferred stock-based compensation of $1.6 million, representing the difference between the exercise price and the deemed fair value of the Company’s common stock at the date of grant. The amount was amortized over the vesting period using the graded vesting method for the individual options. Amortization of deferred stock-based compensation of $0.2 million, $0.7 million and $1.5 million was recognized during 2003, 2002 and 2001, respectively. In addition, ViroLogic recorded stock-based compensation for services rendered by non-employees of $0.3 million, $0.2 million and $0.2 million in 2003, 2002 and 2001, respectively.

The following table summarizes information about the stock options outstanding under the Plan at December 31, 2003:

In February 2000, the board of directors adopted the 2000 Employee Stock Purchase Plan (the “Stock Plan”). The Stock Plan permits eligible employees to acquire shares of ViroLogic’s common stock through payroll deductions of up to 15% of their eligible earnings. All full-time employees of ViroLogic, except 5% stockholders, are eligible to participate in the Stock Plan. The purchase price of the shares is the lesser of 85% of the fair value of the shares at the offering date or purchase date, as defined by the Stock Plan. In 2002, the Company’s shareholders ratified an additional 500,000 shares to be reserved for issuance under the Stock Plan. Of the 1,000,000 shares of common stock reserved for issuance under the Stock Plan, 791,620 shares were issued as of December 31, 2003.

ViroLogic’s 401(k) Plan covers substantially all employees. Employees may contribute up to 15% of their eligible compensation, subject to certain Internal Revenue Service restrictions. ViroLogic matches employee contributions in the form of ViroLogic common shares. In 2000, the 401(k) Plan was amended to increase the matching percentage to 25% of the employee contribution. The match is effective December 31 of each year and is fully vested when made. ViroLogic recorded 401(k) matching expense of $0.2 million in each of 2003, 2002 and 2001. As of December 31, 2003, ViroLogic had issued approximately 337,000 shares under the 401(k) Plan.

At December 31, 2003, ViroLogic had reserved shares of common stock for future issuance as follows:

The reserved shares shown above do not include additional indeterminate amounts reserved for issuance pursuant to penalty, anti-dilution, dividend payments and other provisions relating to the Company’s Series A Preferred Stock and the related warrants.

At December 31, 2003, ViroLogic had federal and state net operating loss carryforwards of approximately $96.9 million and $39.5 million, respectively. At December 31, 2003, ViroLogic also had federal and state research and development tax credits of approximately $1.1 million and $1.0 million, respectively. The federal net operating loss and credit carryforwards will expire at various dates between the years 2010 and 2023, if not utilized. The state of California net operating losses will expire at various dates between the years 2005 and 2014, if not utilized. The California research and development tax credits can be carried forward indefinitely.

Utilization of the federal and state net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net operating losses and credits before utilization.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets for financial reporting purposes and the amount used for income tax purposes. Significant components of ViroLogic’s deferred tax assets for federal and state income taxes are as follows:

Due to ViroLogic’s lack of earnings history, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance increased by $2.0 million, $8.1 million and $9.8 million in 2003, 2002 and 2001, respectively.

In November 2002, the Company implemented a business restructuring plan to reallocate certain personnel and resources to revenue maximizing activities and reduce cash consumption. The plan included a reduction in force of approximately 17% or 35 employees: 8 employees in laboratory operations; 6 employees in research and development; 8 employees in sales and marketing; and 13 employees in administration. In the fourth quarter of 2002, the Company recorded a charge for salaries, severance and other personnel related costs to the respective departments totaling $0.3 million. All amounts related to this restructuring were paid as of December 31, 2002.

On March 22, 2004, the Company entered into a lease termination agreement for its original laboratory and office space of approximately 25,000 square feet in South San Francisco, California. This lease was scheduled to expire in November 2004. The lease termination enabled the Company to decrease the present value of its remaining lease obligations for this facility by approximately 50%. Under the terms of this agreement, the Company will make cash payments to the lessor totaling $0.4 million as follows: $0.2 million in March 2004 and $0.2 million in April 2004. As a result, the Company will record a charge in the first quarter of 2004 of approximately $0.4 million primarily related to the termination payment and the write-off of the net carrying value of the related leasehold improvements.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Our Chief Executive Officer and Chief Financial Officer, with the assistance of other members of our management, have evaluated our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report, and have concluded based on that evaluation that those disclosure controls and procedures are effective. There has been no change in our internal control over financial reporting during the fiscal quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The information with respect to executive officers required by this item is set forth in Part I of this report.

We have adopted a Code of Business Conduct and Ethics Policy that applies to our directors and employees (including our principal executive officer, principal financial officer, principal accounting officer and controller), and have posted the text of the policy on our website (www.virologic.com) in connection with “Investor” materials. In addition, we intend to promptly disclose (i) the nature of any amendment to the policy that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and (ii) the nature of any waiver, including an implicit waiver, from a provision of the policy that is granted to one of these specified individuals, the name of such person who is granted the waiver and the date of the waiver on our website in the future.

The other information required by this item is incorporated by reference to the proxy statement to be filed with the SEC pursuant to Regulation 14A in connection with ViroLogic Inc.’s 2004 annual meeting.

The information required by this item is incorporated by reference to the information under the caption “Executive Compensation” contained in the proxy statement.

The information required by this item is incorporated by reference to the information under the caption “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” contained in the proxy statement.

The information required by this item is incorporated by reference to the information under the caption “Certain Transactions” contained in the proxy statement.

The information required by this item is incorporated by reference to the information under the captions “Independent Auditors’ Fees” and “Pre-Approval Policies and Procedures” contained in the proxy statement.

Reference is made to the Index to Financial Statements under Item 8 in Part II hereof, where these documents are listed.

(a)(2) Financial Statement Schedules — The following schedule is filed as part of this Form 10-K:


	Schedule II — Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2003, 2002 and 2001.

All other schedules have been omitted because they are not applicable or required, or the information required to be set forth therein is included in the Financial Statements or notes thereto included in Item 8 (“Financial Statements and Supplementary Data”).

On November 4, 2003, we filed a report on Form 8-K to furnish our earnings release for the quarter ended September 30, 2003.


(*)	Certain confidential portions deleted pursuant to Order Granting Application Under the Securities Act of 1933 and Rule 406 Thereunder Respecting Confidential Treatment dated May 1, 2000.

(1)	Filed as an exhibit to our Registration Statement on Form S-1 (No. 333-30896) or amendments thereto and incorporated herein by reference.

(2)	Filed as an exhibit to our Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and incorporated herein by reference.

(3)	Filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2000 filed with the Commission and incorporated herein by reference.

(4)	Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 and incorporated herein by reference.

(5)	Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference.

(6)	Filed as an exhibit to our Current Report on Form 8-K filed on July 6, 2001 and incorporated herein by reference.

(7)	Filed as an exhibit to our Current Report on Form 8-K filed on March 26, 2002 and incorporated herein by reference.

(8)	Filed as an exhibit to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference.

(9)	Filed as an exhibit to our Current Report on Form 8-K filed on November 25, 2002 and incorporated herein by reference.


(10)	Filed as an exhibit to our Registration Statement on Form S-3 (No. 333-102995) and incorporated herein by reference.

(11)	Filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2001 filed with the Commission and incorporated herein by reference.

(12)	Filed as an exhibit to our Quarterly Report on Form 10-Q for the Quarter ended September 30, 2003 and incorporated herein by reference.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints William D. Young, Kathy L. Hibbs and Karen J. Wilson, and each of them, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place, and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or his substitute or substituted, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.


	*	Certain confidential portions deleted pursuant to Order Granting Application Under the Securities Act of 1933 and Rule 406 Thereunder Respecting Confidential Treatment dated May 1, 2000.


	(1)	Filed as an exhibit to the Registrant’s Registration Statement on Form S-1 (No. 333-30896) or amendments thereto and incorporated herein by reference.

	(2)	Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 and incorporated herein by reference.

	(3)	Filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2000 filed with the Commission and incorporated herein by reference.

	(4)	Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 and incorporated herein by reference.


	(5)	Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 and incorporated herein by reference.

	(6)	Filed as an exhibit to our Current Report on Form 8-K filed on July 6, 2001 and incorporated herein by reference.

	(7)	Filed as an exhibit to our Current Report on Form 8-K filed on March 26, 2002 and incorporated herein by reference.

	(8)	Filed as an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 and incorporated herein by reference.

	(9)	Filed as an exhibit to our Current Report on Form 8-K filed on November 25, 2002 and incorporated herein by reference.


(10)	Filed as an exhibit to our Registration Statement on Form S-3 (No. 333-102995) and incorporated herein by reference.

(11)	Filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2001 filed with the Commission and incorporated herein by reference.

(12)	Filed as an exhibit to our Quarterly Report on Form 10-Q for the Quarter ended September 30, 2003 and incorporated herein by reference.


DELAWARE		94-3234479
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer identification no.)

345 Oyster Point Blvd South San Francisco, California		94080
(Address of principal executive offices)		(Zip code)


PART I
Item 1.	Business	3
Item 2.	Properties	32
Item 3.	Legal Proceedings	32
Item 4.	Submission of Matters to a Vote of Security Holders	32
PART II
Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters	33
Item 6.	Selected Financial Data	35
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	44
Item 8.	Financial Statements and Supplementary Data	F-1
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	46
Item 9A.	Controls and Procedures	46
PART III
Item 10.	Directors and Executive Officers of the Registrant	46
Item 11.	Executive Compensation	46
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	46
Item 13.	Certain Relationships and Related Transactions	46
Item 14.	Principal Accountant Fees and Services	46
PART IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	47
Signatures		50
EXHIBIT 23.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1


	High		Low

2003
Fourth Quarter	$	3.87	$	1.34
Third Quarter	$	1.74	$	1.05
Second Quarter	$	2.25	$	0.86
First Quarter	$	1.30	$	0.85
2002
Fourth Quarter	$	1.70	$	0.75
Third Quarter	$	2.90	$	0.72
Second Quarter	$	3.40	$	1.95
First Quarter	$	2.96	$	1.78



			Year Ended December 31,

			2003			2002			2001			2000			1999


			(In thousands, except per share amounts)
Statement of Operations Data:
Revenue:
	Product revenue		$	31,911		$	24,530		$	17,815		$	7,466		$	1,069
	Contract revenue			1,468			731			458			—			—

		Total revenue		33,379			25,261			18,273			7,466			1,069
Operating costs and expenses:
	Cost of product revenue			16,713			14,589			11,845			5,457			627
	Research and development			4,733			10,406			11,693			10,080			9,588
	General and administrative			9,256			10,550			11,376			10,841			6,804
	Sales and marketing			8,306			11,716			10,336			5,890			1,196

		Total operating costs and expenses		39,008			47,261			45,250			32,268			18,215

Operating loss				(5,629	)		(22,000	)		(26,977	)		(24,802	)		(17,146	)
Interest income				106			307			1,143			1,868			249
Interest expense				(141	)		(423	)		(466	)		(262	)		(243	)
Other income				156			347			106			—			—

Net loss				(5,508	)		(21,769	)		(26,194	)		(23,196	)		(17,140	)
Deemed dividend to preferred stockholders				(2,155	)		(10,551	)		(2,269	)		(15,700	)		(3,100	)
Preferred stock dividend				(1,610	)		(977	)		(334	)		—			—

Loss applicable to common stockholders			$	(9,273	)	$	(33,297	)	$	(28,797	)	$	(38,896	)	$	(20,240	)

Basic and diluted loss per common share			$	(0.27	)	$	(1.38	)	$	(1.43	)	$	(2.62	)	$	(4.24	)

Shares used in computing basic and diluted loss per common share				34,445			24,157			20,072			14,852			4,772



	December 31,

	2003			2002			2001			2000			1999


	(In thousands)
Balance Sheet Data:
Cash, cash equivalents, and short-term investments	$	9,430		$	11,145		$	8,962		$	23,794		$	2,208
Accounts receivable, net		6,165			4,924			4,562			2,404			550
Working capital(a)		13,038			(239	)		7,508			21,097			522
Restricted cash		776			707			1,000			2,029			950
Total assets		28,378			30,486			37,851			43,647			9,777
Long-term portion of capital lease obligations		87			419			1,341			945			—
Long-term portion of loans payable		—			—			174			1,019			1,051
Long-term advance from subtenant		—			—			975			—			—
Redeemable convertible preferred stock		1,994			4,249			11,228			—			—
Accumulated deficit		(106,272	)		(100,764	)		(78,995	)		(52,801	)		(29,605	)
Total stockholders’ equity(a)		20,587			7,014			13,471			33,643			4,698


Name	Age		Position

William D. Young		59	Chairman, Chief Executive Officer and Director
Karen J. Wilson		40	Vice President, Chief Financial Officer
Tien T. Bui		39	Vice President, Sales and Marketing
Kathy L. Hibbs		40	Vice President, General Counsel
Kenneth N. Hitchner		49	Vice President, Pharmaceutical Collaborations
Christos J. Petropoulos, PhD		50	Vice President, Research and Development
Jeannette M. Whitcomb, PhD		43	Vice President, Operations


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


Item 5.	*Market for Registrant’s Common Equity and Related Stockholder Matters*


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*



		Year Ended
		December 31,

		2003		2002


		(In thousands)
NIH Grants:
	HIV assays	$	509	$	731
	HIV Database		102		—
	HCV assay		107		—
Commercial assay development and other projects			442		—

Total		$	1,160	$	731


		Estimated
		Completion

PhenoSense HIV, a phenotypic HIV test
	Pharmaceutical and patient testing		Completed
GeneSeq HIV, a genotypic HIV test
	Pharmaceutical and patient testing		Completed
PhenoSense GT, a combination phenotype/genotype HIV test
	Pharmaceutical and patient testing		Completed
Replication Capacity HIV, a measurement of fitness(1)
	Pharmaceutical and patient testing		Completed
PhenoScreen, a high-throughput screening assay
	Pharmaceutical testing		Completed
PhenoSense HIV Antibody Neutralization for Vaccine Development
	Pharmaceutical testing		Completed
PhenoSense HIV Entry and GeneSeq HIV Entry, entry inhibitor assays(2)
	Pharmaceutical testing		Completed
	Patient testing(6)		2004


		Estimated
		Completion

PhenoSense HIV Co-Receptor Tropism, an entry assay
	Pharmaceutical testing		Completed
	Patient testing(4)		2004
PhenoSense and GeneSeq HIV Integrase assays
	Pharmaceutical testing		2004
	Patient testing(3)		2006
GeneSeq HCV, a genotypic hepatitis C test
	Pharmaceutical testing		Completed
	Patient testing(3)		2005
PhenoSense HCV, a phenotypic hepatitis C test
	Pharmaceutical testing		2005
	Patient testing(3)		2006
GeneSeq HBV, a genotypic hepatitis B test
	Pharmaceutical testing		Completed
	Patient testing		(5)
PhenoSense HBV, a phenotypic hepatitis B test
	Pharmaceutical testing		(5)
	Patient testing		(5)


(1)	Currently offered free of charge on phenotypic reports, in the future may be offered as a stand-alone product.

(2)	This test may be incorporated into one of our existing products or possibly offered as a stand-alone product.

(3)	This test is expected to be offered after more pharmaceutical drugs are available for patient use and based on demand for the product.

(4)	This test is expected to be validated in 2004 for use in clinical trials, and subsequently offered to patients based on demand for the product.

(5)	The timing of estimated completion is under evaluation and is dependant on securing NIH grants and/or other research and development funding as well as demand for the product.

(6)	The phenotypic test for the FDA approved fusion inhibitor drug, Fuzeon, is expected to be validated in 2004 and available for patient use dependent on demand for the product.



		Payments Due By Period

		Less Than
		1 Year		2-3 Years		4-5 Years		Thereafter		Total


		(In thousands)
Operating leases		$	1,860	$	1,936	$	2,051		1,419	$	7,266
Capital leases			427		71		24		—		522
Equipment loans			135		—		—		—		135
Materials and service contracts			257		—		—		—		257

	Total	$	2,679	$	2,007	$	2,075	$	1,419	$	8,180


Item 7A.	*Quantitative and Qualitative Disclosures about Market Risk*


Item 1.	*Business*


Item 2.	*Properties*


Item 3.	*Legal Proceedings*


Item 6.	*Selected Financial Data*


Item 8.	*Financial Statements and Supplementary Data*


	Page

Report of Ernst & Young LLP, Independent Auditors		F-2
Balance Sheets as of December 31, 2003 and 2002		F-3
Statements of Operations for the years ended December 31, 2003, 2002 and 2001		F-4
Statements of Stockholders’ Equity for the years ended December 31, 2003, 2002 and 2001		F-5
Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001		F-6
Notes to Financial Statements		F-7



							Common							Notes			Accumulated
		Preferred Stock					Stock				Additional			Receivable			Other									Total
											Paid-in			from Officers			Comprehensive			Deferred			Accumulated			Stockholders’
		Shares			Amount		Shares		Amount		Capital			& Employees			Income			Compensation			Deficit			Equity

Balance as of December 31, 2000			—		$	—		19,870	$	20	$	88,772		$	(31	)	$	178		$	(2,495	)	$	(52,801	)	$	33,643
Comprehensive loss:
	Net loss		—			—		—		—		—			—			—			—			(26,194	)		(26,194	)
	Net unrealized loss on securities available-for-sale		—			—		—		—		—			—			(84	)		—			—			(84	)

	Comprehensive loss																										(26,278	)
Issuance of warrants under Series A Preferred Stock, net of issuance costs			—			—		—		—		2,775			—			—			—			—			2,775
Conversion of Series A Preferred Stock to common stock			—			—		402		1		744			—			—			—			—			745
Exercise of warrants			—			—		10		—		—			—			—			—			—			—
Forgiveness of note receivable			—			—		—		—		—			31			—			—			—			31
Reversal of deferred compensation for terminated employees			—			—		—		—		(121	)		—			—			121			—			—
Amortization of deferred compensation			—			—		—		—		—			—			—			1,499			—			1,499
Issuance of common stock under 401K plan			—			—		79		—		228			—			—			—			—			228
Exercise of employee and nonemployee stock options			—			—		33		—		78			—			—			—			—			78
Stock-based compensation related to consultant options			—			—		—		—		384			—			—			—			—			384
Issuance of common stock under employee stock purchase plan			—			—		256		—		700			—			—			—			—			700
Preferred stock dividends			—			—		—		—		(334	)		—			—			—			—			(334	)
Deemed dividend to preferred stockholders			—			—		—		—		2,269			—			—			—			—			2,269
			—			—		—		—		(2,269	)		—			—			—			—			(2,269	)

Balance as of December 31, 2001			—			—		20,650		21		93,226			—			94			(875	)		(78,995	)		13,471
Comprehensive loss:
	Net loss		—			—		—		—		—			—			—			—			(21,769	)		(21,769	)
	Net unrealized loss on securities available-for-sale		—			—		—		—		—			—			(87	)		—			—			(87	)

	Comprehensive loss																										(21,856	)
Issuance of Series C Preferred Stock, net of issuance costs			1			—		—		—		6,224			—			—			—			—			6,224
Issuance of warrants in connection with Series B Preferred Stock, net of issuance costs			—			—		—		—		2,596			—			—			—			—			2,596
Conversion of Series A and B Preferred Stock to common stock			—			—		4,289		4		6,817			—			—			—			—			6,821
Exchange of Series B Preferred Stock for convertible promissory notes			—			—		—		—		(4,556	)		—			—			—			—			(4,556	)
Reversal of deferred compensation for terminated employees			—			—		—		—		(31	)		—			—			31			—			—
Amortization of deferred compensation			—			—		—		—		—			—			—			662			—			662
Issuance of common stock to Pfizer Inc, net of issuance costs			—			—		2,609		3		2,924			—			—			—			—			2,927
Issuance of common stock under 401K plan			—			—		179		—		239			—			—			—			—			239
Exercise of employee and nonemployee stock options			—			—		7		—		5			—			—			—			—			5
Stock-based compensation related to consultant options			—			—		—		—		292			—			—			—			—			292
Issuance of common stock under employee stock purchase plan			—			—		220		—		433			—			—			—			—			433
Preferred stock dividends			—			—		309		—		(244	)		—			—			—			—			(244	)
Deemed dividend to preferred stockholders			—			—		—		—		10,551			—			—			—			—			10,551
			—			—		—		—		(10,551	)		—			—			—			—			(10,551	)

Balance as of December 31, 2002			1			—		28,263		28		107,925			—			7			(182	)		(100,764	)		7,014
Comprehensive loss:
	Net loss		—			—		—		—		—			—			—			—			(5,508	)		(5,508	)
	Net unrealized loss on securities available-for-sale		—			—		—		—		—			—			(6	)		—			—			(6	)

	Comprehensive loss																										(5,514	)
Exercise of warrants			—			—		4,188		5		4,344			—			—			—			—			4,349
Exchange of Series C convertible promissory notes for Series C Preferred Stock			1			—		—		—		12,046			—			—			—			—			12,046
Costs relating to issuance of Series C Preferred Stock			—			—		—		—		(423	)		—			—			—			—			(423	)
Conversion of Series A and C Preferred Stock to common stock			(2	)		—		18,793		19		2,236			—			—			—			—			2,255
Reversal of deferred compensation for terminated employees			—			—		—		—		(10	)		—			—			10			—			—
Amortization of deferred compensation			—			—		—		—		—			—			—			172			—			172
Issuance of common stock under 401K plan			—			—		54		—		202			—			—			—			—			202
Issuance of common stock under employee stock purchase plan			—			—		247		—		252			—			—			—			—			252
Exercise of employee and nonemployee stock options			—			—		40		—		7			—			—			—			—			7
Stock-based compensation related to consultant options			—			—		—		—		205			—			—			—			—			205
Preferred stock dividends			—			—		1,023		1		21			—			—			—			—			22
Deemed dividend to preferred stockholders			—			—		—		—		2,155			—			—			—			—			2,155
			—			—		—		—		(2,155	)		—			—			—			—			(2,155	)

Balance as of December 31, 2003			—		$	—		52,608	$	53	$	126,805		$	—		$	1		$	—		$	(106,272	)	$	20,587


			Operating		Loans			Capital
			Leases		Payable			Leases


			(In thousands)
Year ending December 31:
	2004		$	1,860	$	135		$	427
	2005			949		—			55
	2006			987		—			16
	2007			1,006		—			16
	2008			1,045		—			8
	Thereafter			1,419		—			—

		Total minimum lease and principal payments	$	7,266		135			522

Amount representing interest						(2	)		(34	)

Present value of future payments						133			488
Current portion of loans and leases						(133	)		(401	)

Noncurrent portion					$	—		$	87



		Outstanding Stock Options/Stock Rights

		Shares			Number of			Weighted Average
		Available			Shares			Price Per Share

Balances at December 31, 2000			2,599,923			1,164,639			5.85
	Options/rights granted		(1,707,644	)		1,707,644			4.44
	Options/rights exercised		—			(33,005	)		2.38
	Options/rights forfeited		260,497			(260,497	)		5.50

Balances at December 31, 2001			1,152,776			2,578,781			5.00
	Additional shares authorized		2,000,000			—			—
	Options/rights granted		(1,288,924	)		1,288,924			2.32
	Options/rights exercised		—			(2,865	)		1.66
	Options/rights forfeited		399,872			(399,872	)		4.10

Balances at December 31, 2002			2,263,724			3,464,968			4.11
	Options/rights granted		(1,408,382	)		1,408,382			1.39
	Options/rights exercised		—			(39,999	)		0.98
	Options/rights forfeited		668,962			(668,962	)		3.68

Balances at December 31, 2003			1,524,304			4,164,389			3.29



	Options Outstanding						Options Exercisable

			Weighted Average
Range of	Number		Remaining		Weighted Average		Number		Weighted Average
Exercise Price	Outstanding		Contractual Life		Exercise Price		Exercisable		Exercise Price

$0.64 – 1.05		145,000		8.18	$	1.00		52,000	$	0.91
1.06 – 1.27		683,382		9.16		1.26		61,227		1.24
1.29 – 1.51		659,101		9.46		1.50		4,834		1.49
1.58 – 2.40		336,366		7.68		2.13		234,914		2.19
2.47 – 2.57		723,240		8.16		2.57		434,106		2.56
2.59 – 3.10		87,850		8.20		2.77		47,052		2.75
3.14		240,150		5.86		3.14		240,077		3.14
3.15 – 5.40		533,110		6.62		3.72		428,461		3.83
5.75 – 8.00		524,740		7.01		6.55		408,404		6.58
8.56 – 22.13		231,450		6.73		11.69		208,989		11.69

		4,164,389						2,120,064


	Shares
	Reserved

	(In thousands)
Series A Preferred Stock (as if converted basis)		3,703
Stock options		4,664
Warrants		13,572
Employee Stock Purchase Plan		208

		22,147



			Quarter Ended

			March 31,			June 30,			September 30,			December 31,


			(In thousands, except per share amounts)
2003
	Patient testing		$	5,294		$	6,101		$	6,179		$	5,260
	Pharmaceutical company testing			1,257			1,685			2,580			3,555

		Product revenue		6,551			7,786			8,759			8,815
	Contract revenue			417			167			366			518

	Total revenue			6,968			7,953			9,125			9,333
	Cost of product revenue			3,819			4,268			4,403			4,223
	Net loss			(2,468	)		(2,206	)		(429	)		(405	)
	Loss applicable to common stockholders			(5,090	)		(2,712	)		(842	)		(629	)
	Basic and diluted loss per common share		$	(0.18	)	$	(0.09	)	$	(0.02	)	$	(0.01	)
2002
	Patient testing		$	3,640		$	4,666		$	4,577		$	4,962
	Pharmaceutical company testing			1,853			1,764			1,095			1,973

		Product revenue		5,493			6,430			5,672			6,935
	Contract revenue			215			227			255			34

	Total revenue			5,708			6,657			5,927			6,969
	Cost of product revenue			3,425			3,761			3,463			3,940
	Net loss			(6,138	)		(5,460	)		(5,586	)		(4,585	)
	Loss applicable to common stockholders			(9,206	)		(5,718	)		(5,835	)		(12,538	)
	Basic and diluted loss per common share		$	(0.43	)	$	(0.24	)	$	(0.24	)	$	(0.48	)


Item 9.	*Changes in and Disagreements with Accountants on Accounting and Financial Disclosure*


Item 10.	*Directors and Executive Officers of the Registrant*


Item 12.	*Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters*


Item 13.	*Certain Relationships and Related Transactions*


Item 15.	*Exhibits, Financial Statement Schedules and Reports on Form 8-K*


Exhibit			Exhibit
Footnote			Number

	(10)			3	.1	Amended and Restated Certificate of Incorporation, as currently in effect.
	(4)			3	.2	Bylaws, as currently in effect.
	(3)			4	.1	Reference is made to Exhibits 3.1 and 3.2
	(1)			4	.2	Specimen Stock Certificate.
	(1)			4	.3	Amended and Restated Investors Rights Agreement by and among the Company and certain stockholders of the Company dated August 23, 1999.
	(1)			4	.4	Form of Indemnity Agreement between the Company and its directors and officers.
	(1)			4	.5	Warrant Agreement by and between ViroLogic and Lease Management Services, Inc. dated as of October 16, 1996.
	(1)			4	.6	Warrant Agreement by and between ViroLogic and MMC/ GATX Partnership No. 1 dated as of January 30, 1998.
	(1)			4	.7	Form of Warrant to purchase Common Stock.
	(1)			4	.8	Form of Warrant to purchase Common Stock.
	(1)			4	.9	Form of Warrant to purchase Series A Preferred Stock (automatically converted to warrants to purchase Common Stock in May 2000).
	(1)			4	.10	Form of Warrant to purchase Series A Preferred Stock (automatically converted to warrants to purchase Common Stock in May 2000).
	(1)			4	.11	Form of Warrant to purchase Series B Preferred Stock (automatically converted to warrants to purchase Common Stock in May 2000).
	(1)	†		4	.13	Form of Stock Option Agreement under the 2000 Equity Incentive Plan for options granted prior to May 1, 2000.
	(1)	†		4	.14	Form of Stock Option Agreement Pursuant to the 2000 Equity Incentive Plan for options granted after May 1, 2000.


†	Indicates management or compensatory plan or arrangement required to be identified pursuant to Item 14(c).


Signatures	Title	Date

/s/ WILLIAM D. YOUNG William D. Young	Chairman, Chief Executive Officer and Director (Principal Executive Officer)	March 26, 2004
/s/ KAREN J. WILSON Karen J. Wilson	Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)	March 26, 2004
/s/ EDMON JENNINGS Edmon Jennings	Director	March 26, 2004
/s/ WILLIAM JENKINS, M.D. William Jenkins, M.D.	Director	March 26, 2004
/s/ CRISTINA H. KEPNER Cristina H. Kepner	Director	March 26, 2004
/s/ DAVID H. PERSING, M.D., PH.D. David H. Persing, M.D., Ph.D.	Director	March 26, 2004


		Balance at		Additions Charged					Balance at
		Beginning of		to Operating Costs					End of
Classification		Period		and Expenses		Deductions			Period

Allowance for doubtful accounts:
	Year ended December 31, 2003	$	989	$	101	$	(447	)	$	643
	Year ended December 31, 2002	$	588	$	593	$	(192	)	$	989
	Year ended December 31, 2001	$	175	$	606	$	(193	)	$	588