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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2003

or

For the transition period from                      to                     

Commission file number 000-33139

THERASENSE, INC.

(Exact name of registrant as specified in its charter)

1360 South Loop Road, Alameda, CA 94502

(Address of principal executive offices)

Registrant’s telephone number, including area code: (510) 749-5400

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common stock, $0.001 par value

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

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934): Yes x No ¨.

The aggregate market value of the 36,292,629 shares of voting stock held by non-affiliates of the registrant, computed by reference to the closing price, as reported on the Nasdaq National Market, as of the last business day of registrant’s most recently completed second fiscal quarter (June 30, 2003), was approximately $362,926,290. Registrant has no non-voting common equity.

There were 42,566,797 shares of the registrant’s Common Stock $0.001 par value, issued and outstanding as of March 1, 2004.

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THERASENSE, INC.

2003 ANNUAL REPORT ON FORM 10-K

INDEX

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PART I

Overview

We develop, manufacture and sell easy to use glucose self-monitoring systems that dramatically reduce the pain of testing for people with diabetes. Our first product, the Freestyle® blood glucose monitoring system, received FDA clearance in January 2000, and we began selling FreeStyle in the United States in June 2000. We began selling the FreeStyle Flash^™ blood glucose monitoring system in October 2003. The FreeStyle systems utilize patented technologies that can accurately measure glucose concentrations from a tiny 0.3 microliter sample of blood. Most of the competitive products require blood samples from 1.0 to 10.0 microliters. Our tiny sample size is easily obtained by lancing the forearm, thigh, calf, upper arm or hand and therefore avoids the pain associated with drawing a larger blood sample from the fingertip. These alternate sites are significantly less painful to lance than the traditional fingertip test site, which is more densely populated with highly sensitive nerve endings but yields the larger blood volumes required by most competitive products. Nine out of ten people in our clinical studies found using FreeStyle systems on their forearm less painful than their current finger-stick-based system.

We are developing FreeStyle Navigator^™ which is designed to permit users to accurately and discreetly monitor their glucose levels in real time for up to three days. We submitted our premarket approval application for FreeStyle Navigator in November 2003. We are also developing the CozMore^™ insulin technology system with Deltec, Inc. The CozMore system combines Deltec’s insulin pump and our FreeStyle blood glucose monitoring technology to allow users to test their glucose levels and administer insulin with one device. Our partner Deltec submitted the 510(k) clearance application in June 2003.

We believe that FreeStyle products are well positioned to capture a meaningful share of the blood glucose self-monitoring market. The blood glucose self-monitoring market is the largest self-test market for medical diagnostic products in the world, with a size of approximately $2.0 billion in the United States and $4.0 billion worldwide. It is estimated that the worldwide blood glucose self-monitoring market will amount to $9.0 billion by 2005. We believe that the FreeStyle products could potentially expand this market by substantially reducing the pain and inconvenience associated with testing glucose levels and managing diabetes. This could bring non-testers into the market and encourage under-testers to test more regularly.

Our direct sales force promotes FreeStyle in the United States to health care professionals who advise patients on the monitoring and management of their diabetes. We distribute and sell FreeStyle in the United States to the ten largest national retailers, including Walgreens, Wal-Mart and Rite Aid, through wholesalers, including Cardinal Health, McKesson, and AmeriSourceBergen, and directly to end users over the telephone and through our website.

FreeStyle products are distributed in various European countries through Ypsomed, formerly Disetronic Injection Systems. In Japan FreeStyle products are distributed by Nipro Corporation. The TheraSense headquarters and test strip manufacturing facility are located in Alameda, California.

On January 12, 2004, we entered into an Agreement and Plan of Merger with Abbott Laboratories and Corvette Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of Abbott, providing for the merger of Corvette Acquisition Corp., with and into TheraSense, with TheraSense continuing as the surviving corporation. Our Board of Directors has unanimously approved the merger and the merger agreement. We have filed a notice of special meeting of stockholders and definitive proxy statement for the special meeting of stockholders to be held on April 5, 2004 pursuant to which we will ask our stockholders to adopt and approve the merger agreement and the merger contemplated thereby. For more information about the merger agreement and the merger, please see a copy of the definitive proxy statement filed with the SEC on March 1, 2004 that is available free of charge on our website at www.therasense.com.

Market Opportunity

Diabetes

Diabetes is a chronic, life-threatening disease for which there is no known cure. Diabetes occurs when the body does not produce sufficient levels of, or fails to effectively utilize, insulin. Insulin is a hormone that regulates the storage and metabolism of glucose. Glucose levels in the blood must be maintained within a specific concentration range to ensure optimal cellular function and health. Under normal conditions, the body maintains proper blood glucose levels by releasing insulin in response to increases in blood sugar.

Diabetes is typically classified as Type 1 or Type 2. Type 1 diabetes is the most serious form of the disease and is characterized by a severe lack of insulin secretion by the body. Type 1 diabetes usually occurs during childhood or adolescence, but it can occur at any age. Individuals with Type 1 diabetes require daily insulin injections to survive. Type 2 diabetes is the most common form of the disease and is characterized by the body’s inability to produce enough insulin or to properly utilize insulin. Type 2 diabetes typically occurs in adulthood. However, because of sedentary lifestyles and inappropriate diet, Type 2 diabetes is increasing in incidence among the younger population. Type 2 diabetes is initially managed with diet, exercise and oral medication. However, many people with Type 2 diabetes will eventually require daily insulin injections.

In the United States, approximately 17 million people, about 6% of the population, have diabetes, although only approximately 11 million of these people have been diagnosed with the disease. The share of the United States population diagnosed with diabetes increased 33% between 1990 and 1998, primarily due to the aging of the population, inappropriate

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diets and increasingly sedentary lifestyles. The most rapid onset was in adults ages 30 through 39. It is also on the rise among a younger population base, including children and teenagers. Worldwide, approximately 175 million people, about 3% of the population, have diabetes. The worldwide prevalence of diabetes is expected to increase to approximately 370 million by 2030.

Importance of Glucose Monitoring

Diabetes is the sixth leading cause of death by disease in the United States, with one death due to diabetic complications occurring every three minutes. The failure to frequently monitor and control blood glucose levels leads to severe medical complications over time, including blindness, loss of kidney function, nerve degeneration and cardiovascular disease. Diabetes is estimated to cost the United States economy over $132 billion annually, including indirect costs such as lost productivity.

The goal of glucose monitoring is to avoid the complications of diabetes by allowing patients and their health care providers to determine a treatment regimen, to monitor the effectiveness of the regimen, and to alter it as needed for better overall control of blood glucose levels. Every person’s blood glucose level varies during the course of the day, depending upon factors such as diet, insulin availability, exercise, illness and stress. To successfully maintain blood glucose levels within the proper range, a person with diabetes must first measure his or her glucose level and then manage this level by adjusting insulin intake, oral medication, diet and exercise. Then the person must take additional blood glucose measurements to gauge his or her individual response to the adjustments. The more frequently people with diabetes test their blood glucose levels and track their activities and food intake, the better they will be able to understand and manage their diabetes.

Studies show that active monitoring and management of diabetes reduces the risk of associated diabetes complications. The landmark Diabetes Control and Complications Trial, or DCCT, showed that the onset and progression of eye, kidney and nerve disease in people with Type 1 diabetes can be slowed by intensive therapy to maintain blood glucose levels as close to normal as possible. The DCCT demonstrated that the risk of complications could be reduced by 76% for eye disease, 50% for kidney disease and 60% for nerve disease. Similar studies in the United Kingdom and Japan involving people with Type 2 diabetes support the conclusion of the DCCT study that actively managing blood glucose levels reduces the risk of complications associated with diabetes. People with Type 1 diabetes are encouraged to test four or more times per day, and those with Type 2 diabetes are typically expected to test two or more times per day.

Limitations of Existing Glucose Monitoring Products

Despite the proven benefits of frequent monitoring and intensive management of blood glucose levels, a significant number of people fail to test at their recommended frequency, or at all. The American Diabetes Association estimates that people with diabetes test, on average, slightly more than once per day. To obtain a sample with current glucose monitoring systems, users generally are required to prick one of their fingertips with a lancing device, which typically consists of a spring-loaded needle that penetrates a measured distance into the finger. Users must then draw a sample of blood from the finger, which may require squeezing of the fingertips. After drawing a blood sample, users generally are required to drop the blood sample on a disposable test strip or place the test strip on the blood sample. We believe that under-testing is due to the limitations of existing products including:

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As a result, we believe a significant market opportunity exists for a glucose self-monitoring systems that combine a very small sample size requirement with the ability to test on the fingertip and other body sites. The ability to test on other body sites spares the user the pain associated with testing on the fingertip. The small sample size means the sample can be reliably obtained from other body sites and spares the user the inconvenience and social embarrassment of drawing large blood samples.

The TheraSense Solution

FreeStyle blood glucose monitoring products are easy to use, accurate and competitively priced. They are the only blood glucose monitoring systems that combine a 0.3 microliter sample size requirement with the ability to test on other body sites and the fingertip. We believe FreeStyle blood glucose monitoring products also offer the following significant advantages over existing systems:

Our Strategy

Our objective is to be a leading provider of innovative glucose self-monitoring products that reduce the pain of testing, are easy to use, accurate, cost effective and improve the lives of people with diabetes. To achieve this objective, we are pursuing the following business strategies:

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Our Products

FreeStyle Blood Glucose Monitoring Systems. We began selling our initial product, the FreeStyle blood glucose monitoring system, in the United States in June 2000. In October 2003 we began selling our FreeStyle Flash blood glucose monitoring system in the United States. These FreeStyle systems can be used on the thigh, calf, upper arm and hand. This represents the broadest array of off-finger testing sites cleared by the FDA. The system kit for each of these FreeStyle products includes a meter, an initial supply of 10 proprietary disposable FreeStyle test strips, a lancing device, an initial supply of 10 disposable FreeStyle lancets, FreeStyle control solution and instructional materials. We also sell additional supplies of disposable FreeStyle test strips in quantities of 25, 50 and 100 and additional supplies of disposable FreeStyle lancets in quantities of 100.

FreeStyle Tracker Diabetes Management System. We received FDA clearance for the FreeStyle Tracker System and commenced sales in June 2002. The FreeStyle Tracker System is a diabetes management system that combines the blood

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glucose monitoring technology of our FreeStyle systems with the computing power of the HandSpring^™ Visor^™ personal digital assistant, or PDA. The FreeStyle Tracker System enables patients to test for glucose levels and get a read-out on the PDA screen, graph and chart the results over time, review food lists to track their carbohydrate intake and create reminders about testing or dietary choices. For doctors, the FreeStyle Tracker System provides a time-stamped progression of the patient’s glucose levels as well as patient-entered events and data that affect their diabetic health to make better diagnoses and recommendations for the patient’s diabetes care. Patients can use the Hotsync® synchronization function of the PDA to download information from the FreeStyle Tracker System to our FreeStyle CoPilot System and FreeStyle Connect Software.

FreeStyle CoPilot Web-Based Data Management System. We launched the FreeStyle CoPilot System in July 2002. The FreeStyle CoPilot System is a free web-based service that we offer to users of blood glucose monitoring products and their permitted health care providers. Users can upload their blood glucose test results and other health-related information from their FreeStyle meter, FreeStyle Flash meter or FreeStyle Tracker System to the FreeStyle CoPilot or users can manually enter this information into the FreeStyle CoPilot System. The information can then be transferred into personalized reports focusing on integrated issues of diabetes care, including glycemic control, hypertension, hyperlipidemia, and diet. Users can grant permission to their health care providers to access the users’ information on the FreeStyle CoPilot System.

FreeStyle Connect Data Management Software. We received FDA clearance for the FreeStyle Connect software in May 2000 and we launched the FreeStyle Connect software in December 2000. FreeStyle Connect is a data management software product that downloads data from FreeStyle to a personal computer and displays glucose values in eight different statistical reports, including the number of blood glucose values above, within, and below a given target range. The FreeStyle meter stores up to 250 glucose values each with time and date. This data allows FreeStyle customers and their health care providers to appropriately adjust customers’ diet, exercise and medication to improve and maintain their health.

Products Under Development

FreeStyle Navigator Continuous Glucose Monitoring System. We are developing a continuous monitoring device that will utilize a disposable, miniaturized electrochemical sensor that can be inserted under the skin by the user utilizing a spring-loaded insertion device. This sensor system will enable users to continuously measure and display glucose levels and store the results for further analysis by the user or health care providers. This product is intended to act as a substitute for current glucose self-monitoring devices. The increased number of glucose readings will allow people with diabetes to more effectively adjust insulin, oral medication, diet and exercise, which should result in significantly improved health outcomes for people with diabetes. The FreeStyle Navigator system is being designed to offer people with diabetes the following benefits:

We believe each sensor used with our system will provide up to three days of continuous glucose measurement. The accuracy and precision of our FreeStyle Navigator system will be dependent on the calibration. Therefore, our system will have a built-in FreeStyle meter that will allow for accurate and convenient calibration using FreeStyle test strips. The integrated calibration will also eliminate the risk of human error during data entry. The display unit, which can be worn like a pager, will translate the sensor’s information into a numerical value and periodically, or on demand, display the glucose level and trend. This information will allow users to determine their blood glucose value and whether it is rising, falling or remaining stable. The sensor system is designed to communicate to the wireless display unit within a 10-foot range, so it can be conveniently worn on a belt, carried in a purse or left on a bed stand at night.

We submitted our premarket approval application for the FreeStyle Navigator system in November 2003. The premarket approval process requires considerably more data and FDA review time than the 510(k) clearance process that was applicable to our current FreeStyle systems. The premarket approval process generally takes between one and three years from completion of an application, but may take longer. However, achieving a completed application is a process that may take numerous clinical trials and require filing of amendments over time. Therefore, even if the Navigator System is successfully developed, it may not be commercially available for a number of years.

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CozMore Insulin Technology System. We are developing the CozMore Insulin Technology System with Deltec, Inc., a leading maker and marketer of insulin pumps including the Cozmo^™ Insulin Pump. The CozMore system combines Deltec’s Cozmo insulin pump with our FreeStyle blood glucose monitoring technology to allow users to test their glucose levels and administer insulin with one device. Our partner Deltec submitted the 510(k) clearance application for the CozMore Insulin Technology System in June 2003.

Our Sensor Technologies

We have developed two proprietary miniaturized electrochemical sensor technologies. The first, NanoSample technology, is used in our original FreeStyle System, our FreeStyle Flash System and the FreeStyle Tracker System. The second, Wired Enzyme chemistry, is used in our FreeStyle Navigator continuous glucose monitoring system under development.

NanoSample Technology. NanoSample technology enables FreeStyle to measure glucose levels in blood samples of only 0.3 microliters, a fraction of the sample size required by most competitive products. We have pioneered techniques to obtain accurate, reliable and fast responses when measuring glucose in sub-microliter sample sizes. This technology allows us to measure the total electrical charge generated by the reaction of all of the glucose in the sample, a process referred to as coulometry. In contrast, the most advanced competitive products generally determine glucose levels by taking a measurement of the current generated by the sensor at a point in time, a process referred to as amperometry. Amperometry usually requires the use of a larger blood sample to achieve accurate results. Use of coulometry substantially eliminates some of the errors frequently associated with amperometry, such as dependence of sensor output on temperature and potential interference from commonly found substances in the blood, such as aspirin, acetaminophen, Vitamin C and uric acid, which can distort the glucose measurement.

Wired Enzyme^™ Chemistry. Our Wired Enzyme chemistry is allowing us to develop miniaturized, self-insertable, biocompatible, disposable sensors. We are currently using this technology to develop our FreeStyle Navigator System. Our FreeStyle Navigator sensor, which will be inserted under the skin by the user, will react with the glucose near or at the insertion site to produce an electrical signal that enables glucose concentration measurement. We believe our technology will successfully address the core technical issues that have limited the performance of other implantable glucose sensors, including oxygen dependence and interference from commonly found substances in blood, such as aspirin, acetaminophen, Vitamin C and uric acid. We also believe our system will be calibrated easily and accurately.

Marketing and Sales

United States. Our marketing and sales program is intended to generate awareness of FreeStyle products and penetrate and expand the glucose self-monitoring market. The sales force includes sale representatives who promote FreeStyle products to the health care professionals who strongly influence the health care decisions made by people with diabetes, a group which includes endocrinologists, certified diabetes educators, pharmacists and internal medicine physicians. The primary goal of our sales representatives is to educate and train health care professionals on the benefits of our products. We also provide these health care professionals with free samples of our products. There are also members of our sales force dedicated to serving retail and managed care accounts at the corporate and district level. In addition, our sales force promotes FreeStyle products and monitors stocking levels with retail outlets at the individual store level. We believe that our strategy of selling through our own direct sales force is an important factor in achieving market penetration.

Our direct-to-consumer advertising campaign is aimed at health care professionals, people with diabetes and people who know people with diabetes. Our belief is that pain, reliability and quality of life issues are so important in glucose testing that they are recognized and understood not only by people with diabetes, but also by their co-workers, friends, and families, each of whom will be willing to tell others. To further generate awareness and penetrate the market, our sales and marketing organization provides a wide range of programs, support materials and events that support our national sales force. These include public relations efforts, product training, conference and trade show attendance, and educational and promotional literature.

We primarily sell our products through retail pharmacies. We sell our products directly to national retail pharmacies and supply other retail pharmacies through wholesalers. We also sell to durable medical equipment suppliers and directly to end users through phone orders and our website. Although there is substantial competition from existing products, the consolidation of the retail industry has allowed us to concentrate our sales efforts. The following is a list of our top five retailers and top five wholesalers, ranked by dollar volume of sales for the year ended December 31, 2003:

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International. We intend to expand our international sales efforts for our FreeStyle products and enter new global markets by establishing relationships with international partners who have established relationships with healthcare professionals and developed distribution channels. FreeStyle products are distributed in various European countries through Ypsomed, formerly Disetronic Injection Systems. In Japan, FreeStyle products are distributed by Nipro Corporation.

Under the terms of the Ypsomed agreement, Ypsomed has exclusive responsibility for sales, marketing and customer service in its territory in Europe. We may terminate the agreement if Ypsomed does not meet specified minimum purchase requirements or for any other reason upon prior written notice. The term of the Ypsomed agreement ends in December 2006.

Under the terms of the Nipro Corporation agreement, Nipro has exclusive responsibility for sales, marketing and customer service in Japan. We may terminate the agreement if Nipro does not meet specified minimum purchase requirements. The initial term of the Nipro agreement ends in April 2006.

In addition to the countries covered by the distribution agreements with Ypsomed and Nipro Corporation, as of March 1, 2004, FreeStyle products are sold in more than 30 other countries through local distributors.

Distribution. To establish a worldwide distribution capability for end users, health care professionals and retail customers, we have established relationships with expert distribution partners. For retail order management and shipping of our FreeStyle System kit and other products, we have entered into an exclusive services agreement with UPS Supply Chain Management, a division of UPS Global Logistics that specializes in providing outsourced distribution services for large pharmaceutical and medical device companies. The initial term of this agreement ends in March 2005. We may terminate this agreement prior to March 2005, subject to payment of a termination fee. UPS Supply Chain Management has an extensive network of distribution centers and a sophisticated order management and product tracking system. UPS Supply Chain Management also manages our billing process. Our relationship with UPS Supply Chain Management allows us to meet shipment, delivery and billing expectations while minimizing our internal infrastructure requirements.

Customer Service. We provide customer service 24 hours per day, seven days per week through ICT Group. This service is transparent to the caller and provides a standard of service expected in the industry. This relationship with ICT Group provides customer service, technical support, a help desk and order processing. ICT Group is an international telemarketing and e-support company, with a medical marketing division which has developed a special facility and dedicated customer care agents for us. ICT Group’s agents have the systems capability to handle large volumes of our customer contacts at any time, both over the phone or through our web site. We select and train the ICT Group agents who work on our account, as well as maintain in-house customer service personnel that monitor quality. Our non-exclusive contract with ICT expires in January 2005. We may terminate this agreement prior to January 2005, subject to payment of a termination fee.

Manufacturing

The primary components of our original FreeStyle System kit and the FreeStyle Flash System kit are the meter, FreeStyle disposable test strips, the lancing device, FreeStyle disposable lancets and FreeStyle control solution. The primary components of the FreeStyle Tracker System kit are the FreeStyle Tracker module that is inserted into the HandSpring Visor PDA, FreeStyle disposable test strips, the lancing device, FreeStyle disposable lancets and Freestyle control solution. We manufacture the FreeStyle test strips and contract with third parties for the manufacture of the other FreeStyle components. These contract manufacturing relationships minimize our capital investment, help control costs and allow us to compete with larger volume manufacturers of blood glucose self-monitoring systems.

We manufacture the FreeStyle test strips at our facility in Alameda, California. We have developed a manufacturing process for the test strips that we believe is robust, cost effective and scaleable to meet higher volumes. The test strip is composed of chemicals, adhesive and a printed polyester similar to the material used in credit cards.

Flextronics International assisted us in the design of our FreeStyle meter and FreeStyle Tracker module. Flextronics is responsible for manufacturing our meters in China and assembling the FreeStyle system kits in California. Flextronics is also responsible for manufacturing the FreeStyle Tracker module and assembling the FreeStyle Tracker System kits in California. Flextronics has over 13 years of experience building blood glucose meters, and has facilities in Asia, Europe and the Americas.

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Flextronics has demonstrated strong process control and knowledge of just-in-time and total quality management techniques and has software tools to handle product tracking. We have an on-site manager at Flextronics in San Jose who is responsible for the day-to-day interface with Flextronics. Production release to finished goods inventory is done through our quality assurance department. Our contract with Flextronics expires in November 2005, and is renewable annually thereafter. Either party may terminate this contract for any reason upon one year’s prior written notice to the other.

Facet Technologies LLC, a wholly-owned subsidiary of Matria Healthcare, assisted us in the design of the FreeStyle lancing device and we have agreed to purchase the FreeStyle lancing devices and lancets exclusively from Facet until June 1, 2007. Facet is a leading supplier of lancing devices and lancets, including our lancets. Our FreeStyle lancing device can also use conventional lancets, which are widely available.

Each of the production processes utilized in the manufacture of our products has been verified and validated, as required by the FDA’s quality system regulations. As a medical device manufacturer, our manufacturing facility and the facilities of our suppliers, such as Flextronics and Facet Technologies, are subject to periodic unannounced inspection by regulatory authorities and these operations may undergo compliance inspections conducted by the FDA and corresponding state agencies.

Intellectual Property

We rely on a combination of copyright, patent, trademark, trade secret and other intellectual property laws, nondisclosure agreements and other measures to protect our proprietary rights. As of March 1, 2004, we had 56 issued U.S. patents and had numerous additional U.S. patent applications pending. We believe it will take up to five years, and possibly longer, for some of these U.S. patent applications to result in issued patents. We have also filed foreign patent applications on our technology. The issued patents cover, among other things:

We have obtained registrations for the trademarks TheraSense and FreeStyle in the U.S., Europe and Japan. We have obtained registrations or applied to register these marks in numerous other jurisdictions as well.

In addition to developing our own technology, we have entered into several license agreements. We have acquired rights to patents from the University of Texas at Austin developed by Professor Adam Heller, a co-founder of our company, and his collaborators. We also fund ongoing research at the University of Texas at Austin in the field of biosensors and enzyme electrodes, and we are the licensee of resulting inventions. We have also obtained non-exclusive, worldwide licenses to specific patents owned by Asulab SA and Inverness Medical Innovations, Inc. Each of these licenses grants us the right to use the licensed patents to make and sell diagnostic devices for diabetes monitoring that contain the licensed technology. We pay for these licenses through a combination of fixed payments and royalties on sales of covered products. Each of these licenses continues until expiration of the licensed patents.

Research and Development

Our research and development efforts are currently focused on developing further enhancements to our current FreeStyle systems as well as developing our FreeStyle Navigator System. Our research and development staff has extensive experience in

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the glucose monitoring industry and has been instrumental in technology development and commercialization of glucose monitoring products. Research and development expenses, including clinical and regulatory expenses, were $16.1 million in 2001, $20.3 million in 2002, and $21.6 million in 2003. We expect research and development expenses to continue to increase as we seek to enhance our existing products and develop additional products.

We also fund biosensor and enzyme electrode research under a Sponsored Research Agreement with the University of Texas at Austin. We have specific rights with regard to inventions resulting from the research. The research is currently under the direction of Professor Adam Heller and is focused on improvements to implantable glucose sensors and on extension of the Wired Enzyme technology for the measurement of other biochemicals. This agreement continues on a year-to-year basis unless otherwise agreed by the parties and so long as the University has received sponsored research funds from us in the prior six-month period. We fund such research on a cost plus reasonable overhead basis.

Competition

The medical device industry is subject to intense competition. Four companies, Roche Diagnostics, LifeScan, Inc., a division of Johnson & Johnson, Bayer Corporation and MediSense, a division of Abbott Laboratories, currently account for approximately 90% of the worldwide sales of blood glucose self-monitoring systems. All of these competitors’ products use a meter and disposable test strips to test blood obtained by lancing the finger and, in some cases, other body sites. Bayer recently launched a blood glucose monitoring system that claims a sample size requirement of less than one microliter and is cleared for testing on certain alternative sites. Two products cleared for use on the finger and forearm offer a faster test time than our original FreeStyle system, once the required sample has been obtained, and operate over a broader temperature range. Becton Dickinson launched a blood glucose monitoring system that claims the same sample size requirement as our FreeStyle systems. However, this product is only cleared for use on the fingertip. The Becton Dickinson system is capable of wirelessly communicating to an insulin pump manufactured by Medronic, Inc., the leading supplier of such pumps. This integration of a blood glucose monitor and insulin pump is competitive with the CozMore Insulin Technology System we are developing with Deltec, Inc.

In addition, other companies are developing and/or marketing minimally invasive or noninvasive glucose monitoring devices and technologies that could compete with our FreeStyle blood glucose monitoring systems and the FreeStyle Navigator our continuous glucose monitoring system under development. There are also a number of academic and other institutions involved in various phases of our industry’s technology development. Many of our competitors have significantly greater financial and human resources than we do. At this time, there are three products approved by the FDA for continuous glucose monitoring, none of which is presently approved as a substitute for current glucose self-monitoring devices. Medtronic MiniMed has two continuous glucose monitoring products approved for sale. Each product includes an implantable sensor that measures and stores glucose values for a period of up to three days. One product is a physician product. The sensor is required to be implanted by a physician, and the results of the data aggregated by the system can only be accessed by the physician, who must extract the sensor and download the results to a personal computer for viewing using customized software. The other product is a consumer product which permits the user to download the results to a personal computer for viewing using customized software. This consumer product also provides an alarm if glucose levels fall out of a range set by the user or a physician. The third product for continuous glucose monitoring that has been approved by the FDA, developed by Cygnus Inc., is worn on the wrist like a watch and can take glucose readings as frequently as every ten minutes for up to thirteen hours at a time. It also provides an alarm if glucose levels are high, low or likely to be low within 20 minutes.

We believe that the principal competitive factors in our market include:

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Government Regulation

Our products are medical devices subject to extensive regulation by the FDA and other regulatory bodies. FDA regulations govern, among other things, the following activities that we or our partners perform and will continue to perform:

FDA’s Premarket Clearance and Approval Requirements

Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either prior 510(k) clearance or prior premarket approval from the FDA. The FDA classifies medical devices into one of three classes. Devices deemed to pose lower risk are placed in either class I or II, which requires the manufacturer to submit to the FDA a premarket notification requesting permission for commercial distribution. This process is known as 510(k) clearance. Some low risk devices are exempted from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously cleared 510(k) device are placed in class III, requiring premarket approval.

510(k) Clearance Pathway. To obtain 510(k) clearance, we must submit a premarket notification demonstrating that the proposed device is substantially equivalent to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of premarket approval applications. The FDA’s 510(k) clearance pathway usually takes from four to twelve months from the date the application is completed, but it can take significantly longer.

Blood glucose testing systems have generally qualified for clearance under 510(k) procedures. We received 510(k) clearance for FreeStyle in January 2000 for use on the fingers and forearm. In May 2000, we also obtained 510(k) clearance for FreeStyle Connect, our data management system that enables downloading of blood glucose data stored in a user’s FreeStyle monitor to a personal computer for use by the user or his or her health care provider. In December 2000, we received 510(k) clearance allowing us to promote FreeStyle for use on the thigh, calf, upper arm, and hand, in addition to the fingers and forearm. In December 2001 and December 2003, we received 510(k) clearance for certain labeling changes that we made to FreeStyle. In June 2002, we received 510(k) clearance for our FreeStyle Tracker system, our system that incorporates the blood glucose monitoring technology of FreeStyle into a module for the HandSpring^™ Visor^™ handheld computer.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new 510(k) clearance or could require premarket approval. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or premarket approval is obtained. We have modified aspects of FreeStyle since receiving regulatory approval, but we believe that new 510(k) clearances are not required. If the FDA requires us to seek 510(k) clearance or premarket approval for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant regulatory fines or penalties. We have made and plan to continue to make additional product enhancements to our FreeStyle systems that we believe do not require new 510(k) clearances.

Premarket Approval Pathway. A premarket approval application must be submitted if the device cannot be cleared through the 510(k) process. A premarket approval application must be supported by extensive data including, but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device.

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After a premarket approval application is complete, the FDA begins an in-depth review of the submitted information, which generally takes between one and three years, but may take significantly longer. During this review period, the FDA may request additional information or clarification of information already provided. Also during the review period, an advisory panel of experts from outside the FDA will be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a preapproval inspection of the manufacturing facility to ensure compliance with quality system regulations. New premarket approval applications or premarket approval application supplements are required for significant modifications to the manufacturing process, labeling and design of a device that is approved through the premarket approval process. Premarket approval supplements often require submission of the same type of information as a premarket approval application, except that the supplement is limited to information needed to support any changes from the device covered by the original premarket approval application, and may not require as extensive clinical data or the convening of an advisory panel.

We filed our premarket approval application for FreeStyle Navigator, our continuous glucose monitoring system, with the FDA in November 2003. The application has been accepted for filing and granted expedited review. The premarket approval process requires considerably more data and FDA review time than the 510(k) clearance process that was applicable to our current FreeStyle products. The premarket approval process generally takes between one and three years from completion of an application or even longer. However, achieving a completed application is a process that may take numerous clinical trials and require filing of amendments over time. Therefore, even if the Navigator System is successfully developed, it may not be commercially available for a number of years.

Clinical Trials. A clinical trial is almost always required to support a premarket approval application and is sometimes required for a 510(k) premarket notification. These trials generally require submission of an application for an investigational device exemption to the FDA. The investigational device exemption application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The investigational device exemption application must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a non-significant risk device and eligible for more abbreviated investigational device exemption requirements. Clinical trials for a significant risk device may begin once the investigational device exemption application is approved by the FDA and the appropriate institutional review boards at the clinical trial sites. Future clinical trials of our FreeStyle Navigator may require that we obtain an investigational device exemption from the FDA prior to commencing clinical trials. Our clinical trials must be conducted in accordance with FDA regulations. The results of clinical testing may not be sufficient to obtain approval or clearance of the product.

Pervasive and Continuing FDA Regulation

After a device is placed on the market, numerous regulatory requirements apply. These include:

Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include any of the following sanctions:

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We are subject to unannounced inspections by the FDA and the Food and Drug Branch of the California Department of Health Services, and these inspections may include the manufacturing facilities of our subcontractors. The FDA last conducted an inspection of our facility in Alameda, California in November 2003. The FDA issued a Form 483 with two observations. One observation was corrected and verified during the audit. We submitted a corrective action plan to the FDA for the remaining observation in November 2003. We were last audited by the Food and Drug Branch of the California Department of Health Services in November 2001.

International

International sales of medical devices are subject to foreign government regulations, which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ.

The primary regulatory environment in Europe is that of the European Union, which consists of 15 countries encompassing most of the major countries in Europe. Other countries, such as Switzerland, have voluntarily adopted laws and regulations that mirror those of the European Union with respect to medical devices. The European Union has adopted numerous directives and standards regulating the design, manufacture, clinical trials, labeling, and adverse event reporting for medical devices. Devices that comply with the requirements of a relevant directive will be entitled to bear CE conformity marking, indicating that the device conforms with the essential requirements of the applicable directives and, accordingly, can be commercially distributed throughout Europe. CE is an abbreviation for European Compliance. The method of assessing conformity varies depending on the class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a “Notified Body.” This third-party assessment may consist of an audit of the manufacturer’s quality system and specific testing of the manufacturer’s product. An assessment by a Notified Body in one country within the European Union is required in order for a manufacturer to commercially distribute the product throughout the European Union. In March 2001, our quality system was certified by TÜV Product Service, a Notified Body, under the European Union In-Vitro Diagnostic Directive and Medical Device Directive allowing the CE conformity marking to be applied. In December 2003, we underwent a surveillance audit by TÜV Product Service, our Notified Body. At the successful conclusion of this audit, TÜV Product Service recommended continuation of our ability to apply CE conformity marking.

Nipro Corporation is our exclusive distributor in Japan. Nipro’s application for approval to market FreeStyle in Japan submitted to the Ministry of Health, Labor and Welfare was approved in January 2002.

Third-Party Reimbursement

Self-monitoring of blood glucose is a standard of care in the United States and other developed countries. The costs associated with the purchase of blood glucose monitoring products such as meters and test strips by people with diabetes are generally reimbursed. FreeStyle is currently being reimbursed through Medicare, Medicaid, open formulary plans and certain preferred provider organizations in the United States. International market acceptance of our products may depend, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country, and include both government-sponsored health care and private insurance. Reimbursement has not yet been determined for our Navigator System.

Employees

As of March 1, 2004, we had 512 full-time employees and one part-time employee. None of our employees is represented by a collective bargaining agreement and we have never experienced any work stoppage. We believe that our employee relations are good.

Internet Information

Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website (www.therasense.com) as soon as reasonably practicable after we electronically file the material with, or furnish it to, the Securities and Exchange Commission.

We lease approximately 120,000 square feet of manufacturing, laboratory and office space at 1360 South Loop Road in Alameda, California under a lease expiring on or about March 31, 2013. We are also leasing 17,000 square feet of office space in an adjacent building at 1350 South Loop Road under a lease expiring in May 2004. We are not currently utilizing the 1350 South Loop Road office space. We also have the ability to construct

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additional space on a parcel of land adjacent to 1360 South Loop Road. We believe that our current facilities and ability to expand further will be sufficient for our current business for the next few years.

Litigation with Gem Edwards, Inc. dba GEMCO Medical

From November 2000 through November 2003, Gem Edwards, Inc. dba GEMCO Medical distributed our products pursuant to a series of distribution agreements. In November 2003, we terminated our then-current distribution agreement with GEMCO, and our distribution relationship with GEMCO ended at that time.

In January 2004, GEMCO filed a complaint in the Court of Common Pleas Summit County, Ohio against us and certain of our employees. The lawsuit alleged that we (and in some instances, the employee defendants) engaged in tortious acts that injured GEMCO. The complaint sought: (1) compensatory damages in excess of $6.0 million; (2) punitive damages in excess of $6.0 million; and (3) payment of GEMCO’s reasonable legal fees and costs of its lawsuit. GEMCO voluntarily dismissed the complaint without prejudice on March 1, 2004.

On February 4, 2004, GEMCO filed a complaint in Alameda County Superior Court against us. The lawsuit, Gem Edwards, Inc. dba GEMCO Medical v. TheraSense, Inc., et al. (Case No. RG04139796), alleges that: (1) we breached our distribution agreements with GEMCO; (2) we (and, in some instances, certain unnamed “Doe” defendants) engaged in activity in violation of various sections of the California Business and Professions Code relating to unfair competition and trade practices; and (3) we interfered with GEMCO’s current and potential contractual relationships with its customers. The complaint seeks certain legal and equitable relief, including: (1) compensatory and consequential damages according to proof; (2) doubling or trebling damages as allowed by statute according to proof; (3) equitable relief according to proof; (4) interest, payment of GEMCO’s reasonable legal fees and costs of its lawsuit; and (5) such other and further relief as the court may deem proper.

The time for the defendants to respond to the complaint has not yet expired and, to date, no motions have been filed by any of the parties in this lawsuit. We believe that this lawsuit is without merit and intend to defend against it vigorously.

Litigation Relating to the Proposed Merger

On February 9, 2004, a purported stockholder class action lawsuit was filed in Alameda County Superior Court against us, our directors, certain of our officers and 25 unnamed “Doe” defendants. The lawsuit, Alaska U.F.C.W. Pension Trust v. TheraSense, Inc., et al. (Case No. RG04140525), alleges that the defendants breached their fiduciary duties to our stockholders in connection with our proposed merger with Abbott Laboratories by failing to institute procedures to maximize stockholder value and by advancing their individual interests at the expense of our stockholders. The complaint also alleges that our directors breached their fiduciary duties to act reasonably and establish a “level playing field” for all potential bidders for TheraSense. The complaint seeks certain declaratory and injunctive relief, including: (1) a declaration that the lawsuit is properly maintainable as a class action; (2) a declaration and decree that the merger agreement was entered into in breach of the defendants’ fiduciary duties and that it is therefore unlawful and unenforceable; (3) an injunction prohibiting TheraSense and the other defendants from proceeding with any merger until our Stockholder Rights Agreement is revoked; (4) an injunction prohibiting TheraSense and the other defendants from consummating the merger or a business combination with any third party unless a procedure or process is adopted to protect the interests of the our stockholders; (5) an order directing the individual defendants to exercise their fiduciary duties to obtain a transaction in the best interests of our stockholders; (6) an award of costs and disbursements, including attorneys’ and experts’ fees; and (7) such other equitable relief as the court may deem appropriate.

The time for the defendants to respond to the complaint has not yet expired and, to date, no motions have been filed by any of the parties in this lawsuit. The plaintiff has served discovery requests on certain of the defendants and a third party. We believe that this lawsuit is without merit and intend to defend against it vigorously.

We did not submit any matters to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2003.

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PART II

Market Information

Our Common Stock is traded on the Nasdaq National Stock Market under the symbol “THER”. The following table shows the high and low closing sale prices of our Common Stock for each quarterly period since the date of our initial public offering in October 2001 as reported on the Nasdaq National Stock Market:

The closing sale price of our Common Stock on the Nasdaq National Stock Market on March 1, 2004 was $26.88.

Holders

As of March 1, 2004, we had approximately 147 stockholders of record.

Dividends

Since our incorporation, we have never declared or paid any dividends on our capital stock. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business as currently conducted and we currently do not anticipate paying any cash dividends in the foreseeable future.

Use of Proceeds and Changes in Securities

In October 2001, we closed our initial public offering of 6,900,000 shares of our common stock at a per share price of $19.00 pursuant to a Registration Statement on Form S-1 (Registration No. 333-64456), which was declared effective on October 11, 2001.

To date, we have spent a portion of the net proceeds as follows (i) approximately $14.2 million for the purchase of capital equipment, (ii) approximately $3.6 million to expand our facility in Alameda, California, (iii) approximately $29.6 million to sponsor free product samples and accelerate the hiring of additional sales representatives, (iv) approximately $6.6 million for research and development of enhanced FreeStyle products and our Navigator System and (v) approximately $6.4 million for general working capital purposes. We are currently investing the remaining net proceeds from the offering for future use as additional working capital. Such remaining net proceeds have been invested in highly liquid instruments, such as commercial paper and U.S. Government obligations, with an average maturity of twelve months or less.

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From January 1, 2003 through December 31, 2003, we did not issue any unregistered securities.

The selected consolidated financial data set forth below are derived from our consolidated financial statements. The consolidated statement of operations data for the years ended December 31, 1999 and 2000, and the consolidated balance sheet data as of December 31, 1999, 2000 and 2001 are derived from our audited consolidated financial statements not included in this report. The consolidated statement of operations data for the years ended December 31, 2001, 2002 and 2003, and the consolidated balance sheet data as of December 31, 2002 and 2003 are derived from our audited consolidated financial statements included in this report. Historical results are not necessarily indicative of future results. The selected consolidated financial data set forth below should be read in conjunction with our consolidated financial statements, the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

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This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this report contain forward-looking statements that involve risks and uncertainties. These statements typically may be identified by the use of forward-looking words or phrases such as “believe”“ “expect,” “intend,” “anticipate,” “should,” “planned,” “estimated,” and “potential,” among others. All forward-looking statements included in this document are based on our current expectations, and we assume no obligation to update any such forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for such forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause actual results and experience to differ materially from the anticipated results or other expectations expressed in such forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, and results of our businesses include but are not limited to: (1) failure to consummate our proposed merger with Abbott Laboratories; (2) our history of losses and variable quarterly results; (3) our dependence on FreeStyle for future revenues; (4) our limited sales and marketing experience; (5) risks related to managed care contracts and adverse changes in reimbursement procedures; (6) substantial competition; (7) risks related to failure to protect our intellectual property and litigation in which we may become involved; (8) risks relating to development of innovative products; (9) risks related to noncompliance with FDA regulations; (10) limited manufacturing experience and our reliance on single manufacturers and sole source suppliers; and (11) other factors that are described from time to time in our periodic filings with the Securities and Exchange Commission, including those set forth in this filing as “Risk Factors Affecting Operations and Future Results”.

All percentage amounts and ratios were calculated using the underlying data in thousands. Operating results for the year ended December 31, 2003, are not necessarily indicative of the results that may be expected for any future period.

Overview

We develop, manufacture and sell easy to use glucose self-monitoring systems that dramatically reduce the pain of testing for people with diabetes. Our first product, the FreeStyle blood glucose monitoring system, received FDA clearance in January 2000, and we commenced commercial shipments in the United States in June 2000. We began selling the FreeStyle Flash blood glucose monitoring system in October 2003. We sell the FreeStyle systems in the United States and Canada through national retailers and wholesalers, and directly to consumers over the telephone and through our website. FreeStyle products are distributed in various European countries through Ypsomed, formerly Disetronic Injection Systems. In Japan FreeStyle products are distributed by Nipro Corporation. Our sales of FreeStyle products in Canada and the United Kingdom are through a wholly-owned subsidiary in each country.

We manufacture our disposable test strips ourselves at our facility in Alameda, California. We outsource the manufacturing, packaging and testing of our FreeStyle meters to Flextronics International Ltd., an electronics contract manufacturer. Our lancing device and disposable lancets are manufactured by Facet Technologies LLC, a wholly-owned subsidiary of Matria Healthcare, Inc. Our distribution services are performed by UPS Supply Chain Management f/d/b/a Livingston Health Care Systems Inc., a division of UPS Global Logistics.

Manufacturers typically sell their glucose monitoring system kits at discounts to list prices, offer customer rebates or provide free product samples to expand their installed base of monitoring devices and thus increase the market for their disposable test strips and lancets. We currently distribute the FreeStyle System kit at a financial loss due in part to samples, discounts and rebates to establish an installed base of systems from which we expect to generate recurring revenues from our disposable FreeStyle test strips and lancets. We have been offering and expect to continue to offer similar discounts and rebates on, and free samples of, our FreeStyle system kits. In the event we establish a large installed base of systems, we expect to generate an increasing portion of our revenues through recurring sales of our FreeStyle test strips.

Revenues are generated from sales of our FreeStyle system kits and from the recurring sales of disposable FreeStyle test strips and lancets. We recognize revenue on these products upon shipment. Generally, our sales terms to retailers and wholesalers provide for customer payment within 60 days of shipment on initial orders and payment within 30 days for subsequent orders. However, we have occasionally granted longer credit terms to match our competitors. We perform ongoing credit evaluations of our customers’ financial condition and, generally, require no collateral from our customers. We believe our terms to retailers, wholesalers and end users, including rights to return and payment terms, are similar to our competitors’ terms.

We have incurred significant operating losses and negative cash flows from operations since inception to December 31, 2002 and positive cash flows from operations for four consecutive quarters during 2003. We incurred net losses of $52.9 million in 2001, $29.2 million in 2002 and $4.8 million in 2003. As of December 31, 2003 we had an accumulated deficit of

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$149.5 million. We will need to continue to increase product revenues and reduce product costs to achieve profitability on a sustained basis.

Cost of revenues consists primarily of:

Research and development expenses include costs associated with the design, development and testing of our products. All research and development costs are expensed as incurred. These costs consist primarily of:

Selling, general and administrative expenses primarily consist of:

We have recorded deferred stock-based compensation in connection with stock option grants and sales of restricted stock to employees at exercise or sales prices below the deemed fair market value of our common stock. Deferred stock-based compensation for options granted to non-employees has been determined as the fair value of the equity instruments issued. Deferred stock-based compensation for options granted to non-employees is periodically remeasured as the underlying options vest. As of December 31, 2003 we have recorded aggregate deferred stock-based compensation of $24.6 million, of which $5.7 million will be amortized to expense on a straight line basis through 2006. This amount is being amortized over the respective vesting periods of these equity instruments, which is typically four years. Stock-based compensation expense has been allocated according to employees and their respective departments and by function for non-employees.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to investments, income taxes, litigation and other contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the

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circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management has discussed each of the critical accounting policies and estimates described below with the audit committee of our board of directors.

Revenue Recognition. We believe the following allowances and reserves which are utilized to reduce gross sales to an amount which we recognize as revenue represent some of our more significant judgments and estimates used in the preparation of our consolidated financial statements. For proper matching of costs and revenues, these allowances and reserves are created in the period when the revenue is recognized based on anticipated future events. If there are unanticipated changes in future events, then a reserve or allowance may need to be adjusted to a revised level impacting the period in which the adjustment is taken and causing variability in our financial results.

Allowances for sales returns. Our return policy allows end users in the United States and Canada to return FreeStyle System kits to us for a full cash refund within 30 days of purchase. There are no end user return rights on sales of FreeStyle test strips and lancets. In addition, our FreeStyle system kits and FreeStyle test strips currently have 18-month and 24-month shelf lives, respectively, and retailers and wholesalers in the United States and Canada can return these products to us up to six months beyond this expiration date. We use historical trends and experience to estimate future product returns and create an allowance for sales returns. For the years ended December 31, 2002 and 2003, the allowance for sales returns was 1.6% and 1.8% of gross sales, respectively. The increase reflects historical experience with an increasing level of sales returns. In the year ended December 31, 2001, we did not have sufficient historical trends to estimate an allowance for sales returns. As a result, we deferred the recognition of revenue on sales of FreeStyle test strips until resold by retailers and wholesalers to end users, and we deferred recognition of revenue on Freestyle system kits until 30 days after purchase by the end user.

Reserve for consumer rebates. FreeStyle system kits sold through retailers and wholesalers generally include a $40 consumer rebate. Based on historical trends and experience we determine a reserve for consumer rebates by applying an estimate of future redemption rates to the base of FreeStyle system kits sold through retailers and wholesalers. For the years ended December 31, 2002 and 2003, the reserve for consumer rebates was 0.3% and 0.6% of gross sales, respectively. This increased due to the launch of FreeStyle Flash in the fourth quarter of 2003 which increased system kit units shipped. In the year ended December 31, 2001, we did not have sufficient historical experience to estimate a reserve for consumer rebates. As a result, we assumed a 100% redemption rate.

Reserve for sales coupons. We utilize sales coupons to promote sales to end users in the United States. Historically, our coupon programs have primarily promoted the sale of FreeStyle system kits. These coupons are distributed through retailer circulars, national print advertisings, and direct mail programs. They are also distributed to health care professionals through our direct sales force. Based on historical trends and experience, we determine a reserve for sales coupons by estimating a future redemption rate for each promotional program and applying it to the applicable base of outstanding coupons. This estimate is difficult because each promotional program has unique characteristics and there is a substantial lag between distribution of the coupon and its redemption. There is a time lag between when the coupon is distributed and when an end user takes it to a retailer. The retailer then waits until a number of coupons have been accumulated before sending them to our third-party processor. For the years ended December 31, 2002 and 2003, the reserves for sales coupons were 0.6% and 0.6% of gross sales, respectively.

Reserve for Warranties. We believe the following reserve which is utilized to determine our cost of revenues represents one of our more significant judgments and estimates used in the preparation of our consolidated financial statements. Our meters are sold with a five-year warranty. Our reserve for warranties is estimated in the period that revenues are recognized and is determined based on historical trends and experience with warranty replacement and the cost of replacement. For the years ended December 31, 2002 and 2003, the reserves for warranties were 1.1% and 0.7% of gross sales, respectively. The decrease reflects historical experience with a lower number of warranty returns and lower cost of warranty replacement due to lower meter production costs.

Inventory Reserves. We believe the following reserves which are utilized to reduce the value of our inventory represent one of our more significant judgments and estimates used in the preparation of our consolidated financial statements. Our inventory reserves are primarily related to our inventory of FreeStyle system kits. We employ two types of inventory reserves – net realizable value reserve, or NRV reserve, and excess and obsolete reserve, or E&O reserve. Both the NRV reserves and E&O reserves are based on management’s analysis of inventory levels and sales forecasts.

NRV Reserve. When the market value of our inventory is less than the cost of the inventory, we establish a NRV reserve. The market value of our inventory is based on the average sales price of the product, less reserves for returns, rebates and coupons and estimated selling expenses. We have been offering and expect to continue to offer discounts and rebates on

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our FreeStyle system kits to establish an installed base of systems from which we expect to generate recurring revenues from our disposable FreeStyle test strips and lancets. The cost of our inventory is based on standard cost, which approximates actual cost on a first-in first-out basis. As of December 31, 2002, we did not have a NRV reserve as the market value for our FreeStyle system kits equaled or exceeded their costs. As of December 31, 2003, our NRV reserve was approximately 0.5% of total inventory as the market value for our FreeStyle Tracker system kits were below their costs.

E&O Reserve. We also establish an E&O reserve to adjust the carrying value of impaired inventories to salvage or recoverable value. Excess inventory is defined as the inventory in stock beyond the next twelve months of estimated demand. Obsolete inventory is defined as in stock inventory that either has not sold through within six months of taking title to the inventory or is no longer used in finished goods due to product changes. As of December 31, 2002, we did not have any E&O reserve as none of our inventory fell within our E&O reserve policy. As of December 31, 2003, our E&O reserve was approximately 9.8% of total inventory resulting primarily from slow-moving European system kits and FreeStyle Tracker system kits.

Allowance for Doubtful Accounts. In estimating the uncollectability of our accounts receivable, we analyze historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms. In 2002, our two 10% or more customers accounted for 21% of our product shipments . In 2003, no customers accounted for more than 10% of our product shipments for that year, but our four largest customers accounted for 39% of product shipments. Generally, we do not require collateral from our domestic customers, and we do not require collateral from our two principal international distributors. For our other international customers, accounts receivable balances are generally collateralized by irrevocable letters of credit. Our estimate for the allowance for doubtful accounts related to accounts receivable is based on two methods. The amounts calculated for each of these methods are combined to determine the total amount reserved. First, we evaluate specific accounts where we have information that the customer may have an inability to meet its financial obligations. In these cases, we use our judgment, based on the best available facts and circumstances, and record a specific reserve for that customer against amounts due to reduce the receivable to the amount that is expected to be collected. These specific reserves are reevaluated and adjusted as additional information is received that impacts the amount reserved. Second, a general reserve is established for all customers based on a percentage applied to the outstanding accounts receivable amount. This percentage is based on historical collection and write-off experience. As of December 31, 2002 and 2003, the allowance for doubtful accounts was 2.2% and 1.6% of accounts receivable, respectively. In 2002 and 2003 we decreased our general reserve based on our historical experience with these customers. If circumstances change, such as higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligation to us, our allowance for doubtful accounts could be increased.

Results of Operations

Set forth below are certain expectations concerning trends in 2004 with respect to a number of the line items discussed below. These expectations assume we will continue to operate as a stand-alone company and that the merger with Abbott Laboratories will not be completed.

The following table sets forth, for the fiscal years indicated, the percentage of total revenues represented by certain items reflected in our consolidated statements of operations:

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Years Ended December 31, 2001, 2002 and 2003

Non-GAAP financial information due to impact in 2002 of achieving ability to estimate product return rates. Prior to the quarter ending June 30, 2002 we did not have a sufficient historical basis from which we could estimate product return rates. Accordingly, we deferred recognition of revenue on products shipped to retailers and wholesalers until they were resold to end users and any rights of return had expired. We estimated end user purchases based on data provided to us by third-party data providers. Product shipments that were not recognized as revenue were recorded as deferred revenues on our condensed consolidated balance sheets. The associated cost of these deferred revenues were recorded as deferred cost of products sold on our balance sheets.

Commencing with the quarter ending June 30, 2002 we achieved the ability to estimate product return rates. This event caused a $20.4 million increase in total revenues for the second quarter of 2002 due to the recognition of previously deferred revenues. There was a corresponding $4.2 million increase to our gross profit for the second quarter of 2002 and our gross margin for the period was adversely impacted because the deferred revenues were comprised primarily of lower margin system kits rather than test strips. Similarly, our loss from operations was favorably impacted by the gross profit from the previously deferred revenue which mitigated the loss. The impact of this event is reflected in the condensed consolidated statement of operations data for the twelve months ended December 31, 2002 presented in this report.

Due to the significance of the financial impact from achieving the ability to estimate product return rates in the second quarter of 2002, we have provided the non-GAAP financial information set forth in the tables below. We believe this non-GAAP financial information is useful supplemental information which facilitates meaningful comparisons of operational performance for the fiscal 2002 periods that include this event, with prior and subsequent periods that do not include this event. These non-GAAP measures are not in accordance with, or an alternative for, GAAP and may be different from non-GAAP measures used for other companies.

The following table sets forth, for the twelve months ended December 31, 2002, condensed consolidated statement of operations data in accordance with generally accepted accounting principals (“GAAP”) and on a non-GAAP basis adjusted to exclude the impact from achieving the ability to estimate product return rates and recognizing previously deferred revenues, costs, and gross profit, in the second quarter of 2002. Set forth between the columns showing GAAP and non-GAAP results is a column indicating the reconciliation to the GAAP results.

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The following table sets forth, for the years ended December 31, 2001, 2002 and 2003, the percentage of total revenues represented by certain items reflected in our condensed consolidated statement of operations in accordance with GAAP and, for the twelve months ended December 31, 2002 only, on a non-GAAP basis adjusted to exclude the impact from achieving the ability to estimate product return rates and recognizing previously deferred revenues, costs and gross profit.

Revenues. Revenues recognized in 2001 totaled $71.9 million, principally consisting of sales of FreeStyle test strips and FreeStyle System kits. In 2001, one of our customers, McKesson, and our European distributor individually accounted for more than 10% and collectively accounted for approximately 27% of our product shipments for that year. As of December 31, 2001, deferred revenue, awaiting sale through to end users and for the 30-day cash refund period on FreeStyle system kit sales to lapse, was approximately $22.7 million.

Revenues recognized in 2002 totaled $177.7 million, principally consisting of sales of FreeStyle test strips and FreeStyle system kits. This includes a $20.4 million contribution from achieving the ability to estimate product return rates for sales to retailers and wholesalers in the United States and Canada beginning with the quarter ended June 30, 2002. Prior to the quarter ended June 30, 2002 we deferred revenue recognition until product had been purchased by an end-user and all rights of return had lapsed. The increase in total revenues over the comparable period of 2001 was 119% before the $20.4 million contribution. The increase in revenues from 2001 to 2002 is primarily attributable to an increase in our installed base of end users resulting in increased sales of FreeStyle products to our customers and our expansion into international markets. Due to the recognition of previously deferred revenues from product sales during the quarter ended June 30, 2002, there were no deferred revenues from product sales as of December 31, 2002. In 2002, one of our customers, Cardinal Health, and our European distributor individually accounted for more than 10% and collectively accounted for approximately 21% of our product shipments for that year.

Revenues recognized in 2003 totaled $211.9 million, principally consisting of sales of FreeStyle test strips and FreeStyle System kits. This represents an increase of 35% over 2002 revenues before the $20.4 million contribution. The increase in revenues from 2002 to 2003 is primarily attributable to an increase in our installed base of end users resulting in increased sales of FreeStyle products to our customers. We believe that revenues for 2004 will be greater than revenues for 2003. In 2003, none of our customers individually accounted for more than 10% of our product shipments, but our four largest customers accounted for 39% of our product shipments

Cost of revenues. Cost of revenues in 2001 was $49.1 million and was attributable to product sales. Amortization of deferred stock-based compensation reported in cost of revenues for 2001 was $0.5 million.

Cost of revenues in 2002 was $92.8 million and was attributable to product sales. This increase includes a $16.2 million charge associated with the recognition of previously deferred revenues. The increase in cost of revenues over the comparable period of 2001 was 56% excluding the $16.2 million charge. This increase is due to higher total revenues, which grew by 119% compared with total revenues for the comparable period in 2001, before the $20.4 million contribution. As a percentage of revenues and after excluding the $20.4 million contribution to revenues and the $16.2 million charge, the cost of revenues in

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2002 was 48.7% versus 68.4% in 2001. This decrease reflects increased sales of FreeStyle test strips versus FreeStyle System kits and manufacturing cost reductions for FreeStyle test strips and FreeStyle system kits. Amortization of deferred stock-based compensation reported in cost of revenues for the year ended December 31, 2002 was $0.6 million, as compared to $0.5 million in 2001.

Cost of revenues in 2003 was $88.1 million and was attributable to product sales. This represents an increase of 15% over 2002, excluding the $16.2 million charge. This increase is due to higher total revenues, which grew by 35% over 2002 revenues, before the $20.4 million contribution. As a percentage or revenues the cost of revenues in 2003 was 41.6% versus 48.7% in 2002 after excluding the $20.4 million contribution to revenues and the $16.2 million charge. This decrease reflects increased sales of FreeStyle test strips which typically have higher gross margins, versus FreeStyle System kits, and manufacturing cost reductions for FreeStyle test strips and FreeStyle system kits. Amortization of deferred stock-based compensation reported in cost of revenues for 2003 was $0.5 million, as compared to $0.6 million in 2002. We believe that, as a percentage of revenues, cost of revenues will be lower in 2004 than in 2003.

Research and development expenses. Research and development expenses increased from $16.1 million in 2001, to $20.3 million in 2002 and $21.6 million in 2003. The increase from 2001 to 2002 was primarily attributable to $2.1 million from increased spending on product development efforts, $1.7 million from hiring additional personnel and $0.4 million spent on additional clinical trials. As a percentage of revenues and after excluding the $20.4 million contribution to revenues, research and development expenses in 2002 were 12.9% versus 22.4% in 2001. The increase from 2002 to 2003 was primarily attributable to an increase in spending on Navigator product development efforts. As a percentage of revenues, research and development expenses in 2003 were 10.2% versus 12.9% in 2002 after excluding the $20.4 million contribution to revenues. Amortization of deferred stock-based compensation was $1.3 million in 2001, $1.3 million in 2002, and $1.1 million in 2003. We expect research and development spending to increase in absolute dollars over the next several years as we increase clinical trials for our Navigator System and expand our research and development activities to support our current and future products.

Selling, general and administrative expenses. Selling, general and administrative expenses increased from $60.5 million in 2001, to $94.9 million in 2002 and to $107.4 million in 2003. The increase from 2001 to 2002 was primarily attributable to increases of $12.7 million for our retail sales force and personnel costs related to expanding our U.S. and international sales force, $11.2 million spent on product sampling, advertising, trade shows, exhibits and meetings, $4.1 million for our international expansion, $3.0 million for sales data services and computer services, and $2.6 million for travel costs. As a percentage of revenues and after excluding the $20.4 million contribution to revenues, selling, general and administrative expenses in 2002 were 60.3% versus 84.1% in 2001. The increase from 2002 to 2003 was primarily attributable to increases of $2.2 million for our retail sales force and personnel costs related to expanding our U.S. and international sales force, $9.3 million spent on product sampling, advertising, trade shows, exhibits and meetings, $2.9 million for our international expansion, while we reduced expenses by $1.2 million in sales data and computer services and travel costs. As a percentage of revenues, selling, general and administrative expenses in 2003 were 50.7% versus 60.3% in 2002 after excluding the $20.4 million contribution to revenues. Amortization of deferred stock-based compensation was $3.8 million in 2001, to $4.2 million in 2002 and to $3.8 million in 2003. We expect our selling, general and administrative expenses to increase in absolute dollars as we increase product sampling, expand our sales force, and increase our marketing and promotional activities. As a percentage of revenues, we expect selling, general and administrative expenses to decrease in 2004.

Interest income. Interest income increased from $2.2 million in 2001 to $2.3 million in 2002 and then decreased to $1.7 million in 2003. Interest income increased slightly from 2001 to 2002 due to the full year effect of higher average cash, cash equivalents and investments balances, resulting from the net proceeds of our initial public offering in October 2001, offset by the cash consumed during 2002. Interest income in 2003 decreased from 2002 primarily due to lower average cash, cash equivalents and investments balances as well as lower interest rates.

Interest and other expense. Interest and other expense remained at approximately $1.2 million in 2001 and 2002. Interest and other expense for 2003 was $0.8 million. Interest expense decreased as we paid off debt during 2003. Interest expense reflects the interest on borrowings under available lines of credit, amortization of debt issuance costs associated with warrants issued in connection with lines of credit and capital lease obligations arising under a particular sale and leaseback transaction.

Provision for income taxes. We incurred net operating losses in 2001, 2002, and 2003. We did not pay any federal or state income taxes in 2001 or 2002. For 2003 we provided for $0.3 million for anticipated taxes. As of December 31, 2003, we had accumulated approximately $112.3 million and $54.1 million in federal and state net operating loss carryforwards, respectively, to reduce future taxable income. If not utilized, the federal carryforward will expire in various amounts beginning in 2012, and the state carryforward will expire in 2007. Our net operating loss carryforwards are subject to annual limitations

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under Internal Revenue Code Section 382 due to substantial changes in ownership. Ownership changes as defined by Internal Revenue Code Section 382 have already occurred as a result of certain of our equity financings. We have not recorded a benefit from our net operating loss carryforwards because we believe that it is uncertain that we will have sufficient income from future operations to realize the carryforwards prior to their expiration. Accordingly, we have established a valuation allowance against the deferred tax asset arising from the carryforwards.

We also had federal and state research and development tax credit carryforwards as of December 31, 2003 of approximately $2.9 million and $2.8 million, respectively. If not utilized, the federal research credit will expire in various amounts beginning in 2012. The state research credit can be carried forward indefinitely.

Dividends related to beneficial conversion feature of preferred stock. The difference between the preferred stock purchase price and the fair market value of our common stock on the preferred stock issuance date resulted in a beneficial conversion feature, which has been reflected as preferred stock dividends. Dividends relating to beneficial conversion of our preferred stock of $26.8 million were recorded in 2001. These dividends arose due to the issuance of 6,643,371 shares of Series D preferred stock in January, February and April 2001 for net proceeds of $56.4 million.

Quarterly Results of Operations

The following table sets forth selected quarterly statement of consolidated operations data for each of the eight quarters indicated below. This information is derived from our unaudited consolidated financial statements, which have been prepared by us on a basis consistent with our audited financial statements and, in management’s opinion, include all adjustments necessary, consisting only of normal recurring adjustments, for a fair presentation of this information. These quarterly results of operations are not necessarily indicative of results of operations in any future period.