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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON DC 20549

FORM 10-Q

For the quarterly period ended March 31, 2004

OR

For the transition period from ____________ to ____________.

Commission file number: 0-29975

ACLARA BioSciences, Inc.

(Exact name of registrant as specified in its charter)

1288 Pear Avenue

Mountain View, California 94043

(Address of principal executive offices and zip code)

650-210-1200

(Registrant’s telephone number, including area code)

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

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

The number of shares outstanding of the registrant’s common stock as of April 13, 2004 was 36,143,347.

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ACLARA BIOSCIENCES, INC.

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PART I – FINANCIAL INFORMATION

ITEM 1.    Financial Statements

ACLARA BIOSCIENCES, INC.

CONDENSED BALANCE SHEETS

(In Thousands, Except Share and Per Share Amounts)

(Unaudited)

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

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ACLARA BIOSCIENCES, INC.

CONDENSED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)

(Unaudited)

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

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ACLARA BIOSCIENCES, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

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

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ACLARA BIOSCIENCES, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying unaudited condensed financial statements contain all adjustments consisting of normal recurring adjustments necessary for a fair presentation of the interim financial information for ACLARA BioSciences, Inc. (“ACLARA”). Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for the presentation of complete financial statements. The preparation of interim financial statements in conformity with generally accepted accounting principals requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. Actual results could differ from these estimates.

This Form 10-Q should be read in conjunction with the financial statements and notes thereto included in ACLARA’s Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission. Furthermore, interim results of operations are not necessarily indicative of the results that may be expected for the entire year or for other interim periods.

Comprehensive Income

Comprehensive income generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. ACLARA’s unrealized gains on available-for-sale securities represent the only component of comprehensive income that is excluded from ACLARA’s net loss for the three months ended March 31, 2004 and 2003. As this component of comprehensive income is not significant, individually or in the aggregate, no separate statements of comprehensive income have been presented.

Net Loss Per Share

Basic earnings per share is calculated based on the weighted-average number of common shares outstanding during the period. Diluted earnings per share would give effect to the dilutive effect of common stock equivalents consisting of stock options and warrants (calculated using the treasury stock method). Potentially dilutive securities have been excluded from the diluted earnings per share computations as they have an antidilutive effect due to ACLARA’s net loss.

The following outstanding options and warrants (prior to the application of the treasury stock method), were excluded from the computation of diluted net loss per share as they had an antidilutive effect (in thousands):

Accounting for Stock-Based Compensation

ACLARA accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and its related interpretations and has elected to follow the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) and SFAS No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure an amendment of FASB Statement No. 123.” Under APB No. 25, compensation expense is based on the difference, if any, on the date of the stock option grant between the fair value of ACLARA’s stock and the exercise price of the stock option.

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Had compensation cost for stock-based employee compensation arrangements been determined based on the fair value at the date of the awards consistent with the provisions of SFAS No. 123, the impact on ACLARA’s net loss would be as follows (in thousands, except per share data):

2.    LEGAL MATTERS

ACLARA and certain of its current or former officers and directors (the “ACLARA defendants”) are named as defendants in a securities class action lawsuit filed in the United States District Court for the Southern District of New York. This action, which was filed on November 13, 2001 and is now captioned ACLARA Biosciences, Inc. Initial Public Offering Securities Litigation, also names several of the underwriters involved in ACLARA’s initial public offering (“IPO”) as defendants. This class action is brought on behalf of a purported class of purchasers of ACLARA common stock from the time of ACLARA’s IPO (March 20, 2000) through December 6, 2000. The central allegation in this action is that the underwriters in the ACLARA IPO solicited and received undisclosed commissions from, and entered into undisclosed arrangements with, certain investors who purchased ACLARA stock in the IPO and the after-market. The complaint also alleges that the ACLARA defendants violated the federal securities laws by failing to disclose in the IPO prospectus that the underwriters had engaged in these allegedly undisclosed arrangements. More than 300 issuers who went public between 1998 and 2000 have been named in similar lawsuits. In July 2002, an omnibus motion to dismiss all complaints against issuers and individual defendants affiliated with issuers (including ACLARA defendants) was filed by the entire group of issuer defendants in these similar actions. On February 19, 2003, the Court in this action issued its decision on Defendant’s omnibus motion to dismiss. This decision dismissed the Section 10(b) claim as to ACLARA but denied the motion to dismiss Section 11 claim as to ACLARA and virtually all of the other defendants. On June 26, 2003, the plaintiffs in the consolidated class action lawsuits announced a proposed settlement with us and the other issuer defendants. The proposed settlement, which has been approved by ACLARA’s board of directors, provides that the insurers of all settling issuers will guarantee that the plaintiffs recover $1 billion from non-settling defendants, including the investment banks who acted as underwriters in those offerings. In the event that the plaintiffs do not recover $1 billion, the insurers for the settling issuers will make up the difference. Under the proposed settlement, the maximum amount that could be charged to ACLARA’s insurance policy in the event that the plaintiffs recovered nothing from the investment banks would be approximately $3.9 million. ACLARA believes that the Company has sufficient insurance coverage to cover the maximum amount that we may be responsible for under the proposed settlement. It is possible that the parties may not reach agreement on the final settlement documents or that the Federal District Court may not approve the settlement in whole or part. If a final settlement is not reached or is not approved by the court, ACLARA believes it has meritorious defenses and intends, in that event, to vigorously defend itself against the suit. As a result of this belief, no liability for this suit has been recorded in the accompanying financial statements. However, ACLARA could be forced to incur significant expenses in the litigation, and in the event there is an adverse outcome, its business could be harmed.

The following discussion of the Financial Condition and Results of Operations should be read in conjunction with our condensed financial statements and accompanying footnotes included elsewhere in this Form 10-Q, and in conjunction with the Form 10-K for the year ended December 31, 2003. Statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations that express that ACLARA “believes”, “anticipates”, “expects” or “plans to” as well as other statements that are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. Actual events or results may differ materially as a result of the risks and uncertainties described herein and elsewhere, including, but not limited to, those factors discussed in “Factors Affecting Operating Results” set forth below.

OVERVIEW AND EXECUTIVE SUMMARY

We are a leading developer of assay systems, providing critical high-value information about the expression and interaction of genes and proteins within cells, for drug discovery and development and for life science research.

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Although we initially focused on the development of proprietary microfluidics technologies and products, we initiated a plan of restructuring in 2002 to streamline our operations, reduce costs associated with the microfluidics aspect of our business and increase our focus on our eTag assay technology. Our business is now focused on the further development and commercialization of our eTag assay technology and on the expansion of the applications for which it can be used. The eTag system is comprised of reagent kits, software and services that simplify and automate various aspects of drug development, preclinical testing and clinical assessment. We commercialize our eTag Assay System in two ways. First, we make certain eTag assays available to customers for gene expression profiling and protein expression analysis though the purchase of eTag reagent kits, software, custom assay services, and consulting support. Secondly, we offer collaborative arrangements under which pharmaceutical and biotechnology customers can access our development expertise to provide customized eTag assays and services for use in clinical development programs. These assays can be used as an aide in patient selection in clinical trials of targeted pharmaceutical therapies that may be highly efficacious in selected patient populations while only minimally effective in the general patient population.

We have incurred significant losses since our inception. As of March 31, 2004, our accumulated deficit was $166.8 million and total stockholders’ equity was $92.0 million. Total costs and operating expenses were $4.7 million and $6.8 million for the three months ended March 31, 2004 and 2003, respectively. We expect to incur additional operating losses over at least the next year as we continue to invest heavily in research and development activities and continue to commercialize our eTag products.

Essentially all our revenues in 2003 and in the first quarter of 2004 have been generated from commercialization of our eTag assay system. Our sources of potential revenue in the remainder of 2004 and for the next several years are likely to be primarily from commercialization of our eTag assay system.

We have invested substantial amounts in establishing our assay system for drug development and life science research. Research and development expenses were $2.9 million and $4.4 million for the three months ended March 31, 2004 and 2003, respectively. Over 59% of our 59 employees at March 31, 2004 were engaged in research and development activities, all of which are related to our eTag assay technology.

RESULTS OF OPERATIONS

YEARS ENDED MARCH 31, 2004 AND 2003

Revenue

Revenue.    Total revenues for the three-months ended March 31, 2004 and 2003 were $597,000 and $179,000, respectively. Revenues were primarily derived from commercialization of our eTag assay system. Revenues increased over 2003 due to increased customer collaborations for evaluation and use of our eTag assays. We expect that our potential revenue in 2004 and for the next several years will be derived from further progress in commercialization of our eTag assay system.

Operating Expenses

Research and Development.    The decrease of $1.4 million in 2004 was primarily due to the favorable impact of a restructuring in the second quarter of 2003 that reduced personnel and related expenses by approximately $675,000 in comparison to the first quarter of 2003. Additionally expenses were reduced by approximately $625,000 due to the inclusion in 2003 of non-recurring license costs related to a litigation settlement.

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Selling, General and Administrative.    The decrease of $750,000 in 2004 was primarily due to personnel and related expenses which declined by approximately $350,000 due to the reduction of stock based compensation, relocation and recruiting and approximately $100,000 of outside services.

Legal matters.    ACLARA and certain of its current or former officers and directors (the “ACLARA defendants”) are named as defendants in a securities class action lawsuit filed in the United States District Court for the Southern District of New York. This action, which was filed on November 13, 2001 and is now captioned ACLARA Biosciences, Inc. Initial Public Offering Securities Litigation, also names several of the underwriters involved in ACLARA’s initial public offering (“IPO”) as defendants. This class action is brought on behalf of a purported class of purchasers of ACLARA common stock from the time of ACLARA’s IPO (March 20, 2000) through December 6, 2000. The central allegation in this action is that the underwriters in the ACLARA IPO solicited and received undisclosed commissions from, and entered into undisclosed arrangements with, certain investors who purchased ACLARA stock in the IPO and the after-market. The complaint also alleges that the ACLARA defendants violated the federal securities laws by failing to disclose in the IPO prospectus that the underwriters had engaged in these allegedly undisclosed arrangements. More than 300 issuers who went public between 1998 and 2000 have been named in similar lawsuits. In July 2002, an omnibus motion to dismiss all complaints against issuers and individual defendants affiliated with issuers (including ACLARA defendants) was filed by the entire group of issuer defendants in these similar actions. On February 19, 2003, the Court in this action issued its decision on Defendant’s omnibus motion to dismiss. This decision dismissed the Section 10(b) claim as to ACLARA but denied the motion to dismiss Section 11 claim as to ACLARA and virtually all of the other defendants. On June 26, 2003, the plaintiffs in the consolidated class action lawsuits announced a proposed settlement with us and the other issuer defendants. The proposed settlement, which has been approved by ACLARA’s board of directors, provides that the insurers of all settling issuers will guarantee that the plaintiffs recover $1 billion from non-settling defendants, including the investment banks who acted as underwriters in those offerings. In the event that the plaintiffs do not recover $1 billion, the insurers for the settling issuers will make up the difference. Under the proposed settlement, the maximum amount that could be charged to ACLARA’s insurance policy in the event that the plaintiffs recovered nothing from the investment banks would be approximately $3.9 million. ACLARA believes that the Company has sufficient insurance coverage to cover the maximum amount that we may be responsible for under the proposed settlement. It is possible that the parties may not reach agreement on the final settlement documents or that the Federal District Court may not approve the settlement in whole or part. If a final settlement is not reached or is not approved by the court, ACLARA believes it has meritorious defenses and intends, in that event, to vigorously defend itself against the suit. As a result of this belief, no liability for this suit has been recorded in the accompanying financial statements. However, ACLARA could be forced to incur significant expenses in the litigation, and in the event there is an adverse outcome, its business could be harmed.

Interest Income, Net.    Interest income, net represents income earned on our cash and cash equivalents and marketable investments, net of interest paid on capital leases and equipment loans. Net interest income was $350,000, and $440,000 for the three-months ending March 31, 2004 and 2003, respectively. The decrease in net interest income from 2003 to 2004 was primarily due to lower average balances in cash, cash equivalents, short-term and long-term investments and lower market interest rates.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, we have financed our operations primarily through our initial public offering in March 2000 that raised net proceeds of $201.0 million, private placements of preferred stock totaling $32.3 million, loans from the landlord of our Mountain View facility and equipment financing lines of credit totaling $4.4 million, capital leases totaling $1.8 million, and research and development funding from collaborators and government grants. As of March 31, 2004, we had total cash resources of $85.3 million, comprising $57.2 million in cash and cash equivalents and $28.1 million in marketable investments.

The following table summarizes purchase commitments and minimum rentals due for our facility and other leased assets under long-term, non-cancelable operating leases, capital lease and loans payable as of December 31, 2003 (in thousands):

A loan agreement with the landlord of our Mountain View facility allowed us to borrow approximately $663,000 for leasehold improvements at an annual interest rate of 8.5%. The principle balance of this loan at March 31, 2004 was approximately $431,000 of which approximately $50,000 is due and payable during 2004. The note matures on July 1, 2009.

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In March 1999, we entered into a ten year operating lease agreement for our Mountain View facility.

Our operating activities used cash of $3.5 million, and $5.1 million for the three months ended March 31, 2004 and 2003, respectively. Uses of cash in operating activities primarily resulted from operating losses adjusted for non-cash expenses and changes in working capital and other liabilities.

Our investing activities generated $33.8 million and $43.4 million for the three months ended March 31, 2004 and 2003, respectively. As part of our investing activities, cash outflows for additions of property and equipment were $80,000 and $294,000 for the three months ended March 31, 2004 and 2003, respectively.

Our financing activities provided cash of approximately $531,000 for the three months ended March 31, 2004 and used cash of approximately $20,000 for the three months ended March 31, 2003, respectively. These amounts represent the net proceeds that we received from the issuance of common stock being offset by repayments of equipment financing loans and capital leases.

We believe that our current cash and cash equivalents and marketable investment balances and funding that may be received from customers and will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures for at least the next year. After that time, we cannot be certain that additional funding, if required, will be available on acceptable terms, or at all. We expect that our costs will continue to exceed our revenues on an annual basis for at least the next year. From time to time, we may consider possible strategic transactions, including the potential acquisitions of products, technologies and companies, with the goal of further developing our business and maximizing stockholder value. Such transactions, if any, could materially affect our future liquidity and capital resources. We may raise additional funds through public or private financing, collaborative relationships or other arrangements. Further, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. Our failure to raise capital when needed may harm our business and operating results.

CRITICAL ACCOUNTING POLICIES

There have been no material changes to our critical accounting policies and estimates from those disclosed in our report on Form 10-K for our fiscal year ended December 31, 2003.

FACTORS AFFECTING OPERATING RESULTS

The following risk factors outline certain risks and uncertainties concerning future results and should be read in conjunction with the other information contained in this Annual Report on Form 10-K for the year ended December 31, 2003. Any of these risk factors could materially and adversely affect our business, results of operations, financial condition and future growth prospects. Additional risks and uncertainties that we do not currently know about or that we currently deem immaterial may also impair our business, financial condition, results of operations and future growth prospects.

WE HAVE A HISTORY OF OPERATING LOSSES AND AN ACCUMULATED DEFICIT, AND WE MAY NOT ACHIEVE OR MAINTAIN PROFITABILITY IN THE FUTURE.

Since we were founded in May 1995, we have engaged primarily in research and development efforts. We have incurred operating losses every year since inception, and we may never achieve profitability. Net losses for the years ended December 31, 2003, 2002 and 2001 were $20.0 million, $37.2 million and $29.0 million, respectively. As of March 31, 2004, we had an accumulated deficit of $166.8 million. Our losses have resulted principally from costs incurred in connection with our research and development activities, from litigation settlement charges and from selling, general and administration costs associated with our operations.

To date, we have not generated any significant commercial revenue. Our ability to generate revenues from commercial sales or to achieve profitability is dependent on our ability, alone or with collaborative partners, to successfully design, develop, manufacture and commercialize our proprietary eTag Assay System in a timely manner and on adoption of our technological approach by customers. We expect that our costs will continue to exceed our revenues on an annual basis for at least the next year. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

WE HAVE LIMITED PRODUCT OFFERINGS AND OUR BUSINESS WILL SUFFER IF DEMAND FOR OUR eTag ASSAYS DECLINES OR FAILS TO DEVELOP AS WE EXPECT.

We derived nearly 100% of our revenues in 2003 and in the first quarter of 2004 from our eTag Assay System. Prior to 2003, our revenues were generated principally from collaborative research and development agreements, government grants and commercial collaborations related to our discontinued microfluidics activities. We expect the eTag Assay System to be the primary source of our revenues for the foreseeable future. As a result, we will continue to be subject to the risk of substantial

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decreases in revenues if demand for our eTag Assay System does not develop or declines. Even if we develop additional product offerings for commercial sale and clinical trial use, our future assay products may not be accepted by the research, diagnostic, medical and pharmaceutical marketplaces unless we are able to convince prospective customers that our products are more reliable and cost-effective than other means for the detection of gene and protein expression in research, development and clinical programs.

Our development of future assay products will be subject to a number of risks, most of which are not within our control, including:

If we are unsuccessful in addressing these risks and uncertainties, we may never become profitable and our financial condition would suffer.

IF OUR ASSAY PRODUCTS AND SERVICES DO NOT ACHIEVE WIDESPREAD MARKET ACCEPTANCE, OUR ABILITY TO GENERATE SALES WOULD BE LIMITED AND OUR BUSINESS WOULD BE HARMED.

Demand, for our products and services, is substantially dependent upon widespread market acceptance of our assay system for applications in drug discovery and development. Our assay system represents a new technological approach, and our ability to sell this assay system will depend on the willingness of customers to adopt such new technological approaches. We cannot assure you that our assay system will achieve substantial acceptance in our target markets. Market acceptance will depend on many factors, including:

Further, failure of our initial assay products and services to be favorably received by the market could undermine our ability to successfully introduce subsequent assay products and services. If our assay products and services do not gain market acceptance, our losses would increase and we may be unable to remain in business.

OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.

Our operating results have fluctuated in the past and are likely to do so in the future. These fluctuations could cause our stock price to decline. Some of the factors that could cause our operating results to fluctuate include:

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If revenue declines in a quarter, whether due to a delay in recognizing expected revenue or otherwise, our earnings will decline because many of our expenses are relatively fixed in the short-term. In particular, research and development and selling, general and administrative expenses are not affected directly by variations in revenue.

Due to fluctuations in our revenue and operating expenses, we believe that period-to-period comparisons to results of historical operations are not a good indication of our future performance. It is possible that in some future quarter or quarters, our operating results will be below the expectations of securities analysts or investors, or will be below the level of prior periods. In these cases, our stock price could fluctuate significantly or decline.

IF WE ARE UNABLE TO ACHIEVE VOLUME MANUFACTURING OF OUR PRODUCTS AND LARGE-SCALE DELIVERY OF OUR eTag SERVICES, OUR REVENUES WILL SUFFER AND OUR BUSINESS MAY NOT DEVELOP OR MAY DECLINE.

In late 2002, we initiated the commercialization of our eTag Assay System, including the sale of eTag reagent kits, software, custom assay services, and consulting support and the establishment of collaborative agreements under which pharmaceutical and biotechnology customers can use our eTag assays in clinical development programs as an aide in patient selection in clinical trials of pharmaceutical therapies that are being targeted on selected patient populations. However, we have limited experience with developing, manufacturing, distributing or selling products and delivering services on a commercial basis.

To date, we have limited our manufacturing activities to low volume manufacturing of eTag assay products for testing purposes and for validation and small volume commercial use by our collaborative partners and potential customers. The nature of our assay products necessitates access to specialized chemicals, reagents and raw materials, such as antibodies used in conjunction with our eTag components. There are only a limited number of vendors who supply these materials and for some of these materials the suppliers are the sole source of supply. We cannot be certain that we will be able to successfully secure supply of all needed materials, nor can we be certain that these vendors will supply these materials consistently or in the quantities necessary for high volume production. We will need to enter into contractual relationships with these or other manufacturers to facilitate commercial scale production of eTag assay products, and we cannot assure you that we will be able to do so on a timely basis, for sufficient quantities of products or on commercially reasonable terms.

Additionally, we may not be able to adequately provide the desired level of services required under our commercial collaborations. For instance, we have limited experience establishing the high degrees of accuracy, reliability and ease of use required for large-scale delivery of our services. In addition, we have limited experience in developing and providing the software tools necessary to perform analyses of data derived from our eTag Assay System.

Even though we have designed products and delivered services on a limited volume and evaluation basis, we cannot assure you that we will be able to adapt the design or develop our organization or perfect the design of our eTag Assay System to allow for volume manufacturing and large-scale delivery of our services. If we are unable to successfully deliver and market our assay products on a significant scale, or other products or systems, either independently or with our collaborative partners, we may be unable to remain in business.

WE DEPEND ON SINGLE OR LIMITED SOURCE SUPPLIES FOR SOME OF THE KEY COMPONENTS AND MATERIALS IN OUR PRODUCTS, WHICH MAKES US SUSCEPTIBLE TO SUPPLY SHORTAGES OR PRICE FLUCTUATIONS THAT COULD ADVERSELY AFFECT OUR OPERATING RESULTS.

We are dependent on Third Wave for our supply of the Cleavase enzyme that is a critical component of eTag assays for gene expression applications, which enzyme is proprietary to Third Wave. Failure of Third Wave to supply enzyme could seriously impair our business. Pursuant to the Supply Agreement with Third Wave, we purchased an initial quantity of Cleavase

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enzyme from Third Wave in 2002. This initial quantity of enzyme represents more than one year’s supply and we cannot assure you that we will fully utilize this inventory in a reasonable timeframe. This inventory of enzyme represents substantially all of the total inventory balance at March 31, 2004. In addition, we are subject to a limited source of antibodies for use in our protein applications. We cannot assure you that we will be able to obtain adequate amounts of these components and materials in a timely manner in the future and at commercially reasonable costs. We may experience difficulty identifying and obtaining alternative sources of supply and, even if we obtain alternative sources of supply, may experience delays evaluating, testing and integrating the alternative components and materials into our eTag Assay System. Any interruption or delay in the supply of any of these components or materials, or the inability to obtain these components or materials from alternative sources at acceptable prices and within a reasonable amount of time, would impair our ability to deliver our products to our customers, obtain widespread market acceptance of our eTag Assay System and could adversely affect our operating results.

IF WE ARE UNABLE TO SUCCESSFULLY DEVELOP OUR SALES AND MARKETING CHANNELS, WE MAY BE UNABLE TO GENERATE SIGNIFICANT REVENUES.

We do not have fully developed sales and distribution channels for our products. We currently have a small business development group that is focused on commercializing our eTag assays with pharmaceutical and biotechnology companies. We may not be able to develop significant revenues with this group and we may not be able to successfully build a sales and marketing organization to fully exploit the commercial opportunity for eTag assays.

Our ability to generate revenues will be dependent on the development of the appropriate partnerships, on the resources devoted by our partners to commercialization activities and on the success of those activities. Our ability to generate revenue will also be dependent on our success in recruiting management and business development personnel and in building a sales and marketing organization. We cannot assure you that we will be able to successfully build and manage effective sales and distribution channels, or that our partners will devote sufficient resources to our commercialization efforts to be effective.

BECAUSE A SMALL NUMBER OF CUSTOMERS HAVE ACCOUNTED FOR, AND ARE LIKELY TO CONTINUE TO ACCOUNT FOR, A SUBSTANTIAL PORTION OF OUR REVENUE, OUR REVENUE COULD DECLINE OR BE DELAYED DUE TO THE LOSS OF ONE OR MORE OF THESE CUSTOMERS.

Historically, we have had very few customers from which we have derived the majority of our revenue. If we were to lose any one or more of these customers or if there was a delay in the attainment of milestones in our collaborations, our revenue would decrease substantially. In 2003, two commercial customers accounted for 56% and 17% of our total revenues, respectively. Although we anticipate that future sales of our products will further expand our revenue base, we expect that we will continue to rely on a few customers for the majority of our revenues.

WE HAVE LIMITED EXPERIENCE DELIVERING FDA-APPROVED PRODUCTS AND SERVICES AND ARE SUBJECT TO THE REGULATORY AND CLINICAL PROBLEMS EXPERIENCED BY OUR CUSTOMERS, WHICH MAY ADVERSELY AFFECT OUR REVENUES AND OPERATING RESULTS.

Our customers are involved in the discovery and development of new drugs and associated pre-clinical and clinical trial testing of candidates for new drugs in which our customers may use our products. Clinical trials are long, expensive and uncertain processes. Our customers may encounter difficulties in their pre-clinical and clinical trials unrelated to our products, including failure to obtain FDA approvals or other regulatory difficulties, which may cause our customers, among other possible outcomes, to delay timing of their clinical trials, to change the methodology used to test their drugs under development or to discontinue their new drug development efforts entirely, any of which could materially and adversely affect our revenues and results of operations.

Our current eTag Assay System is not subject to oversight by nor does its sale require prior approval by the Food and Drug Administration (FDA). However, we may be subject to FDA and other regulation with regard to future diagnostic kits and services that we may develop. Under the Federal Food, Drug and Cosmetic Act and related regulations, the FDA regulates the design, development, manufacturing, labeling, sale, distribution and promotion of drugs, medical devices and diagnostics. Before a new drug, device or diagnostic product can be introduced in the market, the product must undergo rigorous testing and an extensive regulatory approval process implemented by the FDA under federal law. In addition, the FDA imposes additional regulations on manufacturers of approved products. We have limited experience with obtaining FDA approvals and developing, manufacturing, distributing or selling products within FDA requirements. Any failure to obtain FDA and other requisite governmental approvals with regard to any future products that we may develop could have a material adverse affect on our business, results of operations and financial condition.

IF WE ARE UNABLE TO EFFECTIVELY PROTECT OUR INTELLECTUAL PROPERTY, WE WOULD BE UNABLE TO PREVENT THIRD PARTIES FROM USING OUR TECHNOLOGY, WHICH COULD IMPAIR OUR ABILITY TO COMPETE IN THE MARKET. THE COST OF ENFORCING OUR PROPRIETARY RIGHTS MAY BE EXPENSIVE AND RESULT IN INCREASED LOSSES.

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Our success will depend in part on our ability to obtain and maintain meaningful patent protection for our products, both in the United States and in other countries, and our inability to do so could harm our competitive position. We rely on our portfolio of issued and pending patent applications in the United States and in other countries to protect a large part of our intellectual property and our competitive position. We continually strive to strengthen and expand our large portfolio of patents and patent applications. We have 63 pending and issued U.S. patents related to the eTag technology and 71 pending and issued U.S. patents related to microfluidic and nanofluidic technologies, as well as a large number of international patent applications and patents. We cannot assure you that any of the currently pending or future patent applications will be issued as patents, or that any patents issued to us will not be challenged, invalidated, held unenforceable or circumvented. Further, we cannot assure you that our intellectual property rights will be sufficiently broad to prevent third parties from producing competing products similar in design to our products.

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

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

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, COULD ALSO CAUSE US TO PAY SUBSTANTIAL DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.

Our commercial success also depends in part on avoiding the infringement of other parties’ patents or proprietary rights and the breach of any licenses that may relate to our technologies and products. We are aware of various third-party patents that may relate to our technology. We believe that we do not infringe these patents but cannot assure you that we will not be found in the future to infringe these or other patents or proprietary rights of third parties, either with products we are currently developing or with new products that we may seek to develop in the future. If third parties assert infringement claims against us, we may be forced to enter into license arrangements with them. We cannot assure you that we could enter into the required licenses on commercially reasonably terms, if at all. The failure to obtain necessary licenses or to implement alternative approaches may prevent us from commercializing products under development and would impair our ability to be commercially competitive. We may also become subject to interference proceedings conducted in the U.S. Patent and Trademark Office to determine the priority of inventions.

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

WE DEPEND ON OUR KEY PERSONNEL, THE LOSS OF WHOM WOULD IMPAIR OUR ABILITY TO COMPETE.

Our performance is substantially dependent on the performance of our senior management and key scientific and technical personnel. The loss of the services of any member of our senior management, scientific or technical staff may significantly delay or prevent the achievement of product development and other business objectives and could have a material adverse effect on our business, operating results and financial condition. Our future success will also depend on our ability to identify, recruit and retain additional qualified scientific, technical and managerial personnel. There is currently a shortage of skilled executives and intense competition for such personnel in the areas of our activities, and we cannot assure you that we will be able to continue to attract and retain personnel with the advanced qualifications necessary for the development of our business. The inability to attract and retain the necessary scientific, technical and managerial personnel could have a material adverse effect on our research and development activities, sales revenue, operating costs and future growth prospects.

WE FACE STRONG COMPETITION IN OUR MARKETS AND EXPECT THE LEVEL OF COMPETITION TO GROW IN THE FORESEEABLE FUTURE.

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We compete with companies that design, manufacture and market analytical instruments, assays and reagents for drug discovery and development using alternate technologies for applications such as gene expression analysis and protein function analysis and other products and systems. In addition, a number of companies are developing new technologies for miniaturizing various laboratory procedures for the drug discovery and development markets targeted by us, using such methods as beads, hybridization chips and high-density microwell plates.

We anticipate that we will face increased competition in the future as companies enter the market with new technologies. Rapidly changing technology, evolving industry standards, changes in customer needs, emerging competition and new product introduction, characterize the markets for our products. One or more of our competitors may render our technology obsolete or uneconomical by advances in existing technological approaches or the development of different approaches. Many of these competitors have greater financial and personnel resources and more experience in research and development than we have. We also cannot assure you that we will be able to compete effectively with the competitors’ greater market presence. Furthermore, we cannot assure you that the pharmaceutical and biotechnology companies which are our potential customers or our strategic partners will not develop competing products.

WE MAY BE SUBJECT TO PRODUCT LIABILITY CLAIMS AND MAY NOT BE ABLE TO OBTAIN ADEQUATE INSURANCE, WHICH WOULD INCREASE OUR LOSSES IF SUCH CLAIMS OCCURRED.

As we begin commercialization of our products, we will face exposure to product liability claims if our products fail to accurately diagnose or detect, cause injury or are otherwise cause damage. Any product liability claims arising in the future, regardless of their merit or eventual outcome, could increase our losses or exceed our assets. We cannot assure you that we will continue to be able to maintain our current product liability insurance coverage or obtain new insurance on acceptable terms with adequate coverage, or at reasonable costs. In addition, potential product liability claims may exceed the amount of our insurance or may be excluded from coverage under the terms of the policy. Any product liability claims against us, regardless of their merit or successfulness, could harm our reputation, adversely affect our business and cause our stock price to decline.

WE MAY BE UNABLE TO RAISE ADDITIONAL CAPITAL WHEN NEEDED OR GENERATE THE CAPITAL NECESSARY TO EXPAND OUR OPERATIONS AND INVEST IN NEW PRODUCTS, WHICH COULD HURT OUR ABILITY TO COMPETE OR ACHIEVE PROFITABILITY.

It might be necessary for us to raise additional capital over the next few years to continue our research and development efforts and to commercialize our products. We believe that the proceeds from our initial public offering and projected revenue from collaborations should be sufficient to fund our anticipated levels of operations through at least the next 12 months. However, we cannot assure you that our business or operations will not change in a manner that would consume available resources more rapidly than anticipated. We also cannot assure you that existing or potential future collaborations or sales revenue will be adequate to fund our operations. We may need additional funds sooner than planned to meet operational needs, capital requirements for product development and commercialization and payment of monetary damages in any on-going or future litigation. From time to time, we may consider possible strategic transactions, including the potential acquisitions of products, technologies and companies, with the goal of further developing our business and maximizing stockholder value. Such transactions, if any, could materially affect our capital resources. We cannot assure you that additional funds will be available when needed, or on terms acceptable to us, or that sufficient revenue will be generated from sales. If adequate funds are not available, we may have to reduce substantially or eliminate expenditures for the development and production of certain of our proposed products or obtain funds through arrangements with collaboration partners that require us to relinquish rights to certain of our technologies or products. Either of these alternatives could have a material adverse effect on our business, operating results, financial condition and future growth prospects.

CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS.

Our executive officers, directors and their affiliates presently beneficially own or control a significant percentage of the outstanding shares of common stock. Accordingly, our current executive officers, directors and their affiliates, if acting together, would have the ability to influence the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets and any other significant corporate transactions. The concentration of ownership could also delay or prevent a change of control of our company at a premium price if these stockholders oppose it.

THE MARKET PRICE OF OUR COMMON STOCK IS HIGHLY VOLATILE.

There has only been a public market for our common stock since March 21, 2000, and since then our common stock has traded in a range between $1.30 and $60.00 per share.

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The trading price of our common stock may continue to be highly volatile and could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including: quarterly fluctuations in results of operations; our ability to successfully commercialize our products; technological innovations or new commercial products by us or our competitors; developments concerning government regulations or proprietary rights which could affect the potential growth of our customers; the execution of new collaborative agreements and material changes in the relationships with business partners; market reaction to trends in revenues and expenses, especially research and development; changes in earnings estimates by analysts; sales of common stock by existing stockholders; and economic and political conditions.

The market price for our common stock may also be affected by our ability to meet analysts’ expectations. Any failure to meet such expectations, even slightly, could have an adverse effect on the market price of our common stock. In addition, the stock market, and the NASDAQ National Market and the market for technology companies in particular, is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. In the past, companies that have experienced volatility in the market price of their securities have been the subjects of securities class action litigation, and as noted elsewhere in this Form 10-Q, we have been sued in a securities class action lawsuit. Although we believe that the class action lawsuit and the other lawsuits described elsewhere in this Form 10-Q are without merit, an adverse determination in any of the lawsuits could have a very significant effect on our business and results of operations, and could materially affect the price of our stock. Moreover, regardless of the ultimate result, it is likely that the lawsuits will divert management’s attention and resources from other matters, which could also adversely affect our business and the price of our stock.

ANTI-TAKEOVER PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW LIMIT THE ABILITY OF ANOTHER PARTY TO ACQUIRE US, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE.

Certain provisions of our certificate of incorporation and our bylaws could delay or prevent a third party from acquiring us, even if doing so might be beneficial to our stockholders. For example, we have a classified board of directors whose members serve staggered three-year terms and are removable only for cause. In addition, on March 16, 2001, we adopted a stockholder rights plan (the “Rights Plan”). Pursuant to the Rights Plan, our Board of Directors declared a dividend distribution of one Preferred Share Purchase Right (a “Right”) on each outstanding share of our common stock. Each Right will entitle stockholders to buy one-one hundredth of a share of newly created Series A Junior Participating Preferred Stock at an exercise price of $40.50 in the event that the Rights become exercisable. Subject to limited exceptions, the Rights will be exercisable if a person or group acquires 15% or more of the Company’s common stock or announces a tender offer for 15% or more of the common stock. If we are acquired in a merger or other business combination transaction which has not been approved by the Board of Directors, each Right will entitle its holder to purchase, at the Right’s then-current exercise price, a number of the acquiring company’s common shares having a market value at the time of twice the Right’s exercise price. These provisions may have the effect of making it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, control of ACLARA. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit large stockholders from consummating a merger or combination with us. These factors could also limit the price that investors might be willing to pay for our common stock in the future.

IF WE FAIL TO MANAGE GROWTH EFFECTIVELY, OUR BUSINESS COULD BE DISRUPTED WHICH COULD HARM OUR OPERATING RESULTS.

Our ability to manage our operations and growth effectively requires us to continue to expend funds to enhance our operational, financial and management infrastructure, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. Failure to attract and retain sufficient numbers of talented employees will further strain our human resources and could impede our growth. If we are unable to expand on and implement improvements to our manufacturing and assay development process for our eTag assay system in an efficient or timely manner, or if we encounter deficiencies in existing systems and controls, then we will not be able to manufacture sufficient products required to successfully commercialize our technology. Any failure to effectively manage future growth could have a material adverse effect on our business, results of operations and financial condition.

WE USE HAZARDOUS CHEMICALS AND BIOLOGICAL MATERIALS IN OUR BUSINESS, AND ANY CLAIMS RELATING TO ANY ALLEGED IMPROPER HANDLING, STORAGE, USE OR DISPOSAL OF THESE MATERIALS COULD ADVERSELY HARM OUR BUSINESS.

Our research and development and manufacturing processes involve the use of hazardous materials, including chemicals and biological materials. Our operations also produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to damages in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use, or the use by third parties, of these materials, and our liability may exceed our total

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assets. Compliance with environmental laws and regulations is expensive, and current or future environmental regulations may impair our research, development or production efforts.

IF OUR FACILITIES WERE TO EXPERIENCE CATASTROPHIC LOSS, OUR OPERATIONS WOULD BE SERIOUSLY HARMED.

Our facilities could be subject to a catastrophic loss such as fire, flood or earthquake. All of our research and development activities, manufacturing, our corporate headquarters and other critical business operations are located near major earthquake faults in the San Francisco Bay Area. Any such loss at any of our facilities could disrupt our operations, delay production, shipments and revenue and result in large expense to repair and replace our facilities. The insurance we maintain does not cover earthquake related losses and may not be adequate to cover other losses resulting from disasters or other business interruptions.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to interest rate risk relates primarily to our investment portfolio. Fixed rate securities may have their fair market value adversely impacted due to fluctuations in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principle if forced to sell securities that have declined in market value due to changes in interest rates. The primary objective of our investment activities is to preserve principal while at the same time maximize yields without significantly increasing risk. To achieve this objective, we invest in debt instruments of the U.S. Government and its agencies and high-quality corporate issuers, and, by policy, restrict our exposure to any single corporate issuer by imposing concentration limits. To minimize the exposure due to adverse shifts in interest rates, we maintain investments at an average maturity of generally less than two years. Assuming a hypothetical increase in interest rates of one percentage point, the fair value of our total investments as of March 31, 2004 would have potentially declined by approximately $607,000.

We do not utilize derivative financial instruments, derivative commodity instruments or other market-risk sensitive instruments, positions or transactions in any material fashion.

ITEM 4.    CONTROLS AND PROCEDURES

Our management have evaluated, with the participation of our Chief Executive Officer, who is our principal executive officer, and our Chief Financial Officer and Vice President of Finance, who is our principal financial officer, the effectiveness of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities and Exchange Act of 1934, as amended) as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer and Vice President of Finance concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission rules and forms.

There has been no change in the Company’s internal controls over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II.    OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

Information with respect to this item is incorporated into this Part II, Item 1 by reference to Note 3, “Legal Matters” contained in Part 1, Item 1 above

ITEM 2.    CHANGES IN SECURITIES AND USE OF PROCEEDS

Not applicable.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.

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ITEM 5.    OTHER INFORMATION

Not Applicable.

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.    The exhibits listed below are incorporated by reference as part of this report

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(b) Reports on Form 8-K:

On January 28, 2004, we filed a current report on Form 8-K regarding the announcement of results for our fiscal year ended December 31, 2003.

On April 29, 2004, we filed a current report on Form 8-K regarding the announcement of results for our fiscal quarter ended March 31, 2004.

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SIGNATURES

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

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