VIROLOGIC INC - 10-Q Quarterly Report

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

As of May 5, 2005 there were 121,620,467 shares of the registrant’s common stock outstanding.

The accompanying unaudited condensed financial statements have been prepared by ViroLogic, Inc., also referred to as the Company, we, us, or our, in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting only of adjustments of a normal recurring nature) considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005 or any other future periods. The condensed balance sheet as of December 31, 2004 has been derived from the audited financial statements as of that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004.

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

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

ViroLogic considers all highly liquid investments with original maturities of three months or less from the date of purchase to be cash equivalents. Management determines the appropriate classification of its cash equivalents and investment securities at the time of purchase and reevaluates such determination as of each balance sheet date.

ViroLogic has deposits securing credit arrangements primarily relating to leased facilities totaling $0.5 million as of March 31, 2005 and December 31, 2004, respectively.

Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in comprehensive income (loss). The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary, if any, on available-for-sale securities are included in other income or expense. Unrealized gains and losses are included in accumulated other comprehensive income in stockholders’ equity. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income.

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

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

Goodwill represents the excess of the purchase consideration over the fair values of the identifiable assets acquired and liabilities assumed from the Company’s merger with ACLARA. Goodwill is not amortized but, in accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”), the Company tests for impairment of goodwill on an annual basis and at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable.

Other intangible assets include acquired developed product technology, costs of patents and patent applications related to products and products in development, which are capitalized and amortized on a straight-line basis over their estimated useful lives ranging from 8 to 15 years.

The Company conducts an annual impairment analysis to identify whether the carrying value of intangible assets including goodwill, developed product technology and capitalized patent costs, has been impaired. Circumstances that could trigger an impairment test include but are not limited to: a significant adverse change in the business or legal factors; an adverse action or assessment by a regulator; unanticipated competition or loss of key personnel. The Company concluded that there were no indicators of impairment as of December 31, 2004.

Product revenue is recognized upon completion of tests made on samples provided by customers and the shipment of test results to those customers. Services are provided to certain patients covered by various third-party payor programs, such as Medicare and Medicaid. Billings for services under third-party payor programs are included in revenue net of allowances for differences between the amounts billed and estimated receipts under such programs. The Company estimates these allowances based on historical payment information and current sales data. If the government and other third-party payors significantly change their reimbursement policies, an adjustment to the allowance may be necessary. Revenue generated from the Company’s database of resistance test results is recognized when earned under the terms of the related agreements, generally upon shipment of the requested reports. Contract revenue consists of revenue generated from National Institutes of Health (“NIH”) grants, commercial assay development, and other non-product revenue. NIH grant revenue is recorded on a reimbursement basis as grant costs are incurred. The Company’s commercial and research collaborations, including eTag and oncology collaborations generally consist of assay development, assay services, reagents, license and system support. Revenue generated from these collaborations is recognized when earned under the terms of the related agreements, generally upon the completion of the assay development, delivery of the reagents or as services are performed. For commercial and research collaborations, the Company recognizes non-refundable milestone payments received related to substantive at-risk milestones when performance of the milestone under the terms of the collaboration is achieved and there are no further performance obligations. The costs associated with contract revenue are included in research and development expenses. Deferred revenue relates to up front payments received in advance of meeting the revenue recognition criteria described above.

In accordance with Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables,” revenue arrangements entered into after June 15, 2003, that include multiple deliverables, are divided into separate units of accounting if the deliverables meet certain criteria, including whether the stand alone fair value of the delivered items can be determined and whether there is evidence of fair value of the undelivered items. In addition, the consideration is allocated among the separate units of accounting based on their fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units of accounting.

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

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

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

The Company estimates the fair value of stock options and stock purchase rights at the date of grant using the Black-Scholes option valuation model with the following assumptions for the three months ended March 31, 2005 and 2004: risk-free interest rate of 4.2% and 2.8% in 2005 and 2004, respectively; a weighted-average expected life of stock options from grant date of four years; a weighted-average expected stock purchase right of six months; volatility factor of the expected market price of ViroLogic’s common stock of 100%; and a dividend yield of zero.

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

The Company accounts for stock option grants to non-employees in accordance with the Emerging Issues Task Force Consensus No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires the options subject to vesting to be periodically re-valued over their service periods, which approximates the vesting period. For the three months ended March 31, 2005 and 2004, the Company recorded $19,000 and $12,000 of stock based compensation for non-employees, respectively.

In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 123R “Share Based Payment”, or SFAS 123R. This statement is a revision to SFAS 123 and supersedes Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” This statement requires a public entity to expense the cost of employee services received in exchange for an award of equity instruments. This statement also provides guidance on valuing and expensing these awards, as well as disclosure requirements of these equity arrangements. In April 2005, the SEC adopted a new rule which defers the compliance date of SFAS 123R until 2006 for calendar year companies such as ViroLogic. Consistent with the new rule, the Company will adopt SFAS 123R in the first quarter of 2006.

SFAS 123R permits public companies to choose between the following two adoption methods:

As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, the Company recognizes no compensation cost for employee stock options when the exercise price is equal to or greater than the fair market value of the underlying common stock on the date of grant. The impact of the adoption of SFAS 123R cannot be predicted at this time because it will be depend on levels of share-based payments granted in the future. However, the valuation of employee stock options under SFAS 123R is similar to SFAS 123, with minor exceptions. For information about what the Company’s reported results of operations and loss per common share would have been had we adopted SFAS 123, see “Stock-Based Compensation” in Note 1 above. Accordingly, the adoption of SFAS 123R’s fair value method is expected to have a significant impact on the Company’s results of operations, although it will likely have no impact on the Company’s overall financial position. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company has not yet completed the analysis of the ultimate impact that this new pronouncement will have on the results of operations, nor the method of adoption to be utilized for this new standard.

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

Basic loss per common share is calculated based on the weighted-average number of common shares outstanding during the periods presented. Diluted loss per common share would give effect to the dilutive impact of potential common shares which consists of convertible preferred stock (using the as-if converted method), and stock options and warrants (using

the treasury stock method). Potentially dilutive securities have been excluded from the diluted loss per common share computations in all years presented as such securities have an anti-dilutive effect on loss per common share due to the Company’s net loss.

On December 10, 2004, the Company completed its merger with ACLARA BioSciences, Inc., (“ACLARA”) a Delaware corporation pursuant to an Agreement and Plan of Merger and Reorganization dated May 28, 2004 as amended on October 18, 2004 (the “Merger Agreement”). Under the terms of the Merger Agreement, each outstanding share of ACLARA common stock was exchanged for 1.7 shares of the Company’s common stock and 1.7 Contingent Value Rights (“CVR”). The Company issued 61.9 million shares of common stock valued at $1.94 per share. The fair value of the Company’s common stock utilized in determining the purchase price was derived using the Company’s average stock price for the period two days before through two days after the terms of the acquisition were agreed to and announced on October 19, 2004. The CVRs are governed by a Contingent Value Rights Agreement. The transaction has been accounted for as a business combination and accordingly the assets acquired and liabilities assumed have been recorded at their respective fair values. The Company engaged independent valuation specialists to assist in determining the fair values of the assets acquired and liabilities assumed. Such a valuation requires management to make significant estimates and assumptions, particularly with regard to the valuation of intangible assets.

For intangible assets, including purchased in-process research and development (“IPR&D”), the Company utilized the “income method” to determine fair value of the purchased IPR&D. This method starts with a forecast of anticipated future net cash flows, which are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions include the amount and timing of projected cash flows; expected costs to develop IPR&D into commercially viable products and estimates of cash flows from the projects when completed; the expected useful lives of technologies and products; and the discount rate reflecting the inherent risks in the future cash flows. All of these judgments and estimates can materially impact results of operations.

The purchase consideration has been allocated based on the fair value of the assets acquired and liabilities assumed, as follows (in thousands):

The merger with ACLARA resulted in non-cash items being recorded in the statement of operations for the three months ended March 31, 2005. These include other non-operating expense of $5.3 million related to an unfavorable change in estimated fair value of the liability under the CVRs, net favorable stock compensation adjustments and deferred compensation amortization of $2.0 million, of which $0.7 million is recorded in research and development, $0.2 million is recorded in sales and marketing and $1.1 million is recorded in general and administrative. These adjustments are primarily the result of the impact of variable accounting due to the CVRs for ACLARA options assumed, and the recognition of expense for the value of CVRs related to ACLARA options that vested during the three months ended March 31, 2005. See “Contingent Value Rights” note below for further details.

In connection with the merger with ACLARA, the Company has taken actions to integrate and restructure the former ACLARA operations. We intend to relocate the ACLARA personnel and operations from the facility in Mountain View, California to our South San Francisco, California facilities in the second quarter of 2005. A restructuring accrual was established for the costs of vacating and subleasing the Mountain View facility including an estimate of the excess of our lease costs over our anticipated sublease income and for the anticipated severance costs for ACLARA employees whose employment is terminating as a result of the merger. Changes to the estimates of completing the currently approved restructuring plans, which were originally recorded in goodwill, will be recorded in goodwill for up to one year following the merger consummation date of December 10, 2004. After December 10, 2005, reductions to these estimates will be recorded as an adjustment to goodwill, while increases to the estimates will be recorded in our results of operations.

As part of the purchase consideration in the merger with ACLARA, the Company issued Contingent Value Rights to ACLARA stockholders and is obligated to issue CVRs to holders of assumed ACLARA stock options upon future exercise of those options. Each CVR represents the right to receive, on June 10, 2006, a potential cash payment, up to $0.88 per CVR, of the amount by which the then-current market value of ViroLogic common stock is less than $2.90 per share. Pursuant to the terms of the related agreement the determination of the current market value of ViroLogic common stock at that date will be based on a formula averaging trading prices during the 15 consecutive trading day period immediately prior to June 10, 2006. The first $0.50 per CVR of any such payment that is made must be made in cash, with the balance of up to $0.38 per CVR being payable, at the Company’s option, in cash, shares of ViroLogic common stock, or a combination of cash and ViroLogic common stock. In addition, holders of the assumed ACLARA options will have the right to receive shares of ViroLogic common stock and CVRs upon the exercise of the assumed option (or applicable cash payment, if any, upon exercise after June 10, 2006). If the current market value of ViroLogic common stock for each trading day in any 30 consecutive trading day period prior to the 18 month anniversary date of the effective time of the transaction is greater than or equal to $3.50, the CVRs will automatically extinguish and will no longer represent the right to receive any amount.

The Company recorded the initial liability under the CVRs based on the fair value of the liability at the closing date and will record adjustments to this liability based on changes in the fair value each quarter as non-operating income or expense in our statement of operations. As of the closing date of the merger, with respect to CVRs issued in respect of common stock outstanding and issuable in respect of assumed vested ACLARA stock options outstanding, the Company estimated fair value using a Black-Scholes based valuation of the underlying CVR securities of $0.66 per CVR, or $43.8 million in the aggregate. Subsequent to the closing of the merger, an active trading market has developed for the CVR securities and the liability was revalued at March 31, 2005 and December 31, 2004 based on the actual closing value of the CVRs on the OTC Bulletin Board of $0.31 and $0.23 per CVR, or $20.7 million and $15.3 million, respectively, in the aggregate. In addition, the Company will record an additional liability each quarter for additional CVRs related to assumed ACLARA stock options as they vest during each quarter. The Company recorded $0.1 million for additional CVRs related to the stock options assumed that vested during the quarter ended March 31, 2005.

At March 31, 2005, the Company leased a building with 41,000 square feet in South San Francisco, California. The lease expires in April 2010 and provides the Company with an option to extend the term for an additional ten years. In addition, at March 31, 2005, the Company subleased approximately 27,000 square feet in South San Francisco, California. This sublease expires in December 2006 and provides the Company with an option to extend the term for one year.

As a result of the merger with ACLARA, the Company assumed the lease for a facility of approximately 44,200 square feet of office and laboratory space in Mountain View, California. This lease expires in July 2009. The Company expects to relocate the employees and operations from that facility to the South San Francisco facilities in the second quarter of 2005 and is currently seeking a subtenant for this space. Included in the table below is approximately $5.3 million of lease obligation related to this facility. The Company also assumed a loan agreement for leasehold improvements at an interest rate of 8.5% per annum. The loan matures on July 1, 2009 and the amount outstanding at March 31, 2005 was $0.4 million of which $0.1 million is included in current liabilities and $0.3 million is included in long-term liabilities.

In September 2004, the Company entered into a loan agreement of $0.5 million to finance its insurance premiums at an interest rate of 6.0% per annum. The loan matures in June 2005 and the amount outstanding at March 31, 2005 was $0.2 million included in current liabilities.

In March 2004, the Company terminated a lease for laboratory and office space of approximately 25,000 square feet in South San Francisco, California. Under the terms of the lease termination agreement, a charge of $433,000 was recorded and paid primarily related to the termination payment and the write-off of the net carrying value of the related leasehold improvements.

In June 2002, the Company assigned a lease of excess laboratory and office space and sold the related leasehold improvements and equipment to a third party. In the event of default by the assignee, the Company would be contractually obligated for payments under the lease of: $0.3 million in 2005; $0.9 million in 2006; $1.5 million in 2007; $1.5 million in 2008; $1.6 million in 2009 and $2.4 million from 2010 to 2011.

As of March 31, 2005, future minimum payments, excluding the lease assignment guarantee described above, are as follows:

In addition, the Company is obligated to pay dividends to the Series A preferred stockholders as discussed in the “Capital Stock” note below.

In connection with the merger with ACLARA, the Company issued CVRs to ACLARA stockholders and will issue CVRs to holders of ACLARA stock options upon future exercise of those options. Each CVR represents the right to receive, on June 10, 2006, a potential cash payment, up to $0.88 per CVR. The maximum aggregate amount payable by the Company under the CVRs is currently estimated to be approximately $60.4 million, based on 61.9 million CVRs issued in connection with our merger with ACLARA and 6.7 million CVRs related to assumed ACLARA stock options, assuming exercise of all such options. See “Contingent Value Rights” note to the financial statements for further discussion.

The Company has been informed by Bayer Diagnostics, or Bayer, that it believes the Company requires one or more licenses to patents controlled by Bayer in order to conduct certain of the Company’s current and planned operations and activities. The Company, in turn, believes that Bayer may require one or more licenses to patents controlled by the Company. Although the Company believes it does not need a license from Bayer for its HIV products, the Company is in discussions with Bayer concerning the possibility of entering into a cross-licensing or other arrangement, and believes that if necessary, licenses from Bayer would be available to the Company on commercial terms.

ACLARA, with which the Company merged, and certain of its former officers and directors, referred to together as 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, or 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 March 20, 2000 IPO 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 the defendants’ 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 ACLARA and the other issuer defendants. The proposed settlement, which was 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. The Company believes that ACLARA had sufficient insurance coverage to cover the maximum amount that the Company may be responsible for under the proposed settlement. While the Federal District Court has preliminarily approved the settlement it is possible that it may not give its final approval to the settlement in whole or part. If a final settlement is not reached or is not approved by the court, the Company believes that it has meritorious defenses and intends to vigorously defend against the suit. As a result of this belief, no liability for this suit has been recorded in the accompanying financial statements. However, the Company could be forced to incur significant expenses in the litigation, and in the event there is an adverse outcome, its business could be harmed.

In 2004, ViroLogic’s stockholders approved an increase to the number of authorized shares of the Company’s common stock from 100,000,000 shares to 200,000,000 shares.

Upon the Company’s merger with ACLARA, all outstanding shares of ACLARA common stock were exchanged, or became exchangeable, for approximately 61.9 million shares of the Company’s common stock. See “Merger with ACLARA BioSciences, Inc.” note above for further details.

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

Of the 1,625 shares issued in the financing, 249 shares remain outstanding as of March 31, 2005, and the remainder was converted into an aggregate of approximately 7.6 million shares of the Company’s common stock. As a result of the Company’s sale of Series C Preferred Stock in 2002, the conversion price of the Series A Preferred Stock and the exercise price of the warrants issued to the purchasers of the Series A Preferred Stock has each been reduced to $1.11. Accordingly, the 249 shares of Series A Preferred Stock outstanding are convertible into approximately 2.2 million shares of common stock. For the three months ended March 31, 2005, the Company received $4.2 million in proceeds from the exercise of warrants for approximately 3.8 million shares of common stock. In addition, the Company issued 1.4 million shares of common stock upon net warrant exercises. As of March 31, 2005, the outstanding warrants are exercisable for approximately 6.4 million shares of common stock.

The Series A Preferred Stock bears dividends payable in common stock semi-annually. The dividends were initially at an annual rate of 6% but increased to an 8% annual rate on the fourth such payment, which was made in 2003, and will increase by 2 percentage points every six months up to a maximum annual rate of 14%. This dividend is paid as a stock dividend semi-annually. Subject to the limitations described below, the holders of Series A Preferred Stock may elect to convert their shares into the Company’s common stock at any time, just as they may choose to exercise their warrants at any time. Also subject to the limitations described below, the Company may, at its option, convert the Series A Preferred Stock into common stock at any time after June 21, 2002 for Series A Preferred Stock issued at the first closing and after July 9, 2002 for Series A Preferred Stock issued at the second closing, but only if the Company’s stock price exceeds $5.10 for 20 consecutive trading days. The Company may also, at its option, convert the Series A Preferred Stock into common stock upon a sale of common stock in a firm commitment underwritten offering to the public if the public offering price exceeds $5.10, the aggregate gross proceeds exceed $40 million and the registration statements covering shares underlying the Series A Preferred Stock are effective.

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

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

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

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

The Company initially recorded the Series A Preferred Stock at its fair value on the date of issuance. In accordance with EITF Topic D-98: Classification and Measurement of Redeemable Securities (“EITF Topic D-98”), the Company has elected not to adjust the carrying value of the Series A Preferred Stock to the redemption value of such shares, since it is uncertain whether or when the redemption events described above will occur. Subsequent adjustments to increase the carrying value to the redemption value will be made when it becomes probable that such redemption will occur. As of March 31, 2005, the redemption value of the Series A Preferred Stock was $2.9 million.

Upon a liquidation of the Company, the holders of the Series A Preferred Stock are entitled to receive an amount equal to $10,000 per share of Series A Preferred Stock plus all accrued and unpaid premiums thereon. Any assets remaining for distribution following the payment of the preferences to the holders of the Series A Preferred Stock shall be distributed to the holders of the common stock. As of March 31, 2005, the liquidation preference of the Series A Preferred Stock was $2.5 million.

In connection with the merger with ACLARA, the Company has taken actions to integrate and restructure the former ACLARA operations. We intend to relocate the ACLARA personnel and operations from the facility in Mountain View, California to our South San Francisco facilities in the second quarter of 2005. A restructuring accrual was established for the costs of vacating and subleasing the Mountain View facility including an estimate of the excess of the Company’s lease costs over the Company’s anticipated sublease income. The accrual established at the closing of the merger was $3.0 million, of which $1.3 million is recorded as current and $1.7 million is recorded as long-term. In addition, a restructuring accrual of $1.1 million was established for the anticipated severance costs for ACLARA employees whose employment is terminating as a result of the merger. Changes to the estimates of completing the currently approved restructuring plans, which were originally recorded in goodwill, will be recorded in goodwill for up to one year following the merger consummation date of December 10, 2004. After December 10, 2005, reductions to these estimates will be recorded as an adjustment to goodwill, while increases to the estimates will be recorded in the results of operations.

The following table sets forth an analysis of the components of the restructuring charges (in thousands):

Following the Company’s merger with ACLARA, the Company entered into a severance agreement with a former executive and recorded a severance charge of $0.2 million in the statement of operations for the year ended December 31, 2004 of which $46,000 was paid as of March 31, 2005.

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

The following discussion of the financial condition and results of operations should be read in conjunction with the financial statements and the notes thereto included in this Form 10-Q.

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

Over the last several years, we have built a business based on the personalized medicine approach in HIV drug resistance testing. With our merger with ACLARA BioSciences, Inc., or ACLARA, in December 2004, we intend to leverage the experience and infrastructure we have built in the HIV market to the substantially larger market opportunity of cancer utilizing the proprietary eTag technology. We were incorporated in the state of Delaware in November 1995 and commenced commercial operations in 1999. Our revenues have grown in each year since the commencement of commercial operations as our tests for HIV drug resistance have been adopted more broadly. We have two sources of revenue related to HIV—from testing of patient samples and from testing services provided to pharmaceutical companies in their clinical trials. While our revenue from pharmaceutical companies in 2004 reflected the delay of a phase III clinical trial by a large pharmaceutical customer, this trial has now commenced and is expected to generate revenues in 2005. We expect to generate oncology-related revenues from similar sources with initial revenues from pharmaceutical companies expected in 2005. We currently expect to make our first oncology test available to patients in 2006, after completion of the transfer of the assays from the research setting into our CLIA certified laboratory and after sufficient clinical data has been generated.

We have incurred losses each year since inception. As of March 31, 2005, we had an accumulated deficit of approximately $195.1 million. We expect to incur additional operating losses at least through 2005 as we complete the development of the eTag technology, transfer the assays into the clinical laboratory, conduct clinical studies and develop the commercial infrastructure to support a commercial launch of our first oncology test.

On December 10, 2004, we completed our merger with ACLARA, a Delaware corporation, pursuant to an Agreement and Plan of Merger and Reorganization dated May 28, 2004 as amended on October 18, 2004, or the Merger Agreement. Under the terms of the Merger Agreement, each outstanding share of ACLARA common stock was exchanged for 1.7 shares of our common stock and 1.7 Contingent Value Rights, or CVRs. We issued 61.9 million shares of common stock valued at $1.94 per share. The fair value of our common stock utilized in determining the purchase price was derived using our average stock price for the period two days before through two days after the amended terms of the acquisition were agreed to and announced on October 19, 2004. The CVRs are governed by a Contingent Value Rights Agreement and are described in more detail in this Item 2 under the heading “Contingent Value Rights.” The transaction has been accounted for as a business combination and accordingly the assets acquired and liabilities assumed have been recorded at their respective fair values. We engaged independent valuation specialists to assist us in determining the fair values of the assets acquired and liabilities assumed. Such a valuation requires us to make significant estimates and assumptions, particularly with regard to the valuation of intangible assets.

CVRs issued in connection with the merger with ACLARA resulted in other non-operating expense of $5.3 million for the three months ended March 31, 2005, related to an unfavorable change in fair value of the estimated liability under the CVRs. In addition, during the three months ended March 31, 2005 we recorded a favorable adjustment to operating expense related to variable accounting for assumed ACLARA stock options with CVRs attached, deferred compensation amortization and CVR expenses related to vested options as follows: $0.7 million to research and development, $0.2 million to sales and marketing and $1.1 million to general and administrative.

In connection with our merger with ACLARA, we have taken actions to integrate and restructure the former ACLARA operations. We intend to relocate the ACLARA personnel and operations from the facility in Mountain View, California to our South San Francisco, California facilities in the second quarter of 2005. A restructuring accrual was established for the costs of vacating and subleasing the Mountain View facility including an estimate of the excess of our lease costs over our anticipated sublease income. The accrual established at the closing of the merger was $3.0 million, of which $1.3 million is recorded as current and $1.6 million is recorded as long-term at March 31, 2005. In addition, a restructuring accrual of $1.1 million was established for the anticipated severance costs for ACLARA employees whose employment is terminating as a result of the merger of which $.4 million was recorded as current at March 31, 2005. Changes to the estimates of completing the currently approved restructuring plans, which were originally recorded in goodwill, will be recorded in goodwill for up to one year following the merger consummation date of December 10, 2004. After December 10, 2005, reductions to these estimates will be recorded as an adjustment to goodwill, while increases to the estimates will be recorded in our results of operations.

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

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

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

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

We accounted for the merger with ACLARA as a business combination which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations. Accordingly, for significant items, we obtained assistance from independent valuation specialists.

The excess of the aggregate purchase consideration over the fair value of assets acquired and liabilities assumed has been allocated to goodwill.

As part of the purchase consideration in our merger with ACLARA, we issued Contingent Value Rights, or CVRs, to ACLARA stockholders and are obligated to issue CVRs to holders of assumed ACLARA stock options upon future exercise of those options. Each CVR represents the right to receive, on June 10, 2006, a potential cash payment, up to $0.88 per CVR, of the amount by which the then-current market value of ViroLogic common stock is less than $2.90 per share.

We recorded the initial liability under the CVRs based on the fair value of the liability at the closing date and will record adjustments to this liability based on changes in the fair value each quarter as non-operating income or expense in our statement of operations. As of the closing date of the merger, with respect to CVRs issued in respect of common stock outstanding and issuable in respect of assumed vested ACLARA stock options outstanding, we estimated fair value using a Black-Scholes based valuation of the underlying CVR securities of $0.66 per CVR, or $43.8 million in the aggregate. Because, subsequent to the closing of the merger, an active trading market has developed for the CVR securities, the liability was revalued at March 31, 2005 and December 31, 2004 based on the actual closing value of the CVRs on the OTC Bulletin Board of $0.31 and $0.23 per CVR, or $20.7 million and $15.3 million, respectively, in the aggregate. In addition, we will record an additional liability each quarter for additional CVRs related to assumed ACLARA stock options as they vest during each quarter. We recorded $0.1 million for additional CVRs related to the stock options assumed that vested during the three months ended March 31, 2005.

Goodwill represents the excess of the purchase consideration over the fair values of the identifiable assets acquired and liabilities assumed from our merger with ACLARA. In accordance with Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangible Assets”, or SFAS 142, we are required to test for impairment of goodwill on an annual basis and at any other time if events occur or circumstances indicate that the carrying amount of goodwill may not be recoverable.

We conduct an annual impairment analysis to identify whether the carrying value of intangible assets including goodwill, developed product technology and capitalized patent costs, has been impaired. Circumstances that could trigger an impairment test include but are not limited to: a significant adverse change in the business or legal factors; an adverse action or assessment by a regulator; and unanticipated competition or loss of key personnel. We concluded that there were no indicators of impairment as of December 31, 2004.

Product revenue is recognized upon completion of tests made on samples provided by customers and the shipment of test results to those customers. Services are provided to certain patients covered by various third-party payor programs, such as Medicare and Medicaid. Billings for services under third-party payor programs are included in revenue net of allowances for differences between the amounts billed and estimated receipts under such programs. We estimate these allowances based on historical payment information and current sales data. If the government and other third-party payors significantly change their reimbursement policies, an adjustment to the allowance may be necessary. Revenue generated from our database of resistance test results is recognized when earned under the terms of the related agreements, generally upon shipment of the requested reports. Contract revenue consists of revenue generated from National Institutes of Health, or NIH, grants, commercial assay development and other non-product revenue. NIH grant revenue is recorded on a reimbursement basis as grant costs are incurred. Our commercial and research collaborations, including eTag and oncology collaborations generally consist of assay development, assay services, reagents, license and system support. Revenue generated from these collaborations is recognized when earned under the terms of the related agreements, generally upon the completion of the assay development, delivery of the reagents or as services are performed. For commercial and research collaborations, we recognize non-refundable milestone payments received related to substantive at-risk milestones when performance of the milestone under the terms of the collaboration is achieved and there are no further performance obligations. The costs associated with contract revenue are included in research and development expenses. Deferred revenue relates to up front payments received in advance of meeting the revenue recognition criteria described above.

determined and whether there is evidence of fair value of the undelivered items. In addition, the consideration is allocated among the separate units of accounting based on their fair values, and the applicable revenue recognition criteria are considered separately for each of the separate units of accounting.

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

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

We have elected to continue to follow Accounting Principles Board Opinion No. 25 “Accounting for Stock-Based Compensation”, or APB 25, to account for employee stock options. Under APB 25, no compensation expense is recognized when the exercise price of our employee stock options equals or exceeds the market price of the underlying stock on the date of grant. Deferred compensation, if recorded, is amortized using the graded vesting method. Statement of Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation”, or SFAS 123, as amended by Statement of Financial Accounting Standards Board Statement No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123”, or SFAS 148, requires the disclosure of pro forma information regarding net loss and loss per share as if we had accounted for stock options under the fair value method. See “Summary of Significant Accounting Policies” note to the financial statements for further discussion.

We recognize compensation expense for assumed ACLARA options based on the intrinsic value of the option in accordance with APB 25. The entitlement to CVRs upon exercise of those options causes an indeterminate exercise price for the optionee resulting in variable stock compensation accounting.

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

In December 2004, the FASB issued Statement 123R, “Share-Based Payment,” which requires public companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. In April 2005, the SEC adopted a new rule which defers the compliance date of SFAS 123R until 2006 for calendar year companies such as ViroLogic. Consistent with the new rule, we will adopt SFAS 123R in the first quarter of 2006.

The standard requires companies to expense the fair value of all stock options that have future vesting provisions, are modified, or are newly granted beginning on the grant date of such options. We are currently evaluating the requirements of SFAS 123R as well as option valuation methodologies related to our employee and director stock options and employee stock purchase plan. Although we have not yet determined the method of adoption or the effect of adopting SFAS 123R, we expect that the adoption of SFAS 123R will have a material impact on our results of operations and loss per common share. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used.

Revenue. Revenue was $10.0 million and $9.0 million for the three months ended March 31, 2005 and 2004, respectively. The increase of $1.0 million was primarily due to eTag and oncology collaborations with pharmaceutical companies and increased funding under NIH grants. We also experienced some growth in the HIV resistance testing market and demand for our PhenoSense HIV, PhenoSense GT and GeneSeq HIV products for patient and pharmaceutical testing. Contract revenue consists of revenue from eTag and oncology collaborations, NIH research grants, commercial assay development and other non-product revenue. In 2004, we were awarded one Small Business Innovation Research, or SBIR, grants from the National Institute of Allergy and Infectious Diseases, or NIAID, a division of the NIH. In 2005, we were awarded one new SBIR grant from the NIAID. These grants will help support the development of analytical and database tools to facilitate the identification and characterization of drug resistant strains of HIV, and assays that will aid in the pre-clinical and clinical evaluation of the next generation of anti-viral therapeutics. We believe increased demand for existing and new products, including the use of our assays in clinical trials by pharmaceutical customers, will be the primary factors contributing to an increased level of sales in 2005 as compared to 2004. We expect to generate initial oncology-related revenues from pharmaceutical companies in 2005 and to make our first oncology test available to patients in 2006, after completion of the transfer of the assays from the research setting into our CLIA certified laboratory and after sufficient clinical data has been generated. We anticipate quarterly variations in revenue due to the timing of various clinical studies for pharmaceutical customers and the seasonal effects observed in patient testing.

Cost of product revenue. Cost of product revenue was $4.2 million and $4.4 million for the three months ended March 31, 2005 and 2004, respectively. Included in these costs are materials, supplies, labor and overhead related to product revenue. Gross margins increased to 52% in the first quarter of 2005 from 49% in the corresponding quarter of 2004. The increase was primarily due to improved operational efficiency and economies of scale. We anticipate that gross margin on product revenue will continue to improve as revenue increases and further operational efficiencies and economies of scale are achieved.

Research and development. Research and development costs were $4.1 million and $1.4 million for the three months ended March 31, 2005 and 2004, respectively. The increase of $2.7 million was due primarily to costs incurred related to oncology and eTag research and development programs, and additional costs incurred to support grants awarded, offset by a favorable adjustment of $0.7 million to stock based compensation related to variable accounting for assumed ACLARA stock options with CVRs attached and CVR expenses related to vested options during the period.

With the completion of our merger with ACLARA, we have expanded our business focus from infectious diseases to include both infectious diseases and oncology, and with the integration of the former ACLARA operations into our operations, our research and development expenditures have increased and will increase significantly in 2005 because of the full year impact of oncology related programs. In addition, we expect to incur additional expenses as we increase our expenditures on oncology programs in preparation for a planned introduction of commercial products. During 2005, we expect to incur expenses to transfer the eTag assays from the research setting to our CLIA certified clinical laboratory and to generate clinical data in support of a commercial launch of eTag assays. The successful development of our products is highly uncertain. Completion dates and research and development expenses can vary significantly for each product and are difficult to predict. For a more complete discussion of the risks and uncertainties associated with completing the development of products, see the “Risk Factors Related to Our Business” below.

Our products in development for HIV and other infectious diseases target viral diseases and reflect a number of approaches to assessing resistance in individual patients to particular drugs. Our product lines overlap and most of our research and development activities in infectious disease are advancing multiple potential product lines. Due to this substantial overlap, we do not track costs on a project by project basis, except for the costs related to contract revenue. A portion of our infectious disease research and development expenses are funded by grants and commercial contracts and the following table sets our costs that are included in research and development expenses that are associated with such revenues:

Below is a summary of our products in development for HIV and other infectious diseases.

Following our merger with ACLARA, some of our research and development expenditures are now directed at continuing the research and development of the eTag System. Our eTag technology has potential application as a research tool in drug discovery and development in gene expression profiling and protein expression analysis. These applications have been considered as developed product technology in the allocation of the purchase consideration for ACLARA, although some ongoing research and development expenditures continue. In addition, our eTag technology has the potential, through detection of unique protein-based biomarkers, to differentiate likely responders from non-responders to certain targeted therapies in certain patient groups. Assays based on this technology have the potential to be used as aides for patient selection in pharmaceutical companies’ clinical trials of therapeutic products targeted on specific patient populations and as diagnostic services and/or kits to guide physicians in the selection of appropriate therapies for particular patients. Products in development are as follows:

As with our infectious disease programs, many of our oncology research and development programs support multiple product areas. In particular, there is substantial overlap between our research and development activities in support of protein expression assays and protein-based clinical assays for clinical collaborations and patient testing. Because of this overlap we do not identify and track costs incurred on a project by project basis. The completion of our research and development projects are subject to a number of risks and uncertainties, including unplanned delays or expenditures during our product development, the extent of clinical testing required for regulatory approvals, the timing and results of clinical trials, failure to validate our technology and products in clinical trials and failure to receive any necessary regulatory approvals. Because of these uncertainties, the nature, timing and estimated costs of the efforts necessary to complete our research and development projects cannot be determined or estimated with any degree of certainty. Any delays or additional research and development efforts may also require us to obtain additional sources of funding to complete development of our products. Our failure to complete development of our products would have a material adverse impact on our ability to increase revenue and on our financial position and liquidity.

Sales and marketing. Sales and marketing expenses were $2.6 million and $2.0 million for the three months ended March 31, 2005 and 2004, respectively. The increase of $0.6 million was primarily attributable to the expansion of our sales force and increased marketing programs related to our products, offset by a favorable adjustment of $0.2 million to stock based compensation related to variable accounting for assumed ACLARA stock options with CVRs attached and CVR expenses related to vested options during the period. We expect sales and marketing expenses in 2005 to increase significantly from 2004 levels due to increase in sales and marketing activities related to our HIV products, initial management and other personnel and programs in preparation for the introduction of oncology products and to support business development efforts related to potential oncology pharmaceutical collaborations.

General and administrative. General and administrative expenses were $1.7 million and $2.0 million for the three months ended March 31, 2005 and 2004, respectively. The decrease of $0.3 million was due to a favorable adjustment of $1.1 million to stock based compensation related to variable accounting for assumed ACLARA stock options with CVRs attached and CVR expenses related to vested options during the period, offset by an increase in professional services and other administrative costs reflecting the increased scope of the Company’s operations. We expect general and administrative expenses in 2005 to increase from 2004 levels to support the administrative infrastructure required to support growth of the business.

Stock Based Compensation. In connection with our merger with ACLARA, we recorded a favorable adjustment related to variable accounting for assumed ACLARA stock options with CVRs attached, deferred compensation amortization and CVR expenses related to vested options during the three months ended March 31, 2005 as follows: $0.7 million to research and development, $0.2 million to sales and marketing and $1.1 million to general and administrative. These items are expected to continue to have an effect on results of operations in future quarters and this impact may be material.

In connection with our merger with ACLARA, $0.3 million of the purchase consideration was allocated to deferred compensation. Deferred compensation for options granted to employees is the difference between the exercise price and the deemed fair value for financial reporting purposes of our common stock on the date certain options were granted, is a component of stockholders’ equity and is amortized over the vesting period for the individual options. In the first quarter of 2005 and 2004, all new options were granted at fair value and no deferred compensation was recorded. We recorded amortization of deferred stock based compensation of $66,000 in the first quarter of 2005.

We expect that expenses will be impacted by stock based compensation primarily related to variable accounting for assumed ACLARA stock options with CVRs attached and CVR expenses related to vested options during the period, and in the first quarter of 2006 by the implementation of SFAS 123R which will require the recognition of expense for all stock options. The impact of adoption of SFAS 123R cannot be predicted at this time because it will depend on, among other things, the levels of share-based payments granted in the future, the method of adoption and the option valuation method used.

Lease termination charge. In March 2004, we terminated a lease for our original laboratory and office space of approximately 25,000 square feet in South San Francisco, California. Under the terms of the lease termination agreement, we recorded a charge of $433,000 primarily related to the termination payment and the write-off of the net carrying value of the related leasehold improvements. This early termination enabled us to eliminate operating expenses related to this lease going forward and reduce our aggregate remaining obligation by approximately half.

Interest and other income, net. Interest income, net was $0.5 million and $10,000 for the three months ended March 31, 2005 and 2004, respectively. Variations in interest income, net are due to changes in our average cash balances and interest rates.

Contingent value rights revaluation. Our liability under the CVRs was recorded at the closing of the merger at fair value, estimated using a calculation based on a Black-Scholes valuation of the underlying CVR securities of $0.66 per CVR. Because subsequent to the closing of the merger, an active trading market had been established, this liability was revalued based on the actual closing price of the CVRs on the OTC Bulletin Board, or $0.31 per CVR at March 31, 2005. This revaluation led to a $5.3 million unfavorable adjustment to the liability and is reflected as non-operating expense in the statement of operations. Further revaluations will be performed each quarter while the CVRs remain outstanding. These revaluations will be based on the then market value of the CVRs on the OTC Bulletin Board which renders the potential revaluation amounts highly unpredictable.

Preferred stock dividend. We recorded a preferred stock dividend of $86,000 and $68,000 for the three months ended March 31, 2005 and 2004, respectively. The Series A Preferred Stock issued in 2001 bore an initial 6% annual dividend rate, payable twice a year in shares of common stock, which increased to an 8% annual rate on the fourth such payment, and then increased by 2 percentage points every six months thereafter up to a maximum annual rate of 14%.

We expect our available cash and cash equivalents, short-term investments and short-term restricted cash of $74.9 million at March 31, 2005, funds provided by the sale of our products, contract revenue, and borrowing under equipment financing arrangements will be adequate to fund our operations through at least December 31, 2005.

We have funded our operations since inception primarily through public and private sales of common and preferred stock, equipment financing arrangements, product revenue and contract revenue. In particular, we have completed three private financings since our initial public offering in May 2000. In addition, during 2004 as the result of the merger with ACLARA, we acquired $74.8 million in cash and short term investments. Although we expect our operating and capital resources will be sufficient to meet future requirements through at least December 31, 2005, we may have to raise additional funds to continue the development and commercialization of our eTag technology and our business operations in general. These funds may not be available on favorable terms, or at all. If adequate funds are not available on commercially reasonable terms, we may be required to curtail operations significantly or sell significant assets and may not be able to continue as a going concern. In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe that we have sufficient funds for current or future operating plans.

Net cash used in operating activities was $2.5 million for the three months ended March 31, 2005. Net cash provided by operating activities was $442,000 for the corresponding period in 2004. Cash flows from operating activities can vary significantly due to various factors including changes in accounts receivable, accrued liabilities and deferred revenue related to new arrangements with customers. The average collection period of our accounts receivable as measured in days sales outstanding can vary and is dependent on various factors, including the type of revenue (i.e. patient testing, pharmaceutical company testing or contract revenue), the payment terms related to that revenue, and whether the related revenue was recorded at the beginning or ending of a period.

Net cash provided by investing activities of $0.2 million for the three months ended March 31, 2005 resulted primarily from proceeds from maturities and sales of short-term investments offset by payment of transaction costs related to our merger with ACLARA of $4.7 million, capital expenditures of $0.9 million and costs associated with acquiring other assets. Net cash used in investing activities of $11,000 for the corresponding period in 2004 resulted primarily from capital expenditures of $0.2 million and costs associated with acquiring other assets of $0.1 million, offset by $0.3 million in proceeds from maturities and sales of short-term investments.

Net cash provided by financing activities of $4.5 million for the three months ended March 31, 2005 resulted primarily from $4.2 million in proceeds from the exercise of warrants for approximately 3.8 million shares of common stock, offset by payments on loans and capital lease obligations. Net cash used in financing activities of $0.1 million for the three months ended March 31, 2004 resulted primarily from payments on loans and capital lease obligations.

At March 31, 2005, future minimum payments, excluding the lease assignment guarantee described above, are as follows:

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

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

Long term capital and liquidity considerations. We expect that we will have to make substantial investments in operating and capital expenditures as we develop and commercialize new clinical testing products and expand the availability of our current testing products.

In infectious disease, our PhenoSense and other testing products have established a leading position in the market for HIV drug resistance testing in the United States. These tests are currently in use in clinical trials of a new class of HIV drug. If these trials are successful and if our tests are determined to play an important role in the use of the drugs once approved, the need for our testing could increase in the United States and internationally. Our tests are not currently available outside of the United States and we do not have any experience in delivery of testing services or products outside of the United States. To do so we may have to develop our own clinical laboratories in key international markets, develop strategic partnerships with existing laboratories or acquire such laboratories, any of which approaches could require substantial capital resources and cause our operating and capital expenditures to increase in the future.

In oncology, our eTag System has been used in a research setting by pharmaceutical and biotechnology companies and has been evaluated by these companies for use as an aide in clinical trials. We plan to deliver a testing service for use by both pharmaceutical companies and physicians in connection with the treatment of cancer patients through our existing clinical laboratory. Additionally we may develop test kits that may be subject to the regulatory authority of the FDA. To market FDA-approved test kits we will have to develop a manufacturing facility that is compliant with the FDA’s Good Manufacturing Procedures, or GMP, regulations, or develop a partnership with a third party that operates such a facility. For both approaches to commercializing our eTag technology, we will have to conduct clinical studies, expand our laboratory facilities and expand our sales and marketing organization. Clinical studies will be required to provide physicians with the data on which they may base their decisions to utilize the testing products, and in the case of FDA-approved test kits, to satisfy FDA requirements. For all these reasons, we expect our operating and capital expenditures will increase in the future as we commercialize testing services and kits.

We anticipate that in 2005, we will incur capital expenditures of approximately $1 million to expand and reconfigure our South San Francisco, California, facilities to accommodate our oncology operations, including the personnel and equipment to be relocated from ACLARA’s former facility in Mountain View, California. While we do not currently have any additional material commitments or plans for future capital expenditures and currently expect our existing facilities to be adequate for our anticipated business level in 2005, we expect that we may have additional requirements for facilities and capital expenditures in the future as we expand our clinical laboratory to accommodate commercial availability of eTag assays for oncology, potentially establish an FDA compliant manufacturing facility and make our HIV and oncology assays available globally in support of drugs for which our tests may be important diagnostics.

We believe that our current cash, cash equivalents, marketable investment balances and short-term restricted cash, which together totaled $74.9 million at March 31, 2005 and funding that may be received from customers will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures at least through December 31, 2005. After that time, we cannot be certain that additional funding, if required, will be available on acceptable terms, or at all. 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 need to obtain additional funding by entering into new collaborations and strategic partnerships to enable us to develop and commercialize our products. Even if we receive funding from future collaborations and strategic partnerships, we may need to raise additional capital in the public equity markets, through private equity financing or through debt financing. 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.

In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 123R “Share Based Payment”, or SFAS 123R. This statement is a revision to SFAS 123 and supersedes Accounting Principles Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” This statement requires a public entity to expense the cost of employee services received in exchange for an award of equity instruments. This statement also provides guidance on valuing and expensing these awards, as well as disclosure requirements of these equity arrangements. In April 2005, the SEC adopted a new rule which defers the compliance date of SFAS 123R until 2006 for calendar year companies such as ViroLogic. Consistent with the new rule, we will adopt SFAS 123R in the first quarter of 2006.

SFAS 123R permits public companies to choose between the following two adoption methods:

As permitted by SFAS 123, we currently account for share-based payments to employees using APB Opinion 25’s intrinsic value method and, as such, we recognize no compensation cost for employee stock options when the exercise price is equal to or greater than the fair market value of the underlying common stock on the date of grant. The impact of the adoption of SFAS 123R cannot be predicted at this time because it will be depend on levels of share-based payments granted in the future. However, the valuation of employee stock options under SFAS 123R is similar to SFAS 123, with minor exceptions. For information about what our reported results of operations and loss per common share would have been had we adopted SFAS 123 (See “Stock-Based Compensation” in Note 1 to the financial statements for further discussion). Accordingly, the adoption of SFAS 123R’s fair value method is expected to have a significant impact on our results of operations, although it will likely have no impact on our overall financial position. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. We have not yet completed the analysis of the ultimate impact that this new pronouncement will have on the results of operations, nor the method of adoption to be utilized for this new standard.

Except for the historical information contained or incorporated by reference, this quarterly report on Form 10-Q contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed here. Factors that could cause or contribute to differences in our actual results include those discussed in the following section, as well as those discussed elsewhere in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and throughout this report . Each of these risk factors could adversely affect our business, operating results and financial condition, as well as adversely affect the value of an investment in our common stock and/or contingent value rights.

We have not achieved profitability and both we and ACLARA had recent and anticipated continuing losses, which may cause our stock price to fall.

Prior to our merger with ACLARA, both we and ACLARA have experienced significant losses each year since inception, and we expect to incur additional losses following our merger. We have experienced losses applicable to common stockholders of $7.4 million and $1.3 million for the three months ended March 31, 2005 and 2004, respectively. As of March 31, 2005, we had an accumulated deficit of approximately $195.1 million. ACLARA experienced net losses of approximately $12.7 million in the nine-month period ended September 30, 2004, $20.0 million, and $37.2 million for the years ended December 31, 2003 and 2002, respectively. As of September 30, 2004, ACLARA had an accumulated deficit of $175.7 million. We expect to continue to incur losses, primarily as a result of expenses related to:

If our losses continue, our stock price may fall and our stockholders may lose part or all of their investment.

Holders of our contingent value rights, or CVRs, will not be able to determine the payment to be received under the contingent value rights until June 10, 2006, and the CVRs may expire or be extinguished without any payment thereunder.

Holders of our CVRs will not know the amount of payment, if any, that a contingent value right will receive until either June 10, 2006, or such earlier time as the contingent value rights are automatically extinguished. The payment, if any, that each contingent value right will entitle its holder to receive will depend on the average volume weighted mean of the sales prices of our common stock for the 15 trading days ending on and including June 10, 2006. For every cent that the 15 day average is below $2.90, the contingent value right will have the right to a payment of $0.01 per CVR, with a maximum payment of $0.88 per CVR. If we are required to make any payment to the holders of CVRs, the first $0.50 per CVR of any such payment must be made in cash. The balance of any such payment, up to $0.38 per CVR, may, at our election, be made in cash, shares of our common stock or a combination of the two. If we elect to make any portion of a payment to holders of CVRs through the issuance of shares of our common stock then, as a condition precedent, such shares must, among other things, be issued either in a transaction that is exempt from registration under the Securities Act through satisfaction of the requirements of Section 3(a)(9) of the Securities Act, or pursuant to an effective registration statement under the Securities Act. If these conditions precedent cannot be satisfied then we must make the entire amount of any payment due under the CVRs in cash.

If at any point during the 18 month period ending on June 10, 2006, the daily volume weighted mean of the sales prices of our common stock is greater than or equal to $3.50 for 30 consecutive trading days, the contingent value rights will be automatically extinguished and no payment will be made on them.

Our potential payments to holders of contingent value rights, which may be greater than currently estimated, would decrease our liquidity and could cause dilution to our stockholders.

Under the terms of the contingent value rights, we are obligated to make a payment to the holders of contingent value rights on June 10, 2006 if the average volume weighted mean of the sales prices of our common stock for the 15 trading days prior to June 10, 2006 is less than $2.90 (unless the CVRs have been automatically extinguished earlier, in accordance with their terms). The maximum aggregate amount payable by us under the contingent value rights is currently estimated to be approximately $54.5 million, based on approximately 36 million shares of ACLARA common stock outstanding as of the date our merger with ACLARA closed. If this total amount becomes due, we must pay the first $31 million in cash, and may, at our option, pay the $23.5 million balance in cash, shares of our common stock or a combination of the two. If we are required to make the maximum payment under the CVRs, totaling approximately $54.5 million, we may have insufficient cash balances to make this entire payment in cash, and if we did have sufficient cash balances and elected to make the entire payment in cash our liquidity would be significantly and adversely affected. If we elected to make a portion of any CVR payment in shares of our common stock, existing stockholders could suffer significant dilution of their ViroLogic holdings. In addition, the maximum amount payable under the CVRs will increase by $5.9 million if all assumed ACLARA stock options are exercised. We can make no assurances as to the timing or extent of any option exercise activity.

If the conditions requiring us to make payments to the holders of contingent value rights are satisfied and all assumed ACLARA options are exercised, we would be required to pay up to approximately $60.4 million, which would result in a decrease in liquidity, which may adversely impact our ongoing business.

Our financial results and financial position may be adversely impacted by, and may fluctuate as a result of, the contingent value rights.

Until June 10, 2006, or the earlier extinguishment of the contingent value rights in accordance with their terms, we will be required under generally accepted accounting principles to record adjustments in our quarterly statements of operations based on the fair value of our estimated obligation to make payments to the holders of contingent value rights and the variable accounting associated with the stock options that have attached CVRs. Our estimated obligation to make these payments under the CVRs will vary depending, at the time the estimate is made, the market price, if any, of the contingent value rights and the stock options associated with CVRs, and the extent to which assumed ACLARA stock options are exercised. As a result, our estimated obligation under the contingent value rights could vary from period to period, resulting in significant fluctuations in our results of operations from quarter to quarter, including our reported earnings or loss per share, which could cause the market price of our common stock to fall abruptly and significantly.

If, at June 10, 2006, we are required to make a payment under the contingent value rights, we will thereafter be obligated to make equivalent payments to holders of assumed ACLARA stock options upon the exercise of those options. The aggregate amount payable upon the exercise of assumed ACLARA stock options will be equal to the number of shares of our common stock subject to those options multiplied by the amount of cash or cash and ViroLogic common stock required to be paid with respect to a single contingent value right. For fiscal periods ending after June 10, 2006, we will be required to record a charge against our statement of operations to reflect the maximum amount payable upon the exercise of assumed ACLARA stock options, based on the number of shares of our common stock for which such options are then exercisable according to their vesting provisions. In addition, we may periodically record a benefit to our statement of operations to the extent that any assumed ACLARA stock options expire prior to exercise. The combination of these charges and benefits could lead to fluctuations in our results of operations from quarter to quarter.

An active public market may not be sustained for the CVRs, or they may trade at low volumes, both of which could depress the resale price, if any, of the securities.

The CVRs are a new security for which there is a limited public trading market. We cannot predict whether an active public trading market for the securities will be sustained. The CVRs are currently quoted on the OTC Bulletin Board (“OTCBB”) under the ticker symbol “VLGCR.OB”. Because the OTCBB is a quotation service for NASD Market Makers, and not an issuer listing service or securities market, there are no listing requirements that must be met by an OTCBB issuer. There are, however, certain requirements that an issuer must meet in order for its securities to be eligible for a market maker to enter a quotation on the OTCBB. We believe that we satisfy these requirements, and that we will continue to satisfy these requirements for the foreseeable future. Investors should note however, that because issuers are not permitted to submit applications to be quoted on the OTCBB, we cannot guarantee that the CVRs will remain listed on the OTCBB. Continued quotation of the CVRs on the OTCBB will depend on ongoing sponsorship by one or more market makers who demonstrate compliance with SEC Rule 15c2-11.

Even if a public trading market for the CVRs is sustained, there may be little or no market demand for the CVRs, making it difficult or impossible to sell CVRs on the public market, and depressing the resale price, if any, of the CVRs. In addition, holders of CVRs may incur brokerage charges in connection with the resale of the CVRs, which in some cases could exceed the proceeds realized by the holder from the resale of its CVRs. We cannot predict the price, if any, at which the CVRs will trade.

Our obligation to make payments to the holders of CVRs will be unsecured, and holders of CVRs are not assured of receiving any payments owed to them under the CVRs.

Our obligation to make payments under the CVRs, if any, will be unsecured. While we intend to maintain cash resources for potential CVR payments, any amounts owing under the CVRs will be general unsecured obligations. If, at June 10, 2006, we are required to make a payment under the CVRs, holders of the CVRs cannot be assured that we will have sufficient funds or available common stock to do so. If we are unable to make a required payment under the CVRs, the holders of CVRs will have equal priority in making claims against and receiving assets from us as will our general creditors. If we are unable to make payments owing under the CVRs, the holder of a CVR may receive none, or only a portion of, any amount that is owed under the CVRs.

Our integration with ACLARA will be complex, time consuming and expensive, and may disrupt our business. We will need to overcome significant challenges in order to realize any benefits or synergies from our merger with ACLARA. These

challenges include the timely, efficient and successful execution of a number of post-transaction integration activities, including:

We estimate that relocation of ACLARA’s former operations into our South San Francisco, California, facilities will be completed in the second quarter of 2005. We expect that the development and commercialization of the propriety eTag assays for use in clinical trials by pharmaceutical and biotechnology customers could exceed one year. In addition, we expect to commercialize clinical assays for diagnostic use in patient testing, upon the successful completion of product development and automation for high throughput, validation of these assays in a CLIA-certified laboratory format, attainment of clinical validation through clinical trials, which could also exceed one year, and successful leveraging of research and development planned to be expended on clinical assays for use in clinical trials by pharmaceutical and biotechnology companies. The completion of these research and development activities is subject to a number of risks and uncertainties including the extent of clinical trials required for regulatory and marketing purposes, the timing and results of clinical trials, failure to validate the technology in clinical trials and failure to achieve necessary regulatory approvals. These factors make it impossible to predict with any degree of certainty the costs and timing of completing the development of commercial products.

The process of integrating operations and technology could cause an interruption of, or loss of momentum in, the activities of one or more of our businesses and the loss of key personnel. The diversion of management’s attention and any delays or difficulties encountered in connection with our merger with ACLARA and the integration of our operations and technology with ACLARA’s could have an adverse effect on our business, results of operations or financial condition. Furthermore, the execution of these post-transaction integration activities will involve considerable risks and may not be successful. These risks include:

We may not succeed in addressing these risks or any other problems encountered in connection with our merger with ACLARA. The inability to successfully integrate the operations, technology and personnel of ACLARA with ours, or any significant delay in achieving integration, could have a material adverse effect on our business and, as a result, on the market price of our common stock.

Proposed new products resulting from the integration of ACLARA’s technology into our operational infrastructure could be delayed or precluded by regulatory, clinical or technical obstacles, thereby delaying or preventing the development, introduction and commercialization of these new products and adversely impacting our revenue and profitability.

We anticipate developing testing products for use in connection with the treatment of cancer patients. These products will be based on ACLARA’s proprietary eTag technology and are expected to utilize our established commercialization infrastructure and experience in patient testing for HIV. We expect that the development and commercialization of eTag assays for use in clinical trials by pharmaceutical and biotechnology customers could exceed one year. In addition, we expect to commercialize clinical assays for diagnostic use in patient testing, upon the successful completion of product development and automation for high throughput, validation of assays in a Clinical Laboratory Improvement Amendments, or CLIA, certified laboratory format, attainment of clinical validation through clinical trials, which could also exceed one year, and successful leveraging of research and development planned to be expended on clinical assays for use in clinical trials by pharmaceutical and biotechnology companies. The completion of these research and development activities are subject to a number of risks and uncertainties including the extent of clinical trials required for regulatory and marketing purposes, the timing and results of clinical trials, failure to validate the technology in clinical trials and failure to achieve necessary regulatory approvals. These factors make it impossible to predict with any degree of certainty the costs and timing of completing the development of commercial products.

The proposed products and services will be developed under the auspices of CLIA regulatory framework. Future cancer testing products may include test kits that may be subject to the regulatory authority of the Food and Drug Administration, or the FDA. The FDA regulatory framework is complicated, and we have limited experience at managing FDA compliance issues.

The proposed cancer testing products that are planned to be delivered through our existing clinical laboratory infrastructure will be based on assays that are in development in a research setting, but have not been transferred to or validated in a CLIA-certified laboratory. We may be unable to accomplish this transfer and validation. Failure to do so would have an adverse effect on our revenue and operations.

If we develop cancer test kits, the kits could be subject to premarket FDA approval requirements, which would be expensive and time-consuming, and could delay or prevent us from marketing these tests. In addition, the production of the future cancer test kits may be subject to Good Manufacturing Practice Regulation, or GMP, under the auspices of the FDA. Our facilities are not GMP compliant. If the manufacture of the proposed kits is subject to GMP regulation, then we will be required to establish a GMP compliant facility, or to enter into a relationship with a third party manufacturer that operates a GMP compliant facility. We do not have experience with GMP compliance. GMP compliance, or entry into a manufacturing relationship with a third party manufacturer, would be time-consuming and expensive. We anticipate that if we are required to establish our own GMP compliant facility, or we elect to enter into a relationship with a GMP compliant third party, either process would be completed in parallel with developing the proposed testing products, could take over one year, and would require additional resources that could exceed $0.5 million in start-up costs and would increase on-going overhead costs.

As our proposed testing products for use in connection with the treatment of cancer patients have not yet been developed, there are currently no revenues associated with them and no significant revenues associated with other acquired ACLARA products and services. FDA regulation, including GMP regulation, could delay or preclude the development, introduction and commercialization of the proposed cancer testing products and prevent or delay us in receiving revenues from the proposed products, adversely affecting the anticipated profitability of the combined company.

As a result of our merger with ACLARA, we are a larger and broader organization. If our management is unable to adequately manage the company, our operating results will suffer.

As a result of our merger with ACLARA, we assumed approximately 35 employees, of 55 employees based at ACLARA’s facility in Mountain View, California before the merger. Currently, our total number of employees is approximately 250. Our proposed testing products using ACLARA’s eTag technology and our commercialization infrastructure have not yet been developed, and the two will need to be integrated as a necessary part of the development process. We do not have experience in commercializing testing products for use in the oncology field. We will face challenges inherent in efficiently managing an increased number of employees and addressing new markets, including the need to implement appropriate systems, policies, benefits and compliance programs.

Difficulties or delays in successfully managing the substantially larger and broader organization could have a material adverse effect on the combined company after our merger with ACLARA and, as a result, on the market price of our common stock.

We could lose key personnel, which could materially affect our business and require us to incur substantial costs to recruit replacements for lost personnel.

We consider William D. Young, Chairman and Chief Executive Officer, Christos J. Petropoulos, Ph.D., Vice President, Research and Development, Virology and Chief Scientific Officer, Sharat Singh, Ph.D., Chief Technical Officer, Oncology, Michael Bates, M.D., Vice President, Clinical Research, and Jeannette Whitcomb, Ph.D., Vice President, Operations, to be key to the management of our business and operations.

Any of our key personnel could terminate their employment at any time and without notice. We do not maintain key person life insurance on any of our key employees. Although we have not faced difficulties in attracting or retaining key personnel in the recent past, any failure to attract and retain key personnel could have a material adverse effect on our business.

Charges to operations resulting from the application of business combination accounting may adversely affect the market value of our common stock.

If the benefits of our merger with ACLARA are not achieved, our financial results, including earnings (loss) per common share, could be adversely affected. In accordance with United States generally accepted accounting principles, we have accounted for the merger as a business combination. We have allocated the total purchase price to the acquired net tangible assets, amortizable intangible assets, and in-process research and development based on their fair values as of the date of completion of the merger, and have recorded the excess of the purchase price over those fair values as goodwill. We will incur additional amortization expense over the estimated useful lives of certain of the intangible assets acquired in connection with our merger with ACLARA, although this is not currently expected to be significant. In addition, to the extent the value of goodwill or intangible assets become impaired, we may be required to incur material charges relating to the impairment of those assets. The additional charges could adversely affect our financial results, including earnings (loss) per common share, which could cause the market price of our common stock to decline.

Because we expect to have larger revenues, operations and financial strength as a result of the merger with ACLARA, third parties with potential litigation claims against either company who decided not to pursue those claims against the individual companies may now consider asserting those claims against us.

As a result of our merger with ACLARA, we anticipate we will have greater revenues and financial strength than either company individually. As a result, third parties who believe that they have claims against us or ACLARA, but who chose not to make known or assert those claims because of the size of the individual companies, might now believe that asserting those claims against the larger combined company may be advantageous. Although we are not currently aware of any such claims against the combined company, ACLARA was involved in significant litigation matters in the past and we cannot assure you that similar litigation will not occur in the future.

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

Our ability to establish our testing products as the standard of care to guide and improve the treatment of viral diseases and cancer will depend on acceptance and use of these testing products by physicians and clinicians and pharmaceutical companies. Testing products for viral diseases are still relatively new, and testing products for the treatment of cancer have not yet been developed. We cannot predict the extent to which physicians and clinicians will accept and use these testing products. They may prefer competing technologies and products. The commercial success of these testing products will require demonstrations of their advantages and potential economic value in relation to the current standard of care, as well as to competing products. Market acceptance of our products will depend on:

If the market does not continue to accept our existing testing products, such as our PhenoSense products or does not accept our future testing products such as products based on the eTag technology, our ability to generate revenue will be limited.

Our stockholders will experience substantial additional dilution if our shares of preferred stock or related warrants are converted into or exercised for shares of common stock. As of March 31, 2005, our outstanding shares of preferred stock and related warrants were convertible into or exercisable for up to an aggregate of 8,639,094 shares of our common stock, or approximately 7% of the number of shares of common stock outstanding.

As of March 31, 2005, we had 121,598,120 shares of common stock outstanding after our merger with ACLARA. However, as of March 31, 2005, we also had outstanding the following shares of preferred stock and related warrants:

We will not receive payment or other consideration for the issuance of shares of common stock upon conversion of the Series A Preferred Stock. Most of the warrants listed above have net exercise provisions, which, if elected as the method of exercise by the holder of the warrant, cause us to not receive cash consideration for the issuance of shares of common stock upon exercise. Together, the common shares reserved for issuance upon conversion of the Series A Preferred Stock and upon exercise of the warrants referenced above represented approximately 8,639,094 shares of our common stock, or 7% of the shares of our common stock outstanding on March 31, 2005. All of these shares are issuable for an approximate weighted-average effective price of $1.18 per share.

Also, the number of shares of common stock that we may be required to issue upon conversion of the Series A Preferred Stock and exercise of certain of these warrants can increase substantially upon the occurrence of several events, including if:

We are also obligated to issue additional shares of common stock every six months to the holders of the Series A Preferred Stock as “premium payments.” As of March 31, 2005, these issuances totaled approximately 300 shares of common stock for every share of Series A Preferred Stock outstanding at the time the issuance is made. All of the previous share totals

are based upon an assumed stock price of $2.39, which reflects the closing price of our common stock on the Nasdaq National Market on March 31, 2005, but the actual number of shares issued will be based upon our stock price from time to time as of the payment dates. If the 249 shares of the Series A Preferred Stock outstanding as of March 31, 2005 were to remain outstanding for five years, we will be required to issue as premium payments an additional 660,000 shares of common stock (again based on an assumed stock price of $2.39) to holders of the Series A Preferred Stock. We will not receive payment or other consideration for these issuances.

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

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

Holders of Series A Preferred Stock have the right, under certain circumstances, to require us to redeem for cash all of the preferred stock that they own. The redemption price for the Series A Preferred Stock is the greater of (i) 115% of the original purchase price plus 115% of any accrued premium payment thereon and (ii) the aggregate fair market value of the shares of common stock into which such shares of Series A Preferred Stock are then convertible. As of March 31, 2005, there were 249 shares of Series A Preferred Stock outstanding, with an aggregate redemption price equal to approximately $2.9 million.

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

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

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

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

Government and third-party payors are attempting to contain or reduce the costs of healthcare and are challenging the prices charged for medical products and services. In addition, increasing emphasis on managed care in the United States will continue to put pressure on the pricing of healthcare products. This could in the future limit the price that we can charge for our products or cause fluctuations in reimbursement rates for our products. This could hurt our ability to generate revenues. Significant uncertainty exists as to the reimbursement status of new medical products like the products we are currently developing and that we expect to develop, particularly if these products fail to show demonstrable value in clinical studies. If government and other third-party payors do not continue to provide adequate coverage and reimbursement for our testing products or do not authorize reimbursement for our planned products, our revenues will be reduced.

Billing complexities associated with health care payors could impair our cash flow and limit our ability to reach profitability.

Billing for laboratory services is complex. Laboratories must bill various payors, such as Medicare, Medicaid, insurance companies, doctors, employer groups and patients, all of whom have different requirements. For the years ended December 31, 2004 and 2003, approximately 31% and 29%, respectively, of our revenues were derived from tests performed for the beneficiaries of the Medicare and Medicaid programs. Medicare and Medicaid represented 29% and 35% of gross accounts receivable balance at March 31, 2005 and December 31, 2004, respectively. Billing difficulties often result in a delay in collecting, or ultimately an inability to collect, the related receivable. This impairs cash flow and ultimately reduces profitability if we are required to record bad debt expense and/or contractual adjustments for these receivables. We recorded bad debt expense of $0.3 million and $0.1 million for the years ended December 31, 2004 and 2003, respectively.

Ultimately, if all issues are not resolved in a timely manner, our cash flows could be impaired and ability to reach profitability could be limited

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

In order to meet future projected demand for our products and fully utilize our current clinical laboratory facilities, we may have to expand the volume of patient samples that we are able to process. We will also need to continue to develop our quality-control procedures and to establish more consistency with respect to test turnaround so that results are delivered in a timely manner. Thus, we will need to continue to develop and implement additional automated systems to perform our tests. We have installed laboratory information systems over the past few years to support the automated tests, analyze the data generated by our tests and report the results. If these systems do not work effectively as we scale up our processing of patient samples, we may experience processing or quality-control problems and may experience delays or failures in our operations. These problems, delays or failures could adversely impact the promptness and accuracy of our transaction processing, which could impair our ability to grow our business, generate revenue and achieve and sustain profitability. We have experienced periods during which processing of our test results was delayed and periods during which the proportion of samples for which results could not be generated were higher than expected. For example, in the fourth quarter of 2003, we completed an automation project, the implementation of which resulted in a temporary backlog of approximately $0.5 million at December 31, 2003 and in the third quarter of 2004 a higher than expected number of samples failed to generate results. While we are taking steps to minimize the likelihood of any recurrence of these issues, future delays, processing problems and backlog may nevertheless occur, resulting in the loss of our customers and/or revenue and an adverse effect on our results of operations.

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

The commercial opportunity for our products will be reduced or eliminated if our competitors develop and market new testing products that are superior to, or are less expensive than, the testing products that we develop using our proprietary technology. The biotechnology industry evolves at a rapid pace and is highly competitive. Our major competitors for our HIV testing products include manufacturers and distributors of phenotypic drug resistance technology, such as Tibotec-Virco (division of Johnson & Johnson) and Specialty Laboratories. We also compete with makers of genotypic test kits such as Applied Biosystems Group, Visible Genetics Inc. (division of Bayer Diagnostics) and laboratories performing genotypic testing as well as other genotypic testing referred to as virtual phenotyping.

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

Each of these competitors is attempting to establish its test as the standard of care. Our competitors may successfully develop and market other testing products that are either superior to those that we may develop or that are marketed prior to marketing of our testing products. 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. Some of these competitors have substantially greater financial resources, market presence and research and development staffs than we do. In addition, some of these competitors have significantly greater experience in developing products, and in obtaining the necessary regulatory approvals of products and processing and marketing products.

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

Our revenues to date consist, and for 2005 are anticipated to consist, largely of sales of PhenoSense products. For the years ended December 31, 2004 and 2003, Quest Diagnostics Incorporated, represented 12% and 9%, respectively, of our total revenue. The agreement with Quest expired in April 2005, but the parties continue to operate pursuant to its pricing terms temporarily while we negotiate a renewal. We cannot assure you that the agreement with Quest will be renewed on

commercially acceptable terms or that Quest will be an effective partner in commercialization of any of our products. For the years ended December 31, 2004 and 2003, approximately 31% and 29%, respectively, of our revenues were derived from tests performed for the beneficiaries of the Medicare and Medicaid programs. Gross accounts receivable balances from Medicare and Medicaid represented 29% and 35% of gross accounts receivable balance at March 31, 2005 and December 31, 2004, respectively. It is likely that we will have significant customer concentration in the future. The loss of any major customer, a slowdown in the pace of increasing physician and physician group sales as a percentage of sales, or the delay of significant orders from any significant customer, even if only temporary, could have a significant negative impact on our revenues and our ability to fund operations from revenues, generate cash from operations or achieve profitability.

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

We purchase some of the testing materials used in our laboratory operations from single qualified suppliers. Although these materials could be purchased from other suppliers, we would need to qualify the suppliers prior to using their materials in our commercial operations. Although we believe we have ample inventory to allow validation of another source, in the event of a material interruption of these supplies, the quantity of our inventory may not be adequate.

Any extended interruption, delay or decreased availability of the supply of these testing materials could prevent us from running our business as contemplated and result in failure to meet our customers’ demands. If significant customer relationships were harmed by our failure to meet customer demands, our revenues may decrease. We might also face significant additional expenses if we are forced to find alternate sources of supplies, or change materials we use. Such expenses could make it more difficult for us to attain profitability, offer our products at competitive prices and continue our business as currently contemplated or at all.

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

We license technology from Roche that we use in our PhenoSense and GeneSeq tests. We hold a non-exclusive license for the life of the patent term of the last licensed Roche patent. We believe that the last Roche patent expired in March of 2005 and were notified by Roche that the license was therefore terminated but advised us that additional licenses may be necessary. We are in the process of reviewing whether additional patients are necessary or useful for our operations. We believe such licenses are available on commercial terms.

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

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

With respect to our viral disease portfolio, we currently have 36 issued patents and 136 pending applications for additional patents, including international counterparts to our U.S. patents. With respect to our potential oncology products and eTag technology, we currently have approximately 142 granted, allowed, issued and pending patent applications in the United States and in other countries, including 15 issued or allowed patents. We have 134 granted, allowed, issued and pending patent applications in the United States and in other countries, including 58 issued or allowed patents, relating to the historic microfluidics business of ACLARA. We have licensed seven patents under the Roche license discussed above. These patents cover a broad range of technology applicable across our entire current and planned product line. We have also licensed certain technology from Third Wave Technologies.

Other companies may have patents or patent applications relating to products or processes similar to, competitive with or otherwise related to our current and planned products. Patent law relating to the scope of claims in the technology fields in which we operate, including biotechnology and information technology, is still evolving and, consequently, patent positions

in their industry are generally uncertain. We will not be able to assure you that we will prevail in any lawsuits regarding the enforcement of patent rights or that, if successful, we will be awarded commercially valuable remedies. In addition, it is possible that we will not have the required resources to pursue offensive litigation or to otherwise protect our patent rights.

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 their collaborative partners upon commencement of a relationship with them. 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 unintended disclosure 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.

In addition, 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 common 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 defending any such litigation or cannot obtain necessary licenses, we may have to pay substantial damages and/or be prohibited from selling our products.

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

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

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

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

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

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

In the past, the FDA has not required that genotypic or phenotypic testing conducted at a clinical laboratory be subject to premarketing clearance or approval, although the FDA has stated that it believes its jurisdiction extends to tests generated in a clinical laboratory. We received a letter from the FDA in September 2001 that asserted such jurisdiction over in-house tests like ours, but which also stated the FDA was not currently requiring premarket approval for HIV monitoring tests such as ours provided that the promotional claims for such tests are limited to its analytical capabilities and do not mention the benefit of making treatment decisions on the basis of test results. The FDA letter to us also asserted that our GeneSeq^™ test had been misbranded due to the use of purchased analyte specific reagents, or ASRs, if test reports do not include a statement disclosing that the test has not been cleared or approved by the FDA. Since 2002, we have utilized in-house prepared ASRs in our products. The FDA has indicated in discussions that the focus of the letter was our genotypic tests and not our phenotypic tests, but there is no certainty its focus will remain narrow.

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

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

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

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

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

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

These standards are complex, and subject to differences in interpretation. We will not be able to guarantee that our compliance measures will meet the specifications for any of these regulations. In addition, certain types of information,

including demographic information not usually provided to us by physicians, could be required by certain payors. As a result of inconsistent application of requirements by payors, or our inability to obtain billing information, we could face increased costs and complexity, a temporary disruption in receipts and ongoing reductions in reimbursements and net revenues. We cannot estimate the potential impact of payors implementing (or failing to implement) the HIPAA transaction standards on our cash flows and results of operations.

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

We may be unable to build brand loyalty because our trademarks and trade names may not be protected. We may not be able to build brand loyalty around the broader focus of the combined company after our merger with ACLARA.

Our registered or unregistered trademarks or trade names such as the names PhenoSense, PhenoSense GT, PhenoScreen, GeneSeq, and eTag may be challenged, canceled, infringed, circumvented or declared generic or determined to be infringing on other marks. We may not be able to protect our rights to these trademarks and trade names, which we need to build brand loyalty. Brand recognition is critical to our short-term and long-term marketing strategies especially as we commercialize future enhancements to our products. In particular as we broaden the company’s commercial focus from viral diseases to oncology and other serious diseases, we will attempt to establish a corporate identity for that broader business focus, possibly including a new corporate name and logo. Doing so could be expensive and time-consuming. We cannot assure you that we will be successful in establishing brand recognition and loyalty for the combined company.

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

Clinicians, patients and others may at times seek damages from us if drugs are incorrectly prescribed for a patient based on testing errors or similar claims. Although we have obtained product liability insurance coverage of up to $6 million, and expect to continue to maintain product liability insurance coverage, we will not be able to guarantee that insurance will continue to be available to us on acceptable terms or that our coverage will be sufficient to protect us against all claims that may be brought against us. We may not be able to maintain our current coverage, or obtain new insurance coverage for our planned future testing services and products, such as planned testing service and kits for use in connection with the treatment of cancer patients, on acceptable terms with adequate coverage, or at reasonable costs. We may incur significant legal defense expenses in connection with a liability claim, even one without merit or for which we have coverage.

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

We have historically used stock options and other forms of equity-related incentives as a key component of our employee compensation packages. We believe that stock options and other long-term equity incentives directly motivate our employees to maximize long-term stockholder value and, through the use of long-term vesting, encourage employees to remain with us. The Financial Accounting Standards Board has issued changes to the U.S. generally accepted accounting principles that will require us to record a charge to earnings for employee stock option grants and other option plans as of the first fiscal year that begins after June 15, 2005. Moreover, applicable stock exchange listing standards related to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant options to employees in the future, which may result in changes in our equity compensation strategy. These and other developments in the provision of equity compensation to employees could make it more difficult to attract, retain and motivate employees, and such a change in accounting rules may adversely impact our future financial condition and operating results.

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

In November 2002, we implemented a business restructuring plan. With the exception of one former employee, all of the employees terminated in connection with the business restructuring signed a release of claims. We have received correspondence from the one former employee that did not sign a release threatening to bring claims against us that stem from that termination. As part of our merger with ACLARA, ACLARA terminated approximately 20 of its 55 employees. It is not possible to predict whether any of these employees will assert a claim against us. We do not have employee practices liability insurance to cover any potential claims by employees terminated in the reduction of force or other employment-related claims. Even if we are eventually successful in the defense of such claims, the time and money spent may prevent it from operating our business effectively or profitably or may distract our management.

ACLARA, with which we merged, and certain of its former officers and directors, referred to together as 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, or 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 March 20, 2000 IPO 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 the defendants’ 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 ACLARA and the other issuer defendants. The proposed settlement, which was 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. We believe that ACLARA had sufficient insurance coverage to cover the maximum amount that we may be responsible for under the proposed settlement. While the Federal District Court has preliminarily approved the settlement it is possible that it may not give its final approval to the settlement in whole or part. If a final settlement is not reached or is not approved by the court, we believe that we have meritorious defenses and intend to vigorously defend against the suit. As a result of this belief, no liability for this suit has been recorded in the accompanying financial statements. However, we could be forced to incur significant expenses in the litigation, and in the event there is an adverse outcome, our business could be harmed.

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

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

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

We anticipate that our capital resources, together with funds from the sale of our products, contract revenue and borrowing under equipment financing arrangements, will enable us to maintain our current research and development, marketing, production and general administrative activities related to HIV drug resistance in the United States, together with the planned integration of ACLARA’s business and its eTag technology into our operations, through at least December 31, 2005. The integration of ACLARA’s eTag technology into our operations is expected to include the development of a testing service and possibly test kits for use in connection with the treatment of cancer patients. However, we may need additional funding to accomplish these goals. To the extent operating and capital resources are insufficient to meet our obligations, including lease payments and future requirements, we will have to raise additional funds to continue the development, commercialization and expansion of our technologies, including the eTag technology and products based on that technology. Our inability to raise capital would seriously harm our business and product development efforts. In addition, we may choose

to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. However, we cannot guarantee that additional financing, in any form, will be available at all, or on terms acceptable to us. If we sell equity or convertible debt securities to raise additional funds, our existing stockholders may incur substantial dilution and any shares so issued will likely have rights, preferences and privileges superior to the rights, preferences and privileges of our outstanding common and preferred stock. In the event financing is not available in the time frame required, we could be forced to reduce our operating expenses, curtail sales and marketing activities, reschedule research and development projects or delay, scale back or eliminate some or all of our activities. Further, we might be required to sell certain of our assets or obtain funds through arrangements with third parties that require us to relinquish rights to certain of our technologies or products that we would seek to develop or commercialize on our own. These actions, while necessary for the continuance of operations during a time of cash constraints and a shortage of working capital, could make it difficult or impossible to implement our long-term business plans or could affect our ability to continue as a going concern.

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

We rely on a single clinical laboratory facility to process patient samples for our tests, which are received via delivery service or mail, and have no alternative facilities. We will also use this facility for conducting other tests we develop, including eTag assays, and even if we move into different or additional facilities they will likely be in close proximity to our current clinical laboratory. Our clinical laboratories and some pieces of processing equipment are difficult to replace and could require substantial replacement lead-time. Our facilities may be affected by natural disasters such as earthquakes and floods. Earthquakes are of particular significance because our facilities are located in the San Francisco Bay Area, an earthquake-prone area, and we do not have insurance against earthquake loss. Our insurance coverage, if any, may not be adequate to cover total losses incurred in a natural disaster. However, even if covered by insurance, in the event our clinical laboratory facilities or equipment is affected by natural disasters, we would be unable to process patient samples and meet customer demands or sales projections. If our patient sample processing operations were curtailed or ceased, we would not be able to perform tests, which would reduce our revenues, and may cause us to lose the trust of our customers or market share.

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 will not be able to 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 do not maintain insurance coverage for damage caused by accidental release of hazardous chemicals, or exposure of individuals to hazardous chemicals off of our premises. 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 under a claim of this nature may exceed our total assets. Compliance with environmental laws and regulations is expensive, and current or future environmental regulations may impair our research, development or production efforts.

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

Following our merger with ACLARA, approximately 34% of our common stock is beneficially held by a small number of stockholders including our directors, our executive officers, and our greater than 5 percent stockholders. The most significant of these stockholders in terms of beneficial ownership are Perry Corp., Deutsche Bank AG, Tang Capital Partners, Sharat Singh and William Young. In addition, our Series A Preferred Stock is held by a small number of stockholders, some of whom also own shares of our common stock and could acquire significant additional shares of our common stock by converting shares of preferred stock. Consequently, a small number of our stockholders may be able to substantially influence our management and affairs. If acting together, they would be able to influence most matters requiring the approval by our stockholders, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets and any other significant corporate transaction. The concentration of ownership may also delay or prevent a change in control of ViroLogic at a premium price if these stockholders oppose it. There are also certain approval rights of the Series A Preferred Stock, and the few holders of those shares could prevent certain important corporate actions by not approving those actions.

Our stock price may be volatile, and our common stock could decline in value.

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

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

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

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

These obligations, and our complicated capitalization structure in general, might frustrate attempts to remove our board or management by making it difficult to find suitable replacements willing to spend substantial amounts of time and efforts on company matters. Moreover, these obligations may deter a potential acquirer from completing a transaction with us. They may also prevent us from taking corporate actions that would be beneficial to us and our stockholders, such as raising capital. Even if we are not prevented from taking such actions, they might be more expensive to us.

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

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

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

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

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

We could adopt a stockholder rights plan, commonly referred to as a “poison pill,” at any time without seeking the approval of our stockholders. Stockholder rights plans can act through a variety of mechanisms, but typically would allow our board of directors to declare a dividend distribution of preferred share purchase rights on outstanding shares of our common stock. Each such share purchase right would entitle our stockholders to buy a newly created series of preferred stock in the event that the purchase rights become exercisable. The rights would typically become exercisable if a person or group acquires over a predetermined portion of our common stock or announces a tender offer for more than a predetermined portion of our common stock. Under such a stockholder rights plan, if we were acquired in a merger or other business combination transaction which had not been approved by our board of directors, each right would entitle its holder to purchase, at the right’s then-current exercise price, a number of the acquiring company’s common shares at a price that is preferential to the holder of the right. If adopted by the our board of directors, a stockholder rights plan 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 us.

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, 2005 would have potentially declined by approximately $0.6 million.

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

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

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

Our Chief Executive Officer and Chief Financial Officer, with the assistance of other members of our management, have evaluated our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of the end of the period covered by this report, and have concluded based on that evaluation that those disclosure controls and procedures are effective.

Our management, including our Chief Executive Officer and Principal Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within ViroLogic have been detected.

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.

On March 24, 2005, we issued 395,875 shares of our common stock and on March 25, 2005, we issued 25,041 shares of our common stock to holders of our warrants upon the net exercise of the warrants by these holders. For these issuances, we relied on the exemption provided by Section 4(2) of the Securities Act.

On March 27, 2005, we issued 50,217 shares of our common stock with a market value of $115,000 as of the date of such issuance as a dividend on certain outstanding shares of Series A Preferred Stock. We received no consideration in connection with such issuance. For this issuance, we relied on the exemption provided by Section 4(2) of the Securities Act.

Pursuant to the requirements of the Securities Act of 1934, as amended, the registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of South San Francisco, County of San Mateo, State of California, on May 10, 2005.


		ViroLogic, Inc.

By:		/s/ William D. Young
		William D. Young
		Chief Executive Officer
		(On Behalf of the Registrant)

		/s/ Alfred G. Merriweather
		Alfred G. Merriweather
		Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)


		PAGE NO.
PART I. FINANCIAL INFORMATION Item 1. Financial Statements
Condensed Balance Sheets as of March 31, 2005 (unaudited) and December 31, 2004		3
Condensed Statements of Operations for the three months ended March 31, 2005 and 2004 (unaudited)		4
Condensed Statements of Cash Flows for the three months ended March 31, 2005 and 2004 (unaudited)		5
Notes to Condensed Financial Statements (unaudited)		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3. Quantitative and Qualitative Disclosures About Market Risk		43
Item 4. Controls and Procedures		43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45
Item 3. Defaults Upon Senior Securities		45
Item 4. Submission of Matters to a Vote of Security Holders		45
Item 5. Other Information		45
Item 6. Exhibits		45
Signatures		46


	March 31, 2005			December 31, 2004
	(Unaudited)			(Note 1)
ASSETS
Current assets:
Cash and cash equivalents	$	8,106		$	6,027
Short-term investments		66,470			72,821
Accounts receivable, net of allowance for doubtful accounts of $635 and $595 at March 31, 2005 and December 31, 2004, respectively		6,474			7,251
Prepaid expenses		824			838
Inventory		1,186			1,059
Restricted cash		350			350
Other current assets		1,100			584

Total current assets		84,510			88,930

Property and equipment, net		8,501			8,369
Restricted cash		107			107
Developed product technology		192			198
Goodwill		8,282			8,282
Other assets		1,923			1,749

Total assets	$	103,515		$	107,635

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,018		$	3,222
Accrued compensation		1,555			1,697
Accrued liabilities		2,512			6,993
Current portion of restructuring costs		1,841			2,519
Deferred revenue		958			546
Current portion of loans payable		258			439
Current portion of capital lease obligations		29			51

Total current liabilities		11,171			15,467

Contingent value rights		20,666			15,269
Long-term portion of loans payable		292			311
Long-term portion of capital lease obligations		32			36
Long-term portion of restructuring costs		1,587			1,710
Other long-term liabilities		354			359
Redeemable Series A convertible preferred stock, $0.001 par value, 249 shares authorized, designated by series, 249 shares issued and outstanding at March 31, 2005 and December 31, 2004; aggregate liquidation preference of $2,520 at March 31, 2005		1,810			1,810
Commitments and contingencies

Stockholders’ equity:

Preferred stock, $0.001 par value, 4,999,751 shares authorized, designated by series, none issued and outstanding at March 31, 2005 and December 31, 2004, respectively		—			—
Common stock, $0.001 par value, 200,000,000 shares authorized; 121,598,120 and 116,034,527 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively		122			116
Additional paid-in capital		263,206			260,591
Accumulated other comprehensive loss		(456	)		(57	)
Deferred compensation		(207	)		(275	)
Accumulated deficit		(195,062	)		(187,702	)

Total stockholders’ equity		67,603			72,673

Total liabilities and stockholders’ equity	$	103,515		$	107,635


	Three Months Ended March 31
	2005			2004
Revenue:
Product revenue	$	8,853		$	8,640
Contract revenue		1,141			382

Total revenue		9,994			9,022

Operating costs and expenses:
Cost of product revenue		4,212			4,416
Research and development		4,106			1,393
Sales and marketing		2,563			1,958
General and administrative		1,702			2,080
Lease termination charge		—			433

Total operating costs and expenses		12,583			10,280

Operating loss		(2,589	)		(1,258	)

Interest and other income, net		535			10
Contingent value rights revaluation		(5,306	)		0

Net loss		(7,360	)		(1,248	)
Preferred stock dividend		(86	)		(68	)

Loss applicable to common stockholders	$	(7,446	)	$	(1,316	)

Basic and diluted net loss per common share	$	(0.06	)	$	(0.02	)

Weighted-average shares used in computing basic and diluted net loss per common share		117,353			53,137


	Three Months Ended March 31,
	2005			2004
OPERATING ACTIVITIES:
Net loss	$	(7,360	)	$	(1,248	)
Adjustments to reconcile net loss to net cash provided by/(used in) operating activities:
Contingent value rights revaluation		5,306			—
Depreciation and amortization		802			720
Stock-based compensation expense/(adjustment)		(2,078	)		12
Provision for doubtful accounts		97			—
Loss on disposal of property and equipment		—			108
Change in assets and liabilities:
Accounts receivable		680			(416	)
Prepaid expenses		14			151
Inventory		(126	)		119
Other current assets		(516	)		116
Accounts payable		954			260
Accrued compensation		(142	)		425
Accrued lease termination		—			189
Accrued liabilities		138			(381	)
Accrued restructuring costs		(801	)		—
Deferred revenue		407			384
Other long-term liabilities		91			3

Net cash provided by/(used in) operating activities		(2,534	)		442

INVESTING ACTIVITIES:
Purchases of short-term investments		(10,067	)		—
Maturities and sales of short-term investments		16,019			286
Capital expenditures		(929	)		(173	)
Transaction costs related to merger		(4,689	)		—
Other assets		(174	)		(124	)

Net cash provided by/(used in) investing activities		160			(11	)

FINANCING ACTIVITIES:
Principal payments on loans payable		(200	)		(79	)
Payments on capital lease obligations		(26	)		(161	)
Proceeds from issuance of common stock		4,679			149

Net cash provided by/(used in) financing activities		4,453			(91	)

Net increase in cash and cash equivalents		2,079			340
Cash and cash equivalents at the beginning of the period		6,027			8,893

Cash and cash equivalents at the end of the period	$	8,106		$	9,233


	March 31, 2005		December 31, 2004
	(In thousands)
Raw materials	$	751	$	658
Work in process		435		401

Total	$	1,186	$	1,059


	Three Months Ended March 31,
	2005			2004
	(In thousands, except per share data)
Net loss:
As reported	$	(7,360	)	$	(1,248	)
Deduct:
Stock-based compensation adjustment included in reported net loss		(2,096	)		—
Deduct:
Stock-based compensation expense for employee awards determined under SFAS 123		(765	)		(529	)

Pro forma net loss		(10,221	)		(1,777	)
Preferred stock dividend		(86	)		(68	)

Pro forma loss applicable to common stockholders	$	(10,307	)	$	(1,845	)

Loss per common share:
As reported	$	(0.06	)	$	(0.02	)

Pro forma	$	(0.09	)	$	(0.03	)


Fair value of ViroLogic’s common stock	$	120,308
Fair value of CVRs related to ACLARA common stock outstanding and vested stock options		43,774
Fair value of ACLARA stock options assumed		9,243
Direct transaction costs		4,635

	$	177,960


Tangible assets acquired:
Cash and cash equivalents	$	2,118
Short-term investments		72,728
Accounts receivable, inventory and other current assets		827
Property and equipment		2,054
Other long-term assets		100
Restructuring accrual, current portion		(2,344	)
Other current liabilities		(4,883	)
Restructuring accrual, long-term portion		(1,710	)
Other long-term liabilities		(311	)

				$	68,579
Deferred compensation related to unvested ACLARA options assumed					299
Intangible assets acquired:
Developed product technology		200
In-process research and development		100,600
Goodwill		8,282			109,082

				$	177,960


	Payments Due By Period								Total
	Less than 1 year		2-3 years		4-5 years		Thereafter		Total
	(In thousands)
Operating leases	$	2,972	$	5,241	$	3,508	$	89	$	11,810
Capital leases		32		32		8		—		72
Loans		288		202		159		—		649

Total	$	3,292	$	5,475	$	3,675	$	89	$	12,531


	Abandonment of facilities			Severance			Total
Liabilities assumed in merger with ACLARA	$	3,000		$	1,054		$	4,054
Amounts paid in cash		(24	)		—			(24	)

Balance at December 31, 2004	$	2,976		$	1,054		$	4,030
Amounts paid in cash	$	(118	)	$	(637	)	$	(755	)

Balance at March 31, 2005	$	2,858		$	417		$	3,275

Current portion	$	1,271		$	417		$	1,688

Non-current portion	$	1,587		$	—		$	1,587


Infectious disease products in development		Status
Replication Capacity HIV, a measurement of fitness		In development(1)
PhenoSense HIV Entry and GeneSeq HIV Entry Assays, entry inhibitor assays		In development(2)
PhenoSense and GeneSeq HIV Integrase		In development(3)
PhenoSense HIV Vaccine Entry, an entry neutralization assay		In development(4)
PhenoSense HCV, a phenotypic hepatitis C test		In development(5)
GeneSeq HCV, a genotypic hepatitis C test		In development(5)


Oncology products in development		Status
Clinical assays for use in clinical trials by pharmaceutical and biotechnology customers		In development(1)
Clinical assays for diagnostic use in patient testing		In development(2)


Exhibit Number		Caption
10.38		ViroLogic, Inc. 2005 Bonus Plan Description

10.39		ViroLogic, Inc. Non-Employee Director Cash Compensation Arrangements

31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(A) or Rule 15d-14(A) promulgated under the Securities Exchange Act of 1934.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(A) or Rule 15d-14(A) promulgated under the Securities Exchange Act of 1934.

32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(B) or Rule 15d-14(B) promulgated under the Securities Exchange Act of 1934.