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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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FORM 10-Q

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(MARK ONE)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001

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

FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .

COMMISSION FILE NUMBER: 000-30369

VIROLOGIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 94-3234479
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

270 EAST GRAND AVENUE
SOUTH SAN FRANCISCO, CA 94080
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

TELEPHONE NUMBER (650) 635-1100
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)

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 [ ]

As of November 12, 2001, there were 20,443,621 shares of the registrant's
common stock outstanding.

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VIROLOGIC, INC.

INDEX

PAGE
NO.
----

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
Condensed Balance Sheets as of September 30, 2001 and December 31, 2000................................. 3
Condensed Statements of Operations for the three and nine months ended September 30, 2001 and 2000...... 4
Condensed Statements of Cash Flows for the nine months ended September 30, 2001 and 2000................ 5
Notes to Condensed Financial Statements................................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.............................................. 13

PART II. OTHER INFORMATION

Item 1. Legal Proceedings....................................................................................... 22
Item 2. Changes in Securities and Use of Proceeds............................................................... 22
Item 3. Defaults Upon Senior Securities......................................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders..................................................... 22
Item 5. Other Information....................................................................................... 23
Item 6. Exhibits and Reports on Form 8-K........................................................................ 23
SIGNATURES....................................................................................................... 24

VIROLOGIC, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS)

SEPTEMBER 30, DECEMBER 31,
2001 2000
------------- ------------
(UNAUDITED) (NOTE 1)

ASSETS
Current assets:
Cash and cash equivalents ............................................... $ 10,189 $ 12,623
Short-term investments .................................................. 7,746 11,171
Accounts receivable, net of allowance for doubtful accounts of $423 in
2001 and $175 in 2000 ................................................ 3,143 2,404
Inventory ............................................................... 823 449
Restricted cash ......................................................... 600 1,050
Other current assets .................................................... 1,681 1,152
-------- --------
Total current assets ............................................ 24,182 28,849
Property and equipment, net ............................................... 18,473 13,234
Restricted cash ........................................................... 1,000 979
Other assets .............................................................. 890 585
-------- --------
Total assets .................................................... $ 44,545 $ 43,647
======== ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................ $ 2,917 $ 1,865
Accrued compensation .................................................... 1,994 1,305
Accrued liabilities ..................................................... 2,368 2,678
Advance from subtenant .................................................. 1,300 --
Deferred revenue ........................................................ 321 116
Current portion of capital lease obligations ............................ 756 398
Current portion of loans payable ........................................ 1,079 1,390
-------- --------
Total current liabilities ....................................... 10,735 7,752
Long-term advance from subtenant .......................................... 1,300 --
Long-term portion of capital lease obligations ............................ 1,153 945
Long-term portion of loans payable ........................................ 234 1,019
Other long-term liabilities ............................................... 267 288
Redeemable convertible preferred stock .................................... 11,457 --
Commitments and contingencies
Stockholders' equity:
Common stock ............................................................ 20 20
Additional paid-in capital .............................................. 92,673 88,772
Deferred compensation ................................................... (1,164) (2,495)
Accumulated other comprehensive income .................................. 125 178
Notes receivable from officers and employees ............................ -- (31)
Accumulated deficit ..................................................... (72,255) (52,801)
-------- --------
Total stockholders' equity ...................................... 19,399 33,643
-------- --------
Total liabilities and stockholders' equity ...................... $ 44,545 $ 43,647
======== ========

See accompanying notes to Condensed Financial Statements.

VIROLOGIC, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2001 2000 2001 2000
-------- -------- -------- --------

Revenue:
Product revenue ................................ $ 4,283 $ 1,885 $ 11,922 $ 4,709
NIH grant revenue .............................. 120 -- 338 --
-------- -------- -------- --------
Total revenue .......................... 4,403 1,885 12,260 4,709
Operating costs and expenses:
Cost of product revenue ........................ 2,760 1,237 8,172 3,369
Research and development ....................... 3,106 2,898 8,750 7,558
General and administrative ..................... 2,851 2,783 8,423 7,909
Sales and marketing ............................ 2,354 1,498 7,026 3,386
-------- -------- -------- --------
Total operating costs and expenses ..... 11,071 8,416 32,371 22,222
-------- -------- -------- --------
Operating loss ................................... (6,668) (6,531) (20,111) (17,513)
Interest income .................................. 223 661 980 1,290
Interest expense ................................. (111) (64) (323) (192)
-------- -------- -------- --------
Net loss ......................................... (6,556) (5,934) (19,454) (16,415)
Deemed dividend to preferred stockholders ........ (2,269) -- (2,269) (15,700)
Preferred stock dividend ......................... (103) -- (103) --
-------- -------- -------- --------
Net loss applicable to common stockholders ....... $ (8,928) $ (5,934) $(21,826) $(32,115)
======== ======== ======== ========
Basic and diluted net loss per common share ...... $ (0.45) $ (0.30) $ (1.09) $ (2.43)
======== ======== ======== ========
Weighted-average shares used in computing basic
and diluted net loss per common share .......... 20,033 19,743 19,956 13,189
======== ======== ======== ========

See accompanying notes to Condensed Financial Statements.

VIROLOGIC, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2001 2000
-------- --------

OPERATING ACTIVITIES
Net loss ....................................................................... $(19,454) $(16,415)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ................................................ 2,311 1,105
Non-cash stock-based compensation ............................................ 1,478 3,250
Allowance for doubtful accounts .............................................. 248 63
Changes in assets and liabilities:
Accounts receivable ....................................................... (987) (1,738)
Inventory ................................................................. (374) (126)
Other current assets ...................................................... (529) (929)
Accounts payable .......................................................... 136 645
Accrued compensation ...................................................... 689 1,325
Accrued liabilities ....................................................... (981) (110)
Deferred revenue .......................................................... 205 302
Other long-term liabilities ............................................... (21) --
-------- --------
Net cash used in operating activities ................................ (17,279) (12,628)
INVESTING ACTIVITIES
Intangible and other assets .................................................... (305) (204)
Purchases of short-term investments ............................................ (6,748) (38,808)
Maturities and sales of short-term investments ................................. 10,120 8,135
Restricted cash ................................................................ 429 (1,064)
Capital expenditures ........................................................... (5,122) (4,512)
Advance from subtenant ......................................................... 2,600 --
-------- --------
Net cash provided by (used in) investing activities .................. 974 (36,453)
FINANCING ACTIVITIES
Proceeds from loans payable .................................................... -- 1,216
Principal payments on loans payable ............................................ (1,096) (854)
Principal payments on capital lease obligations ................................ (378) --
Net proceeds from issuance of common stock ..................................... 427 31,810
Repayments of notes receivable ................................................. -- 7
Net proceeds from issuance of preferred stock .................................. 14,918 15,700
-------- --------
Net cash provided by financing activities ............................ 13,871 47,879
-------- --------
Net decrease in cash and cash equivalents ............................ (2,434) (1,202)
Cash and cash equivalents at beginning of period ............................... 12,623 2,208
-------- --------
Cash and cash equivalents at end of period ..................................... $ 10,189 $ 1,006
======== ========

See accompanying notes to Condensed Financial Statements.

VIROLOGIC, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed financial statements have been prepared
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 accounting principles generally accepted
in the United States 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 nine-month period ended September 30, 2001
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2001. The condensed balance sheet as of December 31, 2000
has been derived from the audited financial statements as of that date but does
not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial
statements. For further information, refer to the audited financial statements
and notes thereto included in our Annual Report to Stockholders on Form 10-K for
the year ended December 31, 2000.

Use of Estimates

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.

Revenue Recognition

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,
including Medicare. Billings for services under third-party payor programs are
included in revenues net of allowances for contractual discounts and allowances
for differences between the amounts billed and estimated payment amounts.
National Institutes of Health ("NIH") grant revenue is recorded on a
reimbursement basis as grant costs are incurred. Costs associated with NIH grant
revenue are included in research and development expenses. Deferred revenue
relates to cash received in advance of delivery of test results.

Inventory

Inventory is stated at the lower of standard cost, which approximates actual
cost, or market. At September 30, 2001 and December 31, 2000, inventories
consisted mainly of raw materials used in the performance of tests.

Reclassification

Certain reclassifications of prior year amounts have been made to conform
with the current year presentation.

Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 requires the Company
to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through net income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the fair
value of the derivative are either offset against the change in fair value of
assets, liabilities, or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of the derivative's change in fair value will be immediately
recognized in earnings. SFAS 133 is effective for the Company's year ending
December 31, 2001. The Company does not currently hold any derivatives and
therefore the adoption of SFAS 133 had no impact on the Company's financial
statements.

disposal of long-lived assets and supercedes SFAS No. 121 "Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of." SFAS
144 will be effective on April 1, 2002. The adoption of SFAS 144 is not expected
to have a significant impact on the Company's financial position.

2. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) is comprised of net income (loss) and other
comprehensive income (loss). Other comprehensive income includes certain changes
in equity that are excluded from net income (loss). Specifically, unrealized
gains and losses on the Company's available-for-sale securities, which are
reported separately in stockholders' equity, are included in accumulated other
comprehensive income. Comprehensive income (loss) and its components for the
three and nine months ended September 30, 2001 and 2000 are as follows (in
thousands):

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -----------------------
2001 2000 2001 2000
------- ------- -------- --------
(UNAUDITED) (UNAUDITED)

Net loss ........................................ $(6,556) $(5,934) $(19,454) $(16,415)
Changes in unrealized gain (loss) on securities
available-for-sale, net of tax ............... 37 -- (53) --
------- ------- -------- --------
Comprehensive loss ............................... $(6,519) $(5,934) $(19,507) $(16,415)
======= ======= ======== ========

3. NET LOSS PER SHARE

Basic earnings (loss) per share is calculated based on the weighted-average
number of common shares outstanding during the periods presented, less the
weighted-average shares outstanding which are subject to the Company's right of
repurchase. Diluted earnings per share would give effect to the dilutive effect
of common stock equivalents consisting of convertible preferred stock and stock
options and warrants, calculated using the treasury stock method. Potentially
dilutive securities have been excluded from the diluted earnings per share
computations as they have an antidilutive effect due to the Company's net loss.

The computation of pro forma net loss per share includes shares issued upon
the automatic conversion of outstanding preferred stock upon the completion of
the Company's initial public offering, assuming such shares were originally
issued as common stock at their respective issuance dates.

A reconciliation of pro forma basic and diluted net loss per common share is
as follows (in thousands, except per share data):

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2001 2000 2001 2000
-------- -------- -------- --------
(UNAUDITED) (UNAUDITED)

ACTUAL:
Net loss ................................................. $ (6,556) $ (5,934) $(19,454) $(16,415)
Deemed dividend to preferred stockholders ................ (2,269) -- (2,269) (15,700)
Preferred stock dividend ................................. (103) -- (103) --
-------- -------- -------- --------
Net loss applicable to common stockholders ............... $ (8,928) $ (5,934) $(21,826) $(32,115)
======== ======== ======== ========
Weighted-average shares of common stock outstanding ...... 20,036 19,772 19,964 13,234
Less: weighted-average shares subject to repurchase ...... (3) (29) (8) (45)
-------- -------- -------- --------
Weighted-average shares used in basic and diluted
net loss per common share .............................. 20,033 19,743 19,956 13,189
======== ======== ======== ========
Basic and diluted net loss per common share .............. $ (0.45) $ (0.30) $ (1.09) $ (2.43)
======== ======== ======== ========
PRO FORMA:
Net loss applicable to common stockholders ............... $(32,115)
========
Shares used above ........................................ 13,189
Adjusted to reflect weighted-average effect of assumed
conversion of preferred stock .......................... 3,694
--------
Weighted-average shares used in pro forma basic
and diluted net loss per common share .................. 16,883
========
Pro forma basic and diluted net loss per common share .... $ (1.90)
========

4. SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK

On June 29, 2001, we entered into a securities purchase agreement with
several investors to issue and sell, in a private placement, an aggregate of
1,625 shares of Series A redeemable convertible preferred stock ("Series A
Preferred Stock") with warrants to purchase an aggregate of 3.19 million shares
of common stock, for an aggregate purchase price of $16.25 million. The
securities purchase agreement contemplated two closings, each for a portion of
the Series A Preferred Stock and the warrants. The first closing occurred on
July 2, 2001, and we received gross proceeds of $6.65 million. The second and
final closing occurred on September 27, 2001, and we received gross proceeds of
$9.6 million. The rights, preferences and privileges of the Series A Preferred
Stock are set forth in the Certificate of Designations, Preferences and Rights
filed with the Delaware Secretary of State. The warrants are subject to the
terms and conditions of the stock purchase warrant issued by us and evidencing
the warrants. We filed registration statements with the Securities and Exchange
Commission, following the first closing and second closing, respectively,
covering the resale of the shares of our common stock issuable upon conversion
of the Series A Preferred Stock, issuable upon exercise of the warrants and that
may become issuable pursuant to the respective rights, preferences and
privileges of the Series A Preferred Stock and warrants. The registration
statement for the first closing was effective September 24, 2001 and the
registration statement for the second closing, which superceded the registration
statement for the first closing and covers the Series A Preferred Stock and
warrants issued in the first and second closing, was effective October 12, 2001.

The Series A Preferred Stock bears an initial 6% annual premium rate,
payable as a dividend, which increases to an 8% annual rate after two years,
then increases by 2% every six months up to a maximum of 14%, payable twice a
year in shares of common stock. The holders of Series A Preferred Stock may
elect to convert their shares into our common stock at any time, just as they
may choose to exercise their warrants at any time. We may, at our 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
our stock price exceeds $5.10 for 20 consecutive trading days. We may also, at
our 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 referenced above 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 our common
stock.

We recorded a deemed dividend of $2.3 million, in the third quarter of 2001,
relating to the beneficial conversion feature of the Series A Preferred Stock.
The deemed dividend increases the loss applicable to common stockholders in the
calculation of basic and diluted net loss per common share and is included in
stockholders' equity as offsetting charges and credits to additional
paid-in-capital.

The investors of Series A Preferred Stock have the right to require us 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, upon
certain triggering events, as defined in our Certificate of Designations,
Preferences and Rights of Series A Convertible Preferred Stock. In addition, we
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, we excluded
the Series A Preferred Stock from equity in our financial statements. The net
proceeds attributable to the warrants of $3.5 million are included in
additional-paid-in-capital.

5. BUILDING SUBLEASE

In July 2001, we began leasing an additional 54,000 square feet of
laboratory and office space. Initially, this facility will provide more space
than is required for our currently planned operations. As a result, we sublet
approximately 40,000 square feet to a third party for a term of approximately
two years, commencing October 1, 2001. In September 2001, we received a $2.6
million advance from the subtenant as specified in our sublease agreement.

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.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain forward-looking
statements within the meaning of the "safe harbor" provisions of the Private
Securities Litigation Reform Act of 1995 including, without limitation,
statements regarding our PhenoSense and GeneSeq testing products, the growth of
our pharmaceutical business, research and development expenditures, adequacy of
our capital resources, and other financial matters. These statements, which
sometimes include words such as "expect," "goal," "may," "anticipate," "should,"
"continue," or "will," reflect our expectations and assumptions as of the date
of this Quarterly Report based on currently available operating, financial and
competitive information. Actual results could differ materially from those in
the forward looking statements as a result of a number of factors, including our
ability to raise additional capital, the market acceptance of our resistance
testing products, the effectiveness of our competition's existing products and
new products, the ability to effectively manage growth and the risks associated
with our dependence on patents and proprietary rights. These factors and others
are more fully described in "Risk Factors" and elsewhere in this Form 10-Q. We
assume no obligation to update any forward-looking statements.

OVERVIEW

We are a biotechnology company developing, marketing and selling innovative
products to guide and improve treatment of viral diseases. We incorporated in
the state of Delaware on November 14, 1995 and commenced commercial operations
in 1999. We developed a practical way of directly measuring the impact of
genetic mutations on drug resistance and using this information to guide
therapy. We have proprietary technology, called PhenoSense, for testing drug
resistance in viruses that cause serious viral diseases such as HIV/AIDS,
hepatitis B and hepatitis C. Our first product, PhenoSense HIV, is a test that
directly and quantitatively measures resistance of a patient's HIV to anti-viral
drugs. In addition, we developed GeneSeq HIV to examine and evaluate the genetic
sequences of a patient's HIV. The test results help physicians select
appropriate drugs for their HIV patients. We are also developing resistance
testing products for other serious viral diseases. We are collecting resistance
test results and related clinical data in an interactive database that we may
use to assist our pharmaceutical customers in drug marketing and drug
development and make available to physicians for use in therapy guidance. Our
other products and products in development include: (i) PhenoSense GT, for HIV,
which combines the features of our PhenoSense and GeneSeq products; (ii)
PhenoSense HBV and GeneSeq HBV, for hepatitis B; (iii) PhenoSense HCV and
GeneSeq HCV, for hepatitis C; (iv) an entry assay, to measure HIV resistance
entry inhibitors; and (v) a test to measure viral fitness, which is a measure of
a virus's ability to reproduce and infect new cells. We believe our products
have the potential to revolutionize the way physicians treat many serious viral
diseases.

SERIES A REDEEMABLE CONVERTIBLE PREFERRED STOCK

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 our
stock price exceeds $5.10 for 20 consecutive trading days. We may also, at our
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 referenced above are effective.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2001 and 2000

Revenue. Revenue increased to $4.4 million in the third quarter of 2001 from
$1.9 million in the corresponding quarter of 2000, an increase of $2.5 million.
The increase was primarily attributable to greater sales of PhenoSense HIV and
GeneSeq HIV. In addition, we were awarded National Institutes of Health ("NIH")
research grants to develop new technologies to measure HIV resistance to entry
inhibitors and viral replication capacity or "fitness." We plan to continue to
expand our patient testing business as well as our pharmaceutical business,
which is comprised of resistance testing for clinical studies, drug screening,
characterization and basic research.

Cost of product revenue. Cost of product revenue increased to $2.8 million in
the third quarter of 2001 from $1.2 million in the corresponding quarter of
2000, an increase of $1.5 million. The increase in cost of product revenue was
due to the higher volume of testing provided in the third quarter of 2001 and
continued expansion of our clinical laboratory activities. Included in these
costs are materials and supplies, labor and overhead related to the tests. We
anticipate that the total cost of product revenue will increase and gross
margins will improve as we increase the volume of our testing.

Research and development. Research and development expenses increased to $3.1
million in the third quarter of 2001 from $2.9 million in the corresponding
quarter of 2000, an increase of $0.2 million. These expenses are primarily
related to research and development efforts to enhance our resistance testing
products and include costs associated with NIH grant revenue. We expect research
and development spending to increase over the next several years as we expand
our research, product development and automation efforts for other viral
diseases.

General and administrative. General and administrative expenses increased to
$2.9 million in the third quarter of 2001 from $2.8 million in the corresponding
quarter of 2000, an increase of $0.1 million. The increase was primarily due to
greater spending on salaries and benefits resulting from increased headcount and
additional corporate infrastructure to support our revenue growth. The increase
was partially offset by a reduction in non-cash compensation expenses related to
vesting of stock and options granted prior to our initial public offering.

Sales and marketing. Sales and marketing expenses increased to $2.4 million
in the third quarter of 2001 from $1.5 million in the corresponding quarter of
2000, an increase of $0.9 million. This increase was primarily due to the
deployment and expansion of our sales force and increased spending on public
relations and marketing programs related to the commercialization of our
products.

Interest income. Interest income decreased to $223,000 in the third quarter
of 2001 from $661,000 in the corresponding quarter of 2000, a decrease of
$438,000. This decrease was primarily due to lower average cash balances
resulting from expenditures made to support growth in company operations and
lower interest rates.

Interest expense. Interest expense increased to $111,000 in the third quarter
of 2001 from $64,000 in the corresponding quarter of 2000, an increase of
$47,000. This increase was primarily due to increased equipment financing.

Nine Months Ended September 30, 2001 and 2000

Revenue. Revenue increased to $12.3 million in the first nine months of 2001
from $4.7 million in the corresponding period of 2000, an increase of $7.6
million. The increase was primarily attributable to greater sales of PhenoSense
HIV and GeneSeq HIV resulting from increased market penetration. In addition,
we were awarded NIH research grants to develop new technologies to measure HIV
resistance to entry inhibitors and viral replication capacity or "fitness." We
plan to continue to expand our patient testing business as well as our
pharmaceutical business, which is comprised of resistance testing for clinical
studies, drug screening, characterization and basic research.

Cost of product revenue. Cost of product revenue increased to $8.2 million in
the first nine months of 2001 from $3.4 million in the corresponding period of
2000, an increase of $4.8 million. The increase in cost of product revenue was
due to the higher volume of testing provided in the nine months of 2001 and
continued expansion of our clinical laboratory activities. Included in these
costs are materials and supplies, labor and overhead related to the tests. We
anticipate that the total cost of product revenue will increase and gross
margins will improve as we increase the volume of our testing.

Research and development. Research and development expenses increased to $8.8
million in the first nine months of 2001 from $7.6 million in the corresponding
period of 2000, an increase of $1.2 million. These expenses are primarily
related to research and development efforts to enhance our resistance testing
products and include costs associated with NIH grant revenue. We expect research
and development spending to increase over the next several years as we expand
our research, product development and automation efforts for other viral
diseases.

General and administrative. General and administrative expenses increased to
$8.4 million in the first nine months of 2001 from $7.9 million in the
corresponding period of 2000, an increase of $0.5 million. The increase was
primarily due to greater spending on salaries and benefits resulting from
increased headcount and additional corporate infrastructure to support our
revenue growth. The increase was partially offset by a reduction in non-cash
compensation expenses related to granting stock and options prior to our initial
public offering.

Sales and marketing. Sales and marketing expenses increased to $7.0 million
in the first nine months of 2001 from $3.4 million in the corresponding period
of 2000, an increase of $3.6 million. This increase was primarily due to the
deployment and expansion of our sales force and increased spending on public
relations and marketing programs related to the commercialization of our
products.

Interest income. Interest income decreased to $1.0 million in the first nine
months of 2001 from $1.3 million in the corresponding period of 2000, a decrease
of $0.3 million. This decrease was primarily due to lower average cash balances
resulting from expenditures made to support growth in company operations and
lower interest rates.

Interest expense. Interest expense increased to $323,000 in the first nine
months of 2001 from $192,000 in the corresponding period of 2000, an increase of
$131,000. This increase was primarily due to increased equipment financing.

RECENT ACCOUNTING PRONOUNCEMENTS

In August 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 addresses the financial accounting and reporting for the
impairment or disposal of long-lived assets and supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of." SFAS 144 will be effective on April 1, 2002. The adoption of SFAS
144 is not expected to have a significant impact on the Company's financial
position.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations since inception primarily through public and
private sales of common and preferred stock and equipment financing
arrangements. As of September 30, 2001, we had an accumulated deficit of
approximately $72.3 million. Management expects to continue to incur substantial
operating losses for at least the next year primarily as a result of expected
increases in expenses for:

- Expanding patient sample processing capabilities

- Research and product development costs

- Sales and marketing

- Additional clinical laboratory and research space and other necessary
facilities

- General and administrative costs

Net cash used in operating activities was $17.3 million and $12.6 million for
the nine months ended September 30, 2001 and 2000, respectively. Cash used in
operating activities primarily relates to ongoing operating losses as discussed
above.

Net cash provided by investing activities was $1.0 million for the nine
months ended September 30, 2001, and net cash used in investing activities was
$36.5 million for the nine months ended September 30, 2000. In September 2001,
we received $2.6 million as an advance from a subtenant as specified in the
sublease agreement. The higher amount used in investing activities in 2000 is
due to the investment of our initial public offering proceeds.

Net cash provided by financing activities was $13.9 million and $47.9 million
for the nine months ended September 30, 2001 and 2000, respectively. During the
third quarter of 2001, we completed an offering of Series A Preferred Stock with
warrants for an aggregate purchase price of $16.25 million. See Series A
Redeemable Convertible Preferred Stock disclosure in the overview section of the
Management's Discussion and Analysis above. The higher amount for 2000 is due
primarily to the sale of Series C preferred stock for approximately $15.7
million in January and February 2000 and the proceeds from our initial public
offering.

We believe that our available cash, investments and short-term restricted
cash of $18.5 million as of September 30, 2001, available borrowing capacity
under existing equipment financing arrangements and cash flows generated from
subletting a portion of our facilities will be adequate to fund our operations
to at least the second quarter of 2002. In addition, we plan to continue to
evaluate with our investment bankers, UBS Warburg LLC and CIBC World Markets,
various strategic opportunities, including research and development
collaborations, international alliances, marketing partnerships, and financing
opportunities.

To the extent operating and capital resources are insufficient to meet future
requirements, we will have to raise additional funds to continue the development
and commercialization of future technologies and our business operations in
general. These funds may not be available on favorable terms, or at all. If
adequate funds are not available on attractive terms, we may be required to
curtail operations significantly or to obtain funds by entering into financing,
supply or collaboration agreements on unattractive terms. 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.

We lease 120,000 square feet of laboratory and office space in South San
Francisco, California. We began leasing 54,000 square feet of this laboratory
and office space in July 2001. Initially, this facility will provide more space
than is required for our planned operations. As a result, we sublet
approximately 40,000 square feet to a third party for approximately two years,
commencing October 1, 2001. In September 2001, we received $2.6 million as an
advance from our subtenant as specified in the sublease agreement. We have
committed to spend an additional $1 million in tenant improvements for the new
facility. We also sublease approximately 12,000 square feet of one of our
existing facilities to another third party for a term of approximately two
years. The income generated from

the subleases is greater than our lease obligations for those spaces. Leases on
our current and future facilities expire in the years 2004 and 2011,
respectively. All leases provide options to extend.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we invest in
may have market risk. This means that a change in prevailing interest rates may
cause the principal amount of the investment to fluctuate. For example, if we
hold a security that was issued with a fixed interest rate at the
then-prevailing rate and the prevailing interest rate later rises, the principal
amount of our investment will probably decline. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and short-term
investments in a variety of securities, including commercial paper, money market
funds, government and non-government debt securities. Due to the relatively
short-term nature of our investments, we believe we do not have material
exposure to interest rate risk arising from our investments. Therefore we have
not included quantitative tabular disclosure in this Form 10-Q.

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 believe we do not have any material
exposure to foreign currency rate fluctuations.

RISK FACTORS

You should carefully consider the following factors and other information in
this Form 10-Q when considering our company and its stock.

WE EXPECT TO INCUR FUTURE OPERATING LOSSES AND MAY NOT ACHIEVE PROFITABILITY,
WHICH MAY CAUSE OUR STOCK PRICE TO FALL.

We have experienced significant and increasing operating losses each year
since our inception. We experienced net losses applicable to common stockholders
of approximately $38.9 million, $20.2 million, and $8.1 million in 2000, 1999
and 1998, respectively. As of September 30, 2001, we had an accumulated deficit
of approximately $72.3 million. We expect to continue to incur substantial
operating losses for at least the next year primarily as a result of expected
increases in expenses for:

- Expanding patient sample processing capabilities

- Research and product development costs

- Sales and marketing

- Additional clinical laboratory and research space and other necessary
facilities

- General and administrative costs

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

IF WE NEED TO RAISE ADDITIONAL CAPITAL AND IT IS NOT AVAILABLE ON COMMERCIALLY
REASONABLE TERMS, OUR ABILITY TO OPERATE OUR BUSINESS MAY BE DIMINISHED.

We anticipate that our existing capital resources will enable us to maintain
currently planned operations to at least the second quarter of 2002.
Nevertheless, due to the expected nature of our operations, we will need to
secure additional financings in order to continue our business, and may need
additional financings in the shorter term. We raised $16.25 million in our
private placement, but these funds do not alleviate our need for future capital.
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. To the extent that
additional capital is raised through the sale of equity or convertible debt
securities, the issuance of these securities could result in dilution to our
stockholders. To the extent

operating and capital resources are insufficient to meet future requirements, we
will have to raise additional funds to continue the development and
commercialization of our technologies. These funds may not be available on
favorable terms, or at all. If adequate funds are not available on attractive
terms, we may be required to curtail operations significantly or to obtain funds
by entering into financing, supply or collaboration agreements on unattractive
terms.

OUR TESTING PRODUCTS MAY NOT ACHIEVE MARKET ACCEPTANCE, WHICH COULD LIMIT OUR
FUTURE REVENUE.

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

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

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

OUR REVENUES WILL BE DIMINISHED IF PAYORS DO NOT AUTHORIZE REIMBURSEMENT FOR OUR
PRODUCTS.

Government and third-party payors, which reimburse patients and healthcare
providers for medical expenses, are attempting to contain or reduce the costs of
healthcare. This could limit the price that we can charge for our products and
hurt our ability to generate revenues. In the United States, federal and state
government healthcare programs have been attempting to reduce costs and
otherwise implement government control of healthcare costs. In addition,
increasing emphasis on managed care in the United States will continue to put
pressure on the pricing of healthcare products. Significant uncertainty exists
as to the reimbursement status of new medical products like PhenoSense HIV,
especially in light of any negative results from clinical studies. Third-party
payors, including state payors and Medicare, have challenged the prices charged
for medical products and services. If government and other third-party payors do
not provide adequate coverage and reimbursement for PhenoSense HIV or other
phenotypic and genotypic testing products, our revenues will be reduced.

IF WE ARE UNABLE TO EXPAND OUR SALES AND MARKETING CAPABILITIES, WE MAY NOT BE
ABLE TO EFFECTIVELY COMMERCIALIZE OUR PRODUCTS.

We currently have nineteen sales people and limited marketing resources. In
order to commercialize our products effectively and to expand into additional
markets, we must expand our sales and marketing capabilities or arrange with a
third party to perform these services. We are currently taking steps in this
direction, but we may not be able to do this successfully. On August 27, 2001,
our Vice President of Sales and Marketing resigned to pursue other interests and
was replaced by her direct reports in both Sales and Marketing. If we enter into
co-promotion or other marketing arrangements, our share of product revenues is
likely to be lower than if we directly marketed and sold our products through
our own sales force. If we fail to effectively commercialize our products our
revenue will be reduced.

WE HAVE LIMITED EXPERIENCE PROCESSING PATIENT SAMPLES FOR OUR RESISTANCE TESTS
AND MAY ENCOUNTER PROBLEMS OR DELAYS IN PROCESSING TESTS, OR IN EXPANDING OUR
AUTOMATED TESTING SYSTEMS, WHICH COULD RESULT IN LOST SALES REVENUE.

Over the last year, we have begun to process a significant number of patient
samples and are continuing to develop our quality-control procedures. In order
to meet the projected demand for PhenoSense HIV, GeneSeq and other future
phenotypic and genotypic resistance testing products, we will have to process
many more patient samples than we are currently processing. We also have to
establish more consistency with respect to test turnaround so that results are
delivered in a timely manner. Thus, we need to develop and implement additional
automated systems to perform our tests. We also need to, and may not be able to,
develop more

sophisticated software to support the automated tests, analyze the data
generated by our tests, and report the results. Further, as we attempt to scale
up our processing of patient samples, processing or quality control problems may
arise. If we are unable to consistently process patient samples on a timely
basis because of these or other factors, or if we encounter problems with our
automated processes, our revenues will be limited.

WE MAY BE OBLIGATED TO REDEEM OUR SERIES A PREFERRED STOCK AT A PREMIUM TO THE
PURCHASE PRICE.

Holders of our Series A Preferred Stock have the right to require us to
redeem all of the Series A Preferred Stock that they own for cash equal to the
greater of (i) 115% of the original purchase price plus 115% of any accrued
dividend 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, in any of the following situations:

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

- if we fail to remove a restrictive legend on any certificate representing
any common stock issued to any holder of Series A Preferred Stock when
required to do so

- if we fail to have sufficient shares of common stock reserved to satisfy
conversions of Series A Preferred Stock

- if we fail to honor requests for conversion, or if we notify any holder of
Series A Preferred Stock of our intention not to honor future requests for
conversion

- upon the institution of bankruptcy proceedings, the making of an
assignment for the benefit of creditors or other similar event

- if we sell all or substantially all of our assets, or if the control of
our company changes

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

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

- if we commit a material breach under, or otherwise materially violate the
terms of, the transaction documents entered into in connection with the
issuance of the Series A Preferred Stock and the warrants

Redemption of the Series A Preferred Stock in any event described above would
require us to expend a significant amount of cash that would substantially
exceed the proceeds that we received in the private placement and could exceed
our ability to make such payment or raise additional capital.

OUR STOCKHOLDERS COULD EXPERIENCE SUBSTANTIAL DILUTION AS A RESULT OF THE
ISSUANCE OF AND TERMS OF OUR SERIES A PREFERRED STOCK AND THE RELATED WARRANTS.

The 1,625 shares of Series A Preferred Stock that were sold in the private
placement are initially convertible into approximately 6,372,561 shares of
common stock. The warrants granted in connection with the sale of Series A
Preferred Stock are initially exercisable for 3,186,286 shares of common stock,
at an exercise price of $2.805 per share. Together, this represents about
9,558,847 shares of common stock, or 46.8% of the outstanding shares of our
common stock at November 12, 2001, issuable for an approximate effective price
of $2.63 per share.

Moreover, the number of shares of common stock set forth above that we may be
required to issue upon conversion of the Series A Preferred Stock and exercise
of the warrants, or otherwise in connection with those securities, can increase
substantially in several events, including if:

- we issue shares of stock for less than the conversion price of the Series
A Preferred Stock (initially $2.55) or the exercise price of the warrants
(initially $2.805), which could be more likely given the historical
volatility of our stock price and the recent volatility of stocks of
companies in our industry and of the stock market in general

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

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

- we fail to grant shares upon exercise of the warrants

We are also obligated to issue additional shares of common stock every six
months to the holders of the Series A Preferred Stock, which constitute
preferred stock dividends as required by the terms of the Series A Preferred
Stock. Initially, these issuances will equal about 118 shares of common stock
for every share of Series A Preferred Stock outstanding at the time the issuance
is made. The number of shares we must issue increases every six months, starting
with the fourth such issuance, by 39 shares of common stock for each share of
Series A Preferred Stock, up to a maximum of 275 shares of common stock for
every share of Series A Preferred Stock. Assuming that all 1,625 shares of the
Series A Preferred Stock remain outstanding for five years following their
issuance, we will issue, which constitute preferred stock dividends, in addition
to the shares issuable as described in the previous paragraph, an additional
3,321,500 shares of common stock, or 16.2% of the shares of common stock
outstanding as of November 12, 2001, to the holders of the Series A Preferred
Stock, for which we will receive no additional consideration.

We may also be required to issue shares of common stock without additional
consideration in the event that we fail to redeem any shares of Series A
Preferred Stock when required.

All of the foregoing issuances of common stock are likely to be substantially
dilutive to the outstanding shares of common stock, especially where, as
described above, the shares of common stock are issued without additional
consideration. Moreover, any increase in the number of shares of common stock we
are required to issue resulting from anti-dilution protection, penalties or
other adjustments to the conversion or exercise prices of the Series A Preferred
Stock and/or the warrants described above will further increase the anticipated
dilution to the outstanding holders of our common stock. We cannot predict
whether or how many additional shares of our common stock will become issuable
due to these provisions.

Any such dilution, potential dilution, or increase in dilution or potential
dilution, may result in a decrease in the value of the outstanding shares of our
common stock. Such a decrease in value, the risk of dilution, any actual
dilution, or any increase in potential dilution may cause our stockholders to
sell their shares, which would contribute to a downward movement in stock price
of our common stock. This could prevent us from sustaining a per share price
sufficient to enable us to maintain an active trading market on the Nasdaq
National Market. In addition, any downward pressure on the trading price of our
common stock could encourage investors to engage in short sales, which would
further contribute to a downward pricing of our common stock.

WE MAY BE REQUIRED TO OBTAIN THE CONSENT OF THE HOLDERS OF SERIES A 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 as the Series A Preferred Stock or incur unsecured indebtedness for
borrowed money, or take other actions with respect to the Series A Preferred
Stock or securities that have fewer rights than the Series A Preferred Stock. We
are also required to obtain the consent of the holders of the Series A Preferred
Stock before we amend or modify our certificate of incorporation or bylaws to
change any of the rights of the holders of Series A Preferred Stock. While these
obligations may deter a potential acquirer from completing a transaction with
us, they may also prevent us from taking corporate actions that would be
beneficial to our stockholders and us, such as raising capital to operate our
business or maintain our capitalization or per share price in attempts to
maximize stockholder volume and liquidity.

WE FACE INTENSE COMPETITION, AND IF OUR COMPETITORS' EXISTING PRODUCTS OR NEW
PRODUCTS ARE MORE EFFECTIVE THAN OUR PRODUCTS, THE COMMERCIAL OPPORTUNITY FOR
OUR PRODUCTS WILL BE REDUCED OR ELIMINATED.

The commercial opportunity for our products will be reduced or eliminated if
our competitors develop and market new testing products that are superior to, or
are less expensive than, our phenotypic and/or genotypic resistance testing
products we develop using our proprietary technologies. The biotechnology
industry evolves at a rapid pace and is highly competitive. Our major
competitors include manufacturers and distributors of phenotypic drug resistance
technology, such as Tibotec-Virco. We also compete with makers of genotypic
tests such as Applied Biosystems Group, Visible Genetics Inc. and laboratories
performing genotypic testing as

well as other genotypic testing referred to as virtual phenotyping. Each of
these competitors is attempting to establish its test as the standard of care.
Tibotec-Virco's phenotypic test and genotypic tests have been commercially
available for a longer time than has PhenoSense HIV or GeneSeq HIV. Genotypic
tests are cheaper and generally faster than our phenotypic resistance tests. Our
competitors may successfully develop and market other testing products that are
either superior to those that we may develop or that are marketed prior to
marketing of our testing products. Some of our competitors have substantially
greater financial resources and research and development staffs than we do. In
addition, some of our competitors have significantly greater experience in
developing products, and in obtaining the necessary regulatory approvals of
products and processing and marketing products.

IF WE DO NOT SUCCESSFULLY INTRODUCE NEW PRODUCTS USING OUR TECHNOLOGY, WE MAY
NOT ACHIEVE PROFITABILITY.

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

SOME OF OUR VENDORS ARE OUR SOLE SOURCE OF SUPPLY FOR CERTAIN OF OUR TESTING
MATERIALS, AND THERE ARE LIMITED SOURCES AND SUPPLIES OF SOME OF THESE
MATERIALS, WHICH COULD RESULT IN OUR INABILITY TO SECURE SUFFICIENT MATERIALS TO
CONDUCT OUR BUSINESS.

We rely on a few vendors as our sole source of supply for various materials
in our testing process. In some cases, there are no other available sources of
materials that we require for our tests. In other instances, there are limited
sources and limited supplies of necessary materials. Any extended interruption,
delay or decreased availability of the supply of these materials could result in
our failure to meet our customers' demands, and prevent us from running our
business as contemplated. We might also face significant additional expenditures
if we are forced to find alternate sources of supplies, or change materials we
use. If significant customer relationships were harmed by our failing to report
test results on a timely basis, or another negative impact on our ability to
procure necessary materials, then our operations and revenues could be adversely
affected. Similarly, if our expenses were to increase dramatically as a result
of changes to our relationships with vendors or ability to procure materials, it
would make it more difficult for us to attain profitability, offer our tests at
competitive prices, and continue our business as currently conducted or at all.

WE ARE DEPENDENT ON A LICENSE FOR TECHNOLOGY WE USE IN OUR RESISTANCE TESTING,
AND OUR BUSINESS WOULD SUFFER IF THE LICENSE WAS TERMINATED OR NOT RENEWED.

We license technology that we use in our PhenoSense and GeneSeq testing from
Roche Molecular Systems, Inc. We hold a non-exclusive license for the life of
the patent term of the last licensed Roche patent. We believe that many of our
competitors, including Tibotec-Virco and other resistance testing companies,
also license this technology on non-exclusive terms. In order to maintain this
license, however, we must pay royalties, make a semi-annual royalty report and
participate in proficiency testing. If Roche were to terminate this license or
this license was not renewed, we would have to change a portion of our testing
methodology, which would halt our testing, at least temporarily, and cause us to
incur substantial additional expenses.

THE INTELLECTUAL PROPERTY UNDERLYING OUR TECHNOLOGY AND TRADE SECRETS MAY NOT BE
ADEQUATE, ALLOWING THIRD PARTIES TO USE OUR TECHNOLOGY OR SIMILAR TECHNOLOGIES,
AND THUS REDUCING OUR ABILITY TO COMPETE IN THE MARKET.

The strength of our intellectual property protection is uncertain. In
particular, we cannot be sure that we were the first to invent the technologies
covered by our patent or pending patent applications; we were the first to file
patent applications for these inventions; others will not independently develop
similar or alternative technologies or duplicate any of our technologies; any of
our pending patent applications will result in issued patents; any patents
issued to us will provide a basis for commercially viable products or will
provide us with any competitive advantages or will not be challenged by third
parties. Other companies may have patents or patent applications relating to
products or processes similar to, competitive with or otherwise related to our
products. Patent law relating to the scope of claims in the technology fields in
which we operate, including biotechnology and information technology, is still
evolving and, consequently, patent positions in our industry are generally
uncertain. We cannot assure you that we will prevail in any of these lawsuits 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 such litigation or to otherwise protect our patent
rights. We also rely on unpatented trade secrets to protect our proprietary
technology. Other companies may independently develop or otherwise acquire
equivalent technology or gain access to our proprietary technology.

OUR PRODUCTS COULD INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS, WHICH
MAY CAUSE US TO ENGAGE IN COSTLY LITIGATION AND, IF WE ARE NOT SUCCESSFUL, COULD
CAUSE US TO PAY SUBSTANTIAL DAMAGES AND PROHIBIT US FROM SELLING OUR PRODUCTS.

Third parties may assert infringement or other intellectual property claims
against us based on their patents or other intellectual property claims. We may
have to pay substantial damages, possibly including treble damages, for past
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 takes significant time, may be expensive and may divert
management attention from other business concerns.

WE MAY BE UNABLE TO BUILD BRAND LOYALTY BECAUSE OUR TRADEMARKS AND TRADE NAMES
MAY NOT BE PROTECTED.

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

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
EXPENSES TO ATTAIN AND MAINTAIN COMPLIANCE.

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

THE FDA MAY IMPOSE MEDICAL DEVICE REGULATORY REQUIREMENTS ON OUR TESTS,
INCLUDING POSSIBLY PREMARKET APPROVAL REQUIREMENTS, WHICH COULD BE EXPENSIVE AND
TIME-CONSUMING AND COULD PREVENT US FROM MARKETING THESE TESTS.

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

We have had and plan to have additional discussions with the FDA related to
its positions set forth in the letter. We plan to either add the requested
disclosure statement to our genotypic test reports, or begin using a different
reagent in our tests so that the statement might no longer be applicable or
required. In any event, we do not at this point believe the FDA will require us
to take steps that materially affect our business or financial performance, but
we cannot guarantee this will remain the case.

We cannot be sure that the FDA will accept the steps we take, or that the FDA
will not require us to alter our promotional claims or undertake the expensive
and time-consuming process of seeking premarket approval with clinical data
demonstrating the sensitivity

and specificity of our tests. If premarket approval is required, we cannot be
sure that we will be able to obtain it in a timely fashion or at all; and in
such event the FDA would have authority to require us to cease marketing tests
until such approval is granted.

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

OUR INFORMATION AND OTHER INTERNAL SYSTEMS MAY NOT WORK EFFECTIVELY AND AS A
RESULT WE MAY NOT BE ABLE TO PROCESS ORDERS, RECORD TRANSACTIONS AND MEET OUR
REPORTING OBLIGATIONS, WHICH IN TURN COULD AFFECT OUR ABILITY TO RUN OUR
BUSINESS EFFICIENTLY OR PROFITABLY.

In 2000, we installed several new information systems, including enterprise
resource and laboratory information systems. If our new information and internal
systems do not work effectively, we may experience delays or failures in our
operations. These delays or failures could adversely impact the promptness and
accuracy of our transaction processing, financial accounting and reporting and
our ability to properly forecast earnings and cash requirements. Our current and
planned systems, transaction processing, procedures and controls may not be
adequate to support future operations. To manage the expected growth of our
operations and personnel, we will need to continue to improve our operational
and financial systems, transaction processing, procedures and controls.

CLINICIANS OR PATIENTS USING OUR PRODUCTS OR SERVICES MAY SUE US AND OUR
INSURANCE MAY NOT SUFFICIENTLY COVER ALL CLAIMS BROUGHT AGAINST US WHICH WILL
INCREASE OUR EXPENSES.

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

OUR LACK OF OPERATING EXPERIENCE MAY CAUSE US DIFFICULTY IN MANAGING OUR GROWTH
AND ATTRACTING AND RETAINING SKILLED PERSONNEL, WHICH COULD HINDER OUR
COMMERCIAL EFFORTS AND IMPAIR OUR ABILITY TO COMPETE.

We have limited experience selling our products and processing patient
samples. If our management is unable to manage our growth effectively, it is
possible that our systems and our facilities may become inadequate. Our success
also depends on our continued ability to attract and retain highly qualified
management and scientific personnel. Competition for personnel is intense. We
believe stock options are a critical component of motivating and retaining our
key employees. As we mature as a public company, stock options may be less
attractive to potential candidates for our management and scientific positions,
and, therefore, it may be more difficult to fill those positions. If we cannot
successfully attract and retain qualified personnel, our research and
development efforts could be hindered and our ability to run our business
effectively and compete with others in our industry will be harmed.

WE MAY BE SUBJECT TO LITIGATION, WHICH WOULD BE TIME CONSUMING AND DIVERT OUR
RESOURCES AND THE ATTENTION OF OUR MANAGEMENT.

We were involved in a dispute with a significant stockholder and former
officer. We settled the dispute in November 1999. In connection with the
settlement, we purchased shares of our common stock held by him for $225,000 in
cash, and allowed him to retain other shares that we had a right to repurchase.
In 1999, we recorded $1.9 million in legal fees and costs related to this
settlement, including a non-cash charge related to the common stock retained by
him. In the future, our stockholders or former employees may bring further
claims and we may have to spend significant additional resources and time. Even
if we are eventually successful in our defense of any such claim, the time and
money spent may prevent us from operating our business effectively or profitably
or may distract our management.

OUR OPERATING RESULTS MAY FLUCTUATE FROM QUARTER TO QUARTER, MAKING IT LIKELY
THAT, IN SOME FUTURE QUARTER OR QUARTERS, WE WILL FAIL TO MEET ANALYSTS'
ESTIMATES OF OPERATING RESULTS OR FINANCIAL PERFORMANCE, CAUSING OUR STOCK PRICE
TO FALL.

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

IF A DISASTER STRIKES OUR BUSINESS, WE MAY BE UNABLE TO RECEIVE AND OR PROCESS
OUR CUSTOMERS' SAMPLES FOR A SUBSTANTIAL AMOUNT OF TIME AND WE WOULD LOSE
REVENUE.

We rely on a single clinical laboratory facility to process patient samples
for our tests, which are received via delivery service or mail, and have no
alternative facilities. We will also use this facility for conducting other
tests we develop, and even if we move into different or additional facilities
they will likely be in close proximity to our current clinical laboratory. Our
clinical laboratory and some pieces of processing equipment are difficult to
replace and could require substantial replacement lead-time. Our processing
facility may be affected by natural disasters such as earthquakes and floods.
Earthquakes are of particular significance since our clinical laboratory is
located in South San Francisco, California, an earthquake-prone area. In the
event our existing clinical laboratory facility or equipment is affected by
man-made or natural disasters, we would be unable to process patient samples and
meet customer demands or sales projections. If our patient sample processing
operations were curtailed or ceased, we would not be able to perform our tests
and we would lose revenue.

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

At November 12, 2001, our directors, entities affiliated with our directors
and our executive officers owned, in the aggregate, approximately 22% of our
outstanding common stock. These stockholders, as a group, are able to
substantially influence our management and affairs. If acting together, they
would be able to influence most matters requiring the approval by our
stockholders, including the election of directors, any merger, consolidation or
sale of all or substantially all of our assets and any other significant
corporate transaction. The concentration of ownership may also delay or prevent
a change in our control at a premium price if these stockholders oppose it.

OUR STOCK PRICE MAY BE VOLATILE, AND OUR 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 since we became a publicly traded company. The
following factors, in addition to other risk factors described in this section,
may have a significant adverse impact on the market price of our common stock:

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

- Results from clinical studies

- Developments concerning proprietary rights, including patents

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

- Regulatory developments in the United States and foreign countries

- Changes in payor reimbursement policies

- Litigation

- Economic and other external factors or a disaster or crisis

- Period-to-period fluctuations in financial results

IF OUR STOCKHOLDERS SELL SUBSTANTIAL AMOUNTS OF OUR COMMON STOCK, THE MARKET
PRICE OF OUR COMMON STOCK MAY FALL.

If our stockholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options and warrants and upon the
conversion of the Series A Preferred Stock, the market price of our common stock
may fall. These sales also might make it more difficult for us to sell equity or
equity-related securities in the future at a time and price that we deem
appropriate. Sales of a substantial number of shares could occur at any time.
This may have an adverse effect on 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 INHIBIT A TAKEOVER,
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 have the effect
of delaying or preventing an acquisition or merger in which we are not the
surviving company or changes in our management. 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
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.

PART II

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(a) None.

(b) On June 29, 2001 and September 27, 2001, we issued an aggregate of
1,625 shares of Series A Preferred Stock. The rights, preferences and
privileges of the Series A Preferred Stock are set forth in the
Certificate of Designations, Preferences and Rights filed with the
Delaware Secretary of State (the "Certificate"). The issuance of the
Series A Preferred Stock has limited certain rights of our common
stockholders as more fully detailed in the Certificate, including, but
not limited to, the following: (i) the Series A Preferred Stock ranks
senior to the common stock as to the distribution of assets upon our
liquidation, dissolution or winding up and (ii) we may be required to
obtain the consent of the holders of Series A Preferred Stock before
taking certain corporate actions, which limits the voting control of the
common stockholders. See also (i) the description of the Series A
Preferred Stock in Part I, Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations and (ii) the risk factor
titled "We May Be Required to Obtain the Consent of the Holders of Series
A Preferred Stock Before Taking Corporate Actions, Which Could Harm Our
Business" in Part I, Item 3 Quantitative and Qualitative Disclosures
about Market Risk.

(d) USE OF PROCEEDS

The effective date of our registration statement on Form S-1 (No.
333-30896) relating to our initial public offering was May 1, 2000. The
initial public offering resulted in gross proceeds of approximately $35.0
million, of which $2.5 million was applied toward the underwriting
discount. Expenses related to the offering totaled approximately $1.3
million.

From the time of the receipt through September 30, 2001, we used
approximately $26.6 million of the net proceeds for operating activities
and capital expenditures. The remaining net proceeds of approximately
$4.6 million are invested in interest-bearing cash accounts or short-term
investments with strong credit ratings. For further information about our
investment policy, refer to the notes included in our Annual Report on
Form 10-K for the year ended December 31, 2000.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

During the quarter, we filed a proxy and solicited shareholder approval for
the sale of $16.25 million of Series A Preferred Stock in a private placement. A
special meeting was held on August 30, 2001.

The voting for the proposal was as follows:

Votes For Votes Against Abstentions
--------- ------------- -----------

11,126,290 513,040 9,675

ITEM 5. OTHER INFORMATION

On September 13, 2001, we announced the appointment of Karen E. Hartwig as
Vice President of Marketing. In connection with Ms. Hartwig's employment, she
entered into an Executive Severance Benefits Agreement effective September 13,
2001.

On September 13, 2001, we announced the appointment of Tien T. Bui as Vice
President of Sales. In connection with Ms. Bui's employment, she entered into an
Executive Severance Benefits Agreement effective September 13, 2001.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

EXHIBIT
NUMBER CAPTION
------- -------

3.1(1) Amended and Restated Certificate of Incorporation, as
currently in effect.

3.2(2) Bylaws, as currently in effect.

4.1(4) Certificate of Designations, Preferences and Rights of
Series A Convertible Preferred Stock

4.2(3) Form of Stock Purchase Warrant.

10.1(3) Securities Purchase Agreement, dated as of June 29, 2001, by
and among ViroLogic, Inc. and each of the Purchasers.

10.2(3) First Registration Rights Agreement, dated as of June 29,
2001, by and between ViroLogic, Inc. and each of the
Purchasers.

10.3(3) Second Registration Rights Agreement, dated as of June 29,
2001 by and between ViroLogic, Inc. and each of the
Purchasers.

- ------------

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

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

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

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

(b) Reports on Form 8-K

On July 6, 2001, we filed a report on Form 8-K announcing agreements to sell
$16.25 million of Series A Preferred Stock in a private placement.

SIGNATURES

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 November 13, 2001.

By: /s/ WILLIAM D. YOUNG
-------------------------------------------
William D. Young
Chief Executive Officer
(Principal Executive Officer)

By: /s/ KAREN J. WILSON
-------------------------------------------
Karen J. Wilson
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

EXHIBITS INDEX

EXHIBIT
NUMBER CAPTION
------- -------

3.1(1) Amended and Restated Certificate of Incorporation, as
currently in effect.

3.2(2) Bylaws, as currently in effect.

4.1(4) Certificate of Designations, Preferences and Rights of
Series A Convertible Preferred Stock

4.2(3) Form of Stock Purchase Warrant.

10.1(3) Securities Purchase Agreement, dated as of June 29, 2001, by
and among ViroLogic, Inc. and each of the Purchasers.

10.2(3) First Registration Rights Agreement, dated as of June 29,
2001, by and between ViroLogic, Inc. and each of the
Purchasers.

10.3(3) Second Registration Rights Agreement, dated as of June 29,
2001 by and between ViroLogic, Inc. and each of the
Purchasers.

- ------------

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

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

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

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