Edgar Filing: THERASENSE INC

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 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 000-33139

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THERASENSE, INC.
(Exact name of registrant as specified in its charter)

Delaware 94-3267373
(State of incorporation) (IRS Employer
Identification No.)

1360 SOUTH LOOP ROAD, ALAMEDA, CA 94502
(510) 749-5400
(Address, including zip code, and telephone number, including area code, of
Registrant's principal executive offices)

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

None

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

Common Stock, $0.001 par value

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

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

Based on the closing sale price of the Common Stock on the NASDAQ National
Market System on March 1, 2002, the aggregate market value of the registrant's
Common Stock held by non-affiliates of the registrant was approximately
$311,760,073.

There were 39,542,380 shares of the registrant's Common Stock $0.001 par
value, issued and outstanding as of March 1, 2002.

DOCUMENTS INCORPORATED BY REFERENCE

Certain information is incorporated by reference to the Proxy Statement for
the registrant's 2002 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A not later than
120 days after the end of the fiscal year covered by this Form 10-K.

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TABLE OF CONTENTS

Page
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PART I
ITEM 1. BUSINESS....................................................... 1

ITEM 2. PROPERTIES..................................................... 16

ITEM 3. LEGAL PROCEEDINGS.............................................. 16

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............ 16

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER INFORMATION........................................ 17

ITEM 6. SELECTED FINANCIAL DATA........................................ 18

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.......................................... 19

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..... 37

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................... 38

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE....................................... 38

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............. 39

ITEM 11. EXECUTIVE COMPENSATION......................................... 39

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT................................................. 39

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................. 39

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K 40

Signatures.............................................................. 43

Financial Statements.................................................... F-1

PART I

ITEM 1. BUSINESS

Overview

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

We believe that FreeStyle is well positioned to capture a meaningful share
of the blood glucose self-monitoring market. The blood glucose self-monitoring
market is the largest self-test market for medical diagnostic products in the
world, with a size of approximately $2.0 billion in the United States and $3.5
billion worldwide in 2000. It is estimated that the worldwide blood glucose
self-monitoring market will amount to $9.0 billion by 2005. We believe that
FreeStyle and other products based on our proprietary technologies can expand
this market by substantially reducing the pain associated with testing and
thereby bring non-testers into the market and encourage under-testers to test
more regularly.

Our direct sales force promotes FreeStyle in the United States to health
care professionals who advise patients on the monitoring and management of
their diabetes. Our contract sales force focuses on high volume pharmacies in
the United States. We distribute and sell FreeStyle in the United States to the
ten largest national retailers, including Walgreens, Wal-Mart and CVS, through
wholesalers, including McKesson, Cardinal Health and Bergen Brunswig, and
directly to end users over the telephone and through our website. In September
2000, we entered into an agreement with Disetronic Group for the exclusive
distribution of FreeStyle in selected European countries. In March 2001, we
obtained the CE Mark, which permits us to commercially distribute FreeStyle
throughout the European Union. Disetronic commenced sales in Germany and Sweden
in May 2001, and since that time has commenced sales in Norway, Finland,
Austria, The Netherlands and Denmark. In April 2001, we entered into an
agreement with Nipro Corporation for the exclusive distribution of FreeStyle in
Japan. An application for approval to market FreeStyle in Japan was approved by
the Japanese Ministry of Health in January 2002, and Nipro launched FreeStyle
in Japan in February 2002. Disetronic and Nipro are the leading suppliers of
insulin pumps in Europe and Japan, respectively. Insulin pump users are
typically highly motivated insulin-dependent diabetes patients who frequently
test their blood glucose levels.

Market Opportunity

Diabetes

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

Diabetes is typically classified as Type 1 or Type 2. Type 1 diabetes is the
most serious form of the disease and is characterized by a severe lack of
insulin secretion by the body. Type 1 diabetes usually occurs during

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

In the United States, approximately 16 million people, about 6% of the
population, have diabetes, although only approximately 10 million of these
people have been diagnosed with the disease. The share of the United States
population diagnosed with diabetes increased 33% between 1990 and 1998,
primarily due to the aging of the population, inappropriate diets and
increasingly sedentary lifestyles. The most rapid onset was in adults ages 30
through 39. It is also on the rise among a younger population base, including
children and teenagers. Worldwide, approximately 175 million people, about 3%
of the population, have been diagnosed with diabetes. The worldwide prevalence
of diagnosed diabetics is expected to increase to 239 million by 2010.

Importance of Glucose Monitoring

Diabetes is the sixth leading cause of death by disease in the United
States, with one death due to diabetic complications occurring every three
minutes. The failure to frequently monitor and control blood glucose levels
leads to severe medical complications over time, including blindness, loss of
kidney function, nerve degeneration and cardiovascular disease. Diabetes is
estimated to cost the United States economy over $98 billion annually,
including indirect costs such as lost productivity.

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

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

Limitations of Existing Glucose Monitoring Products

Despite the proven benefits of frequent monitoring and intensive management
of blood glucose levels, a significant number of people fail to test at their
recommended frequency, or at all. The American Diabetes Association estimates
that people with diabetes test, on average, slightly more than once per day. To
obtain a sample with current glucose monitoring systems, users generally are
required to prick one of their fingertips with a lancing device, which
typically consists of a spring-loaded needle that penetrates a measured
distance into the finger. Users must then draw a sample of blood from the
finger, which often requires squeezing of the fingertips and may require
another finger prick if a sufficient volume of blood is not obtained the first
time. After drawing a

blood sample, users generally are required to drop the blood sample on a
disposable test strip or place the test strip on the blood sample. We believe
that under-testing is due to the limitations of existing products including:

. Pain. Although the fingertips are rich in capillary beds and provide a
good site to obtain a blood sample, they are also more densely populated
with highly sensitive nerve endings. This makes the lancing and subsequent
manipulation of the finger painful. The pain and discomfort are compounded
by the fact that fingers offer limited surface area, so tests are often
performed on areas that are sore from prior tests. Users also suffer pain
when the lance wound is disturbed during regular activities. A wound on
the finger is also more susceptible to infection.

. Large Sample Size. Competitive blood glucose meters require users to draw
a sample size from 1.0 to 10.0 microliters of blood to accurately measure
blood glucose levels. These larger sample sizes are difficult or
impossible to obtain on sites other than the finger. Furthermore, the
larger the blood sample required, the wider or deeper the lancing must be
in order to reliably draw the sample. This leads to increased pain,
greater likelihood of residual bleeding and longer healing time.

. Susceptibility to Interference. The accuracy of other
electrochemical-based glucose monitoring systems can be compromised in the
presence of many substances commonly found in blood, such as aspirin,
acetaminophen, Vitamin C and uric acid. Accuracy can also be compromised
by unusually high or low levels of red blood cells. These levels can be
present in infants, pregnant women, patients on dialysis, athletes and
those living at high altitudes.

. Lifestyle Disruption. The process of measuring blood glucose levels
causes significant disruption in the daily lives of people with diabetes
and their families. Lancing the fingertips on infants is traumatizing to
both parent and child. Obtaining large blood samples is inconvenient and
may cause embarrassment in social situations, particularly for young
children who are often required to be removed from class or activities to
test themselves in the nurse's office. Children may also avoid, or be
prevented from, playing with their classmates following a test because of
the fear that continued bleeding may cause contamination.

As a result, we believe a significant market opportunity exists for a
glucose self-monitoring system that requires a sufficiently small sample of
blood so users can avoid the pain, inconvenience and social embarrassment of
drawing large blood samples from their fingertips.

The TheraSense Solution

FreeStyle is easy to use, accurate and competitively priced. We believe
FreeStyle also offers the following significant advantages over existing blood
glucose monitoring systems:

. Reduction in Pain. FreeStyle requires a tiny blood sample of 0.3
microliters, just a fraction of the sample size required by other systems.
The extremely small volume of blood required enables people using
FreeStyle to obtain blood not only from their fingertips as required by
most other systems on the market today, but alternatively from their
forearm, hand, thigh, upper arm or calf. Ninety percent of people in our
clinical studies found using FreeStyle less painful than their current
finger-stick-based systems. FreeStyle also eliminates soreness from
repeated testing on a small surface area.

. Better Performance. FreeStyle's proprietary measurement technology is
extremely accurate, operates over a broad temperature range and is
unaffected by common interfering substances, such as aspirin,
acetaminophen, Vitamin C and uric acid. It is also unaffected by unusually
high or low levels of red blood cells. The tiny blood sample required by
FreeStyle can be reliably obtained from sites other than the fingertip.

. Improved Quality of Life. The combination of a smaller sample size and
off-fingertip testing enabled by FreeStyle significantly reduces residual
bleeding. This reduces the embarrassment of testing felt by some people
with diabetes and affords them more discretion in testing. The pain and
awkwardness of publicly obtaining large blood samples has deterred some
people with diabetes from testing frequently enough to properly manage
their disease.

Our Strategy

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

. Establish FreeStyle as a leading blood glucose self-monitoring device. We
are creating awareness of the advantages of FreeStyle in the United States
among health care professionals and people with diabetes. We do this
through advertising, extensive retail distribution and a sales force of
more than 140 people. We believe an increased awareness of FreeStyle's
less painful, more discreet and reliable process will lead many current
testers to switch to FreeStyle. In addition, we believe we can expand the
market to those people who have been diagnosed with diabetes but are
currently not testing, as well as increase testing frequency for those who
are under-testing.

. Maintain and enhance retail distribution. We currently have authorized
shelf space with the ten largest chain drug stores, the three largest mass
market retailers and the three largest supermarket retailers. These
retailers represent over 20,000 pharmacy outlets in the United States. We
plan to continue to expand FreeStyle's availability within these
distribution channels through our national accounts sales representatives
and a contract sales force dedicated to detailing pharmacies.

. Focus on our core competencies. We plan to continue to focus our internal
resources on our core competencies--electrochemistry and sensor
manufacturing technologies. Consequently, we have entered into strategic
relationships to enhance speed to market and cost effectiveness for those
business functions not included in our core competencies. For example, we
have a strategic relationship with Flextronics International, which
assisted us with the FreeStyle meter development and is currently
manufacturing our meters and assembling our FreeStyle System kits. Through
these relationships, we believe that we will be able to quickly and
efficiently build infrastructure and services needed to meet anticipated
market demand.

. Provide high quality customer service. We provide all of our customers
with easy, comprehensive access to our products and services through the
use of sophisticated software systems and an educated and caring customer
service team. Our approach is to partner with a service organization while
maintaining a small team of in-house service specialists to monitor
quality. We offer customer service 24 hours per day, seven days per week
with access to dedicated representatives via telephone or the Internet. In
addition, we use the Internet to enable customers to purchase our products
online, enhance awareness of our products, establish e-mail management,
facilitate loyalty programs and provide product support and training.

. Expand International Distribution. We intend to expand our international
sales of FreeStyle and enter new global markets through relationships with
established health care companies that have developed distribution
channels. The Disetronic Group is our exclusive distributor of FreeStyle
in selected European countries. Disetronic has commenced sales in Germany,
Sweden, Norway, Finland, Austria, The Netherlands and Denmark. In February
2002, Disetronic's territory was expanded to include France, Italy and
Belgium. In April 2001, we entered into an agreement with Nipro
Corporation for the exclusive distribution of FreeStyle in Japan. Nipro
launched FreeStyle in Japan in February 2002. Disetronic and Nipro are the
leading suppliers of insulin pumps in Europe and Japan, respectively.
Insulin pump users are typically highly motivated insulin-dependent
diabetes patients who frequently test their blood glucose levels.

. Leverage our proprietary technology platform. We intend to leverage our
proprietary electrochemical sensor technologies to develop new glucose
monitoring products. We are currently developing a Continuous Glucose
Monitoring System intended to continuously measure and display a person's
glucose levels in real time for up to three days. We are also expanding
our current FreeStyle product family by developing enhanced versions of
FreeStyle. FreeStyle Tracker is a module for the Handspring Visor personal
digital assistant that enables it to act as a glucose monitor and
sophisticated diabetes management system. We anticipate commencing sales
of FreeStyle Tracker in 2002, subject to obtaining FDA clearance. We may
also develop a lower priced glucose monitor or a glucose monitoring system
that integrates lancing, sample acquisition and testing in a single device.

Our Products

FreeStyle Blood Glucose Monitoring System. Our initial product, the
FreeStyle blood glucose monitoring system, received FDA clearance in January
2000 for use on the forearm and fingers. We began selling FreeStyle in the
United States in June 2000. In December 2000, we received FDA clearance that
permits FreeStyle to be used on the thigh, calf, upper arm and hand. This
represents the broadest array of off-finger testing sites cleared by the FDA.
In December 2001, we received clearance for revised labeling which provided
users with additional information regarding off-finger testing. The FreeStyle
System kit includes a FreeStyle meter, an initial supply of 10 proprietary
disposable FreeStyle test strips, a FreeStyle lancing device, an initial supply
of 10 disposable FreeStyle lancets, FreeStyle control solution and
instructional materials. We also sell additional supplies of disposable
FreeStyle test strips in quantities of 50 and 100 and additional supplies of
disposable FreeStyle lancets in quantities of 100.

. FreeStyle meter. The FreeStyle meter contains a large display screen to
read test results, a slot where the test strip is inserted to get a blood
glucose reading, and buttons to change the calibration code and review
results in the system memory. It also contains a data port for interfacing
with FreeStyle Connect data management software, which allows users to
download information from the meter to personal computers and analyze
glucose levels. The ergonomically designed meter fits easily in the hand
and weighs 2.1 ounces. The meter displays blood glucose results in a range
of 20 to 500 mg/dl. Once the sample is acquired, the meter takes about 15
seconds to display the result. The meter has the ability to store the last
250 blood glucose test results and to display a 14-day average blood
glucose level.

. FreeStyle test strips. FreeStyle test strips are proprietary disposable
sensors that are used with the FreeStyle meter to measure blood glucose
levels. The test strips are clearly marked to indicate proper placement in
the meter. Inserting the test strip into the meter activates the system
and either side of the test strip can be used for measurement. The
FreeStyle meter beeps one time when sufficient blood has been drawn into
the test strip and beeps two times when the test is complete. Our
proprietary FreeStyle test strips may only be used with our FreeStyle
meter.

. FreeStyle lancing device and lancets. The FreeStyle lancing device is
designed specifically to make blood sample acquisition reliable and
convenient. It requires no mechanical or vacuum assistance to draw blood.
The lancing device offers five adjustable depth settings to allow for
comfort and adequate sample size. Although FreeStyle lancets are
available, other standard lancets are compatible with our system. It is
recommended that a new, sterile lancet be inserted into the lancing device
every time a test is administered. The reduction in pain from FreeStyle is
attributable to the lancing site and the small sample size required, not
the type of lancing device or lancet.

. FreeStyle control solution. The FreeStyle control solution contains a
fixed amount of glucose that may be used periodically to ensure the
FreeStyle System is functioning correctly and users are following correct
testing procedures.

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

Products Under Development

Continuous Glucose Monitoring System. We are developing a continuous
monitoring device that will utilize a disposable, miniaturized electrochemical
sensor that can be inserted under the skin by the user utilizing a
spring-loaded insertion device. This sensor system will enable users to
continuously measure and display glucose levels and store the results for
further analysis by the user or health care providers. This product is intended
to act

as a substitute for current glucose self-monitoring devices. The increased
number of glucose readings will allow people with diabetes to more effectively
adjust insulin, oral medication, diet and exercise, which should result in
significantly improved health outcomes for people with diabetes. The Continuous
Glucose Monitoring System is being designed to offer people with diabetes the
following benefits:

. accurate and discreet measurement of glucose levels on a continuous basis;

. elimination of the anxiety of not knowing glucose levels between periodic
measurements;

. minimally invasive insertion procedure;

. comfort during use;

. warnings against dangerously high or low glucose levels, even while
sleeping; and

. ability to improve health through intensively managed therapy from
continuous glucose information.

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

We have completed two pilot clinical studies, and commenced a Phase I
clinical trial of our Continuous Glucose Monitoring System in December 2001.
Our Continuous Glucose Monitoring System will require premarket approval, which
will require considerably more data and FDA review time than the 510(k)
clearance process that was applicable to FreeStyle. The premarket approval
process generally takes between one and three years from completion of an
application or even longer. However, achieving a completed application is a
process that may take numerous clinical trials and require filing of amendments
over time. Therefore, even if the Continuous Glucose Monitoring System is
successfully developed, it may not be commercially available for a number of
years.

FreeStyle Tracker. FreeStyle Tracker is a module and accompanying software
for the Handspring Visor personal digital assistant that enables it to act as a
glucose monitor and sophisticated diabetes management system. We anticipate
commencing sales of FreeStyle Tracker in 2002, subject to obtaining FDA
clearance.

Additional FreeStyle Products. We will continue to identify and develop
products that fulfill unmet consumer needs and address strategic or competitive
issues. We may develop a lower priced glucose monitoring system or a glucose
monitoring system that integrates lancing, sample acquisition and testing in a
single device.

Our Sensor Technologies

We have developed two proprietary miniaturized electrochemical sensor
technologies. The first, NanoSample technology, is used in our FreeStyle
System. The second, Wired Enzyme chemistry, is used in our Continuous Glucose
Monitoring System under development.

NanoSample Technology. NanoSample technology enables FreeStyle to measure
glucose levels in blood samples of only 0.3 microliters, a fraction of the
sample size required by competitive products. We have pioneered techniques to
obtain accurate, reliable and fast responses when measuring glucose in
sub-microliter sample sizes. This technology allows us to measure the total
electrical charge generated by the reaction of all of the glucose in the
sample, a process referred to as coulometry. In contrast, the most advanced
competitive

products generally determine glucose levels by taking a measurement of the
current generated by the sensor at a point in time, a process referred to as
amperometry. Amperometry requires the use of a larger blood sample to achieve
accurate results. Use of coulometry substantially eliminates some of the errors
frequently associated with amperometry, such as dependence of sensor output on
temperature and potential interference from commonly found substances in the
blood, such as aspirin, acetaminophen, Vitamin C and uric acid, which can
distort the glucose measurement.

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

Marketing and Sales

United States. Our marketing and sales program is intended to generate
awareness of FreeStyle and penetrate and expand the glucose self-monitoring
market. We currently have a national sales force comprised of more than 140
people. The sales force includes 120 sales representatives who promote
FreeStyle to the health care professionals who strongly influence the health
care decisions made by people with diabetes, a group which includes
endocrinologists, certified diabetes educators and internal medicine
physicians. The primary goal of our sales representatives is to educate and
train health care professionals on the benefits of our products. We also
provide these health care professionals with free samples of our products.
There are also members of our sales force dedicated to serving retail and
managed care accounts at the corporate level. We believe that our strategy of
selling through our own direct sales force is an important factor in achieving
market penetration. In addition, we have a contract sales force of more than 50
people who promote FreeStyle and monitor stocking levels with retail outlets at
the individual store level.

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

We primarily sell our products through retail pharmacies. We sell our
products directly to national retail pharmacies and supply other retail
pharmacies through wholesalers. We also sell to durable medical equipment
suppliers and directly to end users through phone orders and our website.
Although there is substantial competition from existing products, the
consolidation of the retail industry has allowed us to concentrate our sales
efforts. The following is a list of our top five retailers and top five
wholesalers, ranked by dollar volume of sales for the year ended December 31,
2001:

Retailers Wholesalers
--------- -----------

Walgreens McKesson
Wal-Mart Cardinal Health
CVS Bergen Brunswig
Eckerd AmeriSource
Rite Aid Bindley Western

International. We intend to expand our international sales efforts for
FreeStyle and enter new global markets by establishing relationships with
international partners who have established relationships with healthcare
professionals and developed distribution channels. In March 2001, we obtained
the CE Mark, which permits us to commercially distribute FreeStyle throughout
the European Union. In September 2000, we entered into an agreement with
Disetronic Group for the exclusive distribution of FreeStyle in Germany,
Switzerland, Denmark, Austria, Sweden, Finland, Norway and the Netherlands. In
February 2002, this agreement was amended to add France, Italy and Belgium to
Disetronic's exclusive distribution territory. In April 2001, we entered into
an agreement with Nipro Corporation for the exclusive distribution of FreeStyle
in Japan. Disetronic and Nipro are the leading suppliers of insulin pumps in
Europe and Japan, respectively. Insulin pump users are typically highly
motivated insulin-dependent diabetes patients who frequently test their blood
glucose levels.

Under the terms of the Disetronic Group agreement, Disetronic has exclusive
responsibility for sales, marketing and customer service in its territory in
Europe. We may terminate the agreement if Disetronic does not meet specified
minimum purchase requirements. Disetronic is also entitled to market FreeStyle
to Disetronic's pump users in North America. The initial term of the Disetronic
agreement ends December 31, 2006. Disetronic commenced sales in Germany and
Sweden in May 2001. Since that time they have commenced sales in Norway,
Finland, Austria, The Netherlands and Denmark.

Under the terms of the Nipro Corporation agreement, Nipro will have
exclusive responsibility for sales, marketing and customer service in Japan. We
may terminate the agreement if Nipro does not meet specified minimum purchase
requirements. The initial term of the Nipro agreement is five years, ending in
April 2006. FreeStyle received regulatory approval for marketing in Japan in
January 2002, and Nipro launched FreeStyle in Japan in February 2002.

Distribution. To establish a worldwide distribution capability for end
users, health care professionals and retail customers, we have established
relationships with expert distribution partners. For retail order management
and shipping of our FreeStyle System kit and other products, we have entered
into an exclusive services agreement with Livingston Healthcare Services, Inc.,
a division of UPS Global Logistics that specializes in providing outsourced
distribution services for large pharmaceutical and medical device companies.
The initial term of this agreement is three years, ending in March 2003. We may
terminate this agreement prior to March 2003, subject to payment of a
termination fee. Livingston has an extensive network of distribution centers
and a sophisticated order management and product tracking system. Livingston
also manages our billing process. Our relationship with Livingston allows us to
meet shipment, delivery and billing expectations while minimizing our internal
infrastructure requirements.

Customer Service. We provide customer service 24 hours per day, seven days
per week through ICT Group. This service is transparent to the caller and
provides a standard of service expected in the industry. This relationship with
ICT Group provides customer service, technical support, a help desk and order
processing. ICT Group is an international telemarketing and e-support company,
with a medical marketing division which has developed a special facility and
dedicated customer care agents for us. ICT Group's agents have the systems
capability to handle large volumes of our customer contacts at any time, both
over the phone or through our web site. We select and train the ICT Group
agents who work on our account, as well as maintain in-house customer service
personnel that monitor quality. Our non-exclusive contract with ICT has an
initial term of three years, ending in April 2003, although it can be
terminated by either party without cause upon 120 days notice.

Manufacturing

The primary components of the FreeStyle System kit are the FreeStyle meter,
FreeStyle disposable test strips, the FreeStyle lancing device, FreeStyle
disposable lancets and FreeStyle control solution. We manufacture the FreeStyle
test strips and contract with third parties for the manufacture of the other
FreeStyle products. These contract manufacturing relationships minimize our
capital investment, help control costs and allow us to compete with larger
volume manufacturers of blood glucose self-monitoring systems.

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

Flextronics International assisted us in the design of our meter and is
responsible for manufacturing the FreeStyle meter and assembling the FreeStyle
System kits in San Jose, California. Flextronics has 12 years of experience
building blood glucose meters, and has facilities in Asia, Europe and the
Americas. Flextronics has demonstrated strong process control and knowledge of
just-in-time and total quality management techniques and has software tools to
handle product tracking. We have an on-site manager at Flextronics who is
responsible for the day-to-day interface with Flextronics. Production release
to finished goods inventory is done through our quality assurance department.
Our contract with Flextronics expires in November 2004, and is renewable
annually thereafter. Either party may terminate this contract for any reason
upon one year's prior written notice to the other.

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

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

Intellectual Property

We rely on a combination of copyright, patent, trademark, trade secret and
other intellectual property laws, nondisclosure agreements and other measures
to protect our proprietary rights. As of March 1, 2002, we had 30 issued U.S.
patents and had numerous additional U.S. patent applications pending. We
believe it will take up to five years, and possibly longer, for some of these
U.S. patent applications to result in issued patents. We have also filed
foreign patent applications on our technology. Our issued patents expire
between November 2010 and October 2019. The issued patents cover, among other
things:

. the designs of our FreeStyle meter and FreeStyle strip and FreeStyle
lancing device products;

. lancing devices of the type sold with our FreeStyle blood glucose
monitoring system;

. aspects of glucose measurement in small sample volumes using
electrochemical sensors, such as those using coulometry, those having
certain fill detection features, those having certain sensor chemistries;

. our "Wired Enzyme" chemistry;

. a "one point calibration method useful in our Continuous Glucose
Monitoring System;

. manufacturing processes for sensors useful in our Continuous Glucose
Monitoring System;

. certain sensing and electronic components useful in our Continuous Glucose
Monitoring System;

. an electrochemical affinity assay system;

. a biological fuel cell; and

. electrochemical methods for verifying amplification of nucleic acids.

We have obtained registrations for the trademark TheraSense in the U.S.,
Canada, Europe and Japan and have applied to register TheraSense in numerous
other jurisdictions as well. We have applied to register FreeStyle in numerous
jurisdictions including the U.S., Canada, Europe and Japan.

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

Research and Development

Our research and development efforts are currently focused on developing
further enhancements to FreeStyle as well as developing our Continuous Glucose
Monitoring System. As of March 1, 2002, our research and development staff
consists of 61 people, including 11 who hold Ph.D. degrees. Our research and
development staff has extensive experience in the glucose monitoring industry
and has been instrumental in technology development and commercialization of
glucose monitoring products. Research and development expenses, including
clinical and regulatory expenses, were $7.7 million in 1999, $12.0 million in
2000 and $16.1 million in 2001. We expect research and development expenses to
continue to increase as we seek to enhance our existing products and develop
additional products.

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

Competition

The medical device industry is subject to intense competition. Four
companies, Roche Diagnostics, LifeScan, Inc., a division of Johnson & Johnson,
Bayer Corporation and MediSense, a division of Abbott Laboratories, currently
account for approximately 90% of the worldwide sales of blood glucose
self-monitoring systems. All of these competitors' products use a meter and
disposable test strips to test blood obtained by lancing the finger or, in some
cases, the forearm. All of the competitive products require significantly
larger blood samples than required by FreeStyle. One product approved for use
on the finger and forearm offers a faster test time than FreeStyle, once the
required sample has been obtained, and operates over a broader temperature
range.

In addition, other companies are developing and/or marketing minimally
invasive or noninvasive glucose monitoring devices and technologies that could
compete with FreeStyle and our proposed Continuous Glucose Monitoring System.
There are also a number of academic and other institutions involved in various
phases of our industry's technology development. Many of these competitors have
significantly greater financial and human resources than we do. At this time,
there are two cleared products for continuous glucose monitoring, neither of
which is presently approved as a substitute for current glucose self-monitoring
devices. The continuous glucose monitoring system developed by MiniMed Inc.,
which was recently acquired by Medtronic, Inc., includes an implantable sensor
that measures and stores glucose values every five minutes, for a period of two
to three days. The MiniMed system is not a consumer product, rather, it is a
physician product. The sensor is required to be implanted by a physician, and
the results of the data aggregated by the MiniMed system can only be viewed by
the physician, who must extract the sensor and download the results for viewing
using customized software. The second cleared product for continuous glucose
monitoring, developed by Cygnus Inc., is worn on the wrist like a

watch and can take glucose readings as frequently as every twenty minutes for
up to twelve hours at a time. This product has only recently been cleared by
the FDA for prescription to adults ages 18 and older who have diabetes.

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

. improved outcomes for people with diabetes through less painful and
accurate testing methods;

. technological leadership and superiority;

. reliability and ease of use;

. customer focus and service;

. effective marketing and distribution;

. acceptance by health care professionals;

. speed to market; and

. exclusivity agreements between third-party payors and competitive brands.

Government Regulation

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

. product design and development;

. product testing;

. product manufacturing;

. product labeling;

. premarket clearance or approval;

. advertising and promotion; and

. product sales and distribution.

FDA's Premarket Clearance and Approval Requirements

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

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

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

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

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

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

Our Continuous Glucose Monitoring System will require premarket approval. We
have completed two pilot clinical studies, and a Phase I clinical trial was
commenced in December 2001. A premarket approval application may never be
submitted, or if submitted, approval may not be obtained for this device in a
timely fashion, or at all.

Clinical Trials. A clinical trial is almost always required to support a
premarket approval application and is sometimes required for a 510(k) premarket
notification. These trials generally require submission of an application for
an investigational device exemption to the FDA. The investigational device
exemption application must be supported by appropriate data, such as animal and
laboratory testing results, showing that it is safe to test the device in
humans and that the testing protocol is scientifically sound. The
investigational device exemption application must be approved in advance by the
FDA for a specified number of patients, unless the product is deemed a
non-significant risk device and eligible for more abbreviated investigational
device exemption requirements. Clinical trials for a significant risk device
may begin once the investigational device exemption

application is approved by the FDA and the appropriate institutional review
boards at the clinical trial sites. Future clinical trials of our Continuous
Glucose Monitoring System may require that we obtain an investigational device
exemption from the FDA prior to commencing clinical trials. Our clinical trials
must be conducted in accordance with FDA regulations. The results of clinical
testing may not be sufficient to obtain approval or clearance of the product.

Pervasive and Continuing FDA Regulation

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

. quality system regulation, which requires manufacturers to follow design,
testing, control, documentation and other quality assurance procedures
during the manufacturing process;

. labeling regulations, which prohibit the promotion of products for
unapproved or "off-label" uses and impose other restrictions on labeling;
and

. medical device reporting regulations, which require that manufacturers
report to the FDA if their device may have caused or contributed to a
death or serious injury or malfunctioned in a way that would likely cause
or contribute to a death or serious injury if it were to recur.

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

. fines, injunctions, and civil penalties;

. recall or seizure of our products;

. operating restrictions, partial suspension or total shutdown of production;

. refusing our request for 510(k) clearance or premarket approval of new
products;

. withdrawing 510(k) clearance or premarket approvals that are already
granted; and

. criminal prosecution.

We are subject to unannounced inspections by the FDA and the Food and Drug
Branch of the California Department of Health Services, and these inspections
may include the manufacturing facilities of our subcontractors. In May 2001,
the FDA conducted an inspection of our facility in Alameda, California. The FDA
issued a Form 483 that noted five observations. One observation was corrected
and verified during the audit. In June 2001, we submitted a corrective action
plan to the FDA addressing the remaining four observations. In November 2001,
we were audited by the Food and Drug Branch of the California Department of
Health Services and no observations were noted.

International

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

The primary regulatory environment in Europe is that of the European Union,
which consists of 15 countries encompassing most of the major countries in
Europe. Other countries, such as Switzerland, have voluntarily adopted laws and
regulations that mirror those of the European Union with respect to medical
devices. The European Union has adopted numerous directives and standards
regulating the design, manufacture, clinical trials, labeling, and adverse
event reporting for medical devices. Devices that comply with the requirements
of a relevant directive will be entitled to bear CE conformity marking,
indicating that the device conforms with the essential requirements of the
applicable directives and, accordingly, can be commercially distributed
throughout

Europe. CE is an abbreviation for European Compliance. The method of assessing
conformity varies depending on the class of the product, but normally involves
a combination of self-assessment by the manufacturer and a third-party
assessment by a "Notified Body." This third-party assessment may consist of an
audit of the manufacturer's quality system and specific testing of the
manufacturer's product. An assessment by a Notified Body in one country within
the European Union is required in order for a manufacturer to commercially
distribute the product throughout the European Union. In March 2001, our
quality system was certified by TUV Product Service, a Notified Body, under the
European Union In-Vitro Diagnostic Directive allowing the CE conformity marking
to be applied. In December 2001, we underwent a surveillance audit by TUV
Product Service, our Notified Body. This audit also included an assessment of
Flextronics International, our meter manufacturer and system kit assembler. In
January 2002, TUV Product Service conducted an audit of our supplier of control
solution. At the successful conclusion of these audits, TUV Product Service
recommended continuation of our ability to apply CE conformity marking.

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

Third-Party Reimbursement

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

Advisory Boards

Medical Advisory Board

We have established a medical advisory board, consisting of individuals with
recognized expertise in fields relating to diabetes treatment. Our members
advise us concerning long-term product planning, research, development and
marketing. Members of our medical advisory board meet formally and informally
with us. Several of the members of our medical advisory board are employed by
academic institutions and may have commitments to or agreements with other
entities that may limit their availability to us. Members of our medical
advisory board may also serve as consultants to other medical product
companies. The members of our medical advisory board have agreed to maintain
the confidentiality of all proprietary information we disclose to them, and
each member has executed a confidentiality agreement with us.

Currently, the following persons comprise our medical advisory board:

Richard Bergenstal, MD is an endocrinologist and is currently the Executive
Director of the International Diabetes Center in Minneapolis, Minnesota. Dr.
Bergenstal's focus has been the development of diabetes treatment algorithms
and education of primary care physicians to improve the level of clinical care
for people with diabetes. Dr. Bergenstal received the Charles H. Best Medal
from the American Diabetes Association for distinguished service for his role
as an investigator in the Diabetes Control and Complications Trial.

John Buse, MD, Ph.D. is an endocrinologist and is currently an Associate
Professor, Division of Endocrinology, at the University of North Carolina
Medical School, Chapel Hill, North Carolina. Dr. Buse has a large clinical
practice as Director of the Diabetes Program and a significant research
practice as Director of Endocrinology Clinics at UNC. Dr. Buse has published
widely on diabetes and drug therapies and is a frequent presenter at
professional conferences around the world.

Alan Moses, MD is an endocrinologist and is currently the Chief Medical
Officer of the Joslin Clinic and Diabetes Center in Boston, Massachusetts. Dr.
Moses is also an Associate Professor of Medicine at Harvard Medical School and
participates in the administration and leadership of numerous diabetes related
clinical and research initiatives. Dr. Moses' research is focused on severe
insulin resistance and novel routes of drug delivery and therapies for
diabetes. He is known as being a vocal advocate of issues involving children
with diabetes.

Anne Peters, MD is an endocrinologist and is currently a Director of the
University of Southern California Diabetes Program in Los Angeles, California.
She has researched and published on diabetes drug therapies and clinical
treatment of diabetes, and has a particular research interest in outcomes
studies in diabetes.

Philip Raskin, MD is an endocrinologist and is currently a Professor of
Medicine for the Department of Internal Medicine at Southwestern Medical
School, University of Texas Health Science Center in Dallas, Texas. Dr. Raskin
was involved in the Diabetes Complications and Control Trial study and was
recognized for achieving the best clinical results among all the clinical study
sites.

Harry Shamoon, MD is an endocrinologist and is currently a Professor for the
Department of Medicine, Division of Endocrinology and Metabolism at the Albert
Einstein College of Medicine in New York, New York. Dr. Shamoon is a leading
expert on hypoglycemia and diabetes and was involved as an investigator in the
Diabetes Control and Complications Trial. He is on the National Board of
Directors for the American Diabetes Association and the American Board of
Endocrinology and Metabolism.

Educator Advisory Board

We have also established an educator advisory board of consultants with
expertise in educating people with diabetes. The educator advisory board meets
formally and informally and provides us advice on training materials,
patient/product acceptance criteria and product marketing. The members of our
educator advisory board have agreed to maintain the confidentiality of all
proprietary information we disclose to them, and each member has executed a
confidentiality agreement with us.

Currently the following persons comprise our educator advisory board:

Jo Ann Ahern, APRN, MSN, CDE is the Diabetes Clinical Nurse Specialist for
Pediatric and Adult Type I patients at the Yale New Haven Hospital, New Haven,
Connecticut. She presents and publishes extensively in diabetes-related matters
and was involved in the landmark Diabetes Control and Complications Trial.

Nancy Bristow, RN, BSN, CDE is the Clinical Nurse of the Diabetes and
Endocrine Associates of Tarrant County in Fort Worth, Texas. She supports
numerous people with diabetes as well as endocrinologists and has been involved
in clinical studies with several local universities and major diabetes related
companies.

Nedra Christensen, RD, Ph.D. is an Assistant Professor at Utah State
University, Logan, Utah. She has practiced diabetes clinical dietetics with the
Joslin Clinic, Vanderbilt University and childrens' diabetes camps. Dr.
Christensen publishes extensively on diabetes treatment and dietetics.

Debbie Hinnen, ARNP, CDE, BC-ADM is the Manager, Diabetes Services at the
Via Christi Regional Medical Center in Wichita, Kansas. She has held numerous
national positions with diabetes professional organizations and publishes
extensively on diabetes management.

Carol Homko, RN, CDE, MS, Ph.D. is a Clinical Nurse Practitioner at the
General Clinical Research Center at Temple University Hospital in Philadelphia,
Pennsylvania. Her academic and clinical focus has been on diabetes and
pregnancy.

Kimberly J. Krapek, RN, MS, CDE is the President and Owner of Diabetes
Education and Consulting, an independent consulting business with an emphasis
on direct diabetes care and education in collaboration with

endocrinologists and primary care physicians. She has been actively involved in
several diabetes medical research programs.

Marsha McCleskey, RD, MS, CDE is the Clinical Dietician for the Diabetes and
Endocrine Associates of Tarrant County in Fort Worth, Texas. She teaches people
in a large clinical practice, consults and speaks extensively on diabetes care.
She has a particular interest in diabetes data management.

Jim Pichert, Ph.D. is the Diabetes Education Program Director of the
Diabetes Research and Training Center at the Vanderbilt University Medical
Center in Nashville, Tennessee. He has researched and published extensively on
educational methods that improve diabetes care. He has held numerous national
positions in diabetes professional organizations and is a popular speaker on
improved diabetes outcomes with innovative teaching methods.

Jane Seley, RN, BSN, MPH, MSN, GNP, CDE, CHES is Clinical Coordinator/Nurse
Practitioner for Endocrine Associates at Mount Sinai Medical Center in New
York, New York and the Diabetes Management Program Director at Beth Israel
Medical Center Continuum Center for Health & Healing in New York, New York. She
is also a Doctoral fellow in the Division of Nursing at New York University in
New York City.

Kris Swenson, RN, CDE is the Director of Clinical Services for Diabetes
Management and Training Centers in Tempe, Arizona, an organization that trains
people with diabetes and health care professionals how to effectively manage
diabetes. She has been actively involved in diabetes management training and
establishing training centers.

Employees

As of March 1, 2002, we had 376 full-time employees, including 146 in sales,
nine in marketing, 57 in operations and manufacturing, 61 in research and
development, 12 in customer service and 91 in general and administrative
functions. None of our employees is represented by a collective bargaining
agreement and we have never experienced any work stoppage. We believe that our
employee relations are good.

ITEM 2. PROPERTIES

We lease approximately 54,500 square feet of manufacturing, laboratory and
office space at 1360 South Loop Road in Alameda, California under a lease
expiring in April 2009. We are also leasing 17,000 square feet of office space
in an adjacent building at 1350 South Loop Road under a lease expiring in May
2004. An additional 3,000 square feet of office space at 1320 South Loop Road
is subject to a lease which expires in October 2002. We are in the planning
stages of an approximately 60,000 square foot expansion of the manufacturing,
warehouse and office areas at our main building at 1360 South Loop Road. We are
also in the planning stages of the construction of a new 33,000 square foot
office building on a parcel of land adjacent to 1360 South Loop Road. We
believe that our current facilities and the planned expansion will be
sufficient for the next few years.

ITEM 3. LEGAL PROCEEDINGS

We are not currently subject to any material pending or threatened legal
proceedings.

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

We did not submit any matters to a vote of security holders during the
fourth quarter of the fiscal year ended December 31, 2001.

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
INFORMATION

(a) Market Information

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

High Low
------ ------

2001
Fourth Quarter (10/12/01 through 12/31/01).... $26.12 $22.26

High Low
------ ------
2002
First Quarter (through 3/01/02)............... $23.39 $19.22

The closing sale price of our Common Stock on the Nasdaq National Stock
Market on March 1, 2002 was $20.18.

(b) Holders

As of March 1, 2002, we had approximately 187 stockholders of record.

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

Use of Proceeds

In October 2001, we closed our initial public offering of 6,900,000 shares
of our common stock at a per share price of $19.00 pursuant to a Registration
Statement on Form S-1 (Registration No. 333-64456), which was declared
effective on October 11, 2001. Our managing underwriters for the offering were
U.S. Bancorp Piper Jaffray Inc., SG Cowen Securities Corporation and Thomas
Weisel Partners LLC. Of the $131,100,000 in gross proceeds raised in connection
with the offering, (i) $9,177,000 was paid to the managing underwriters in
connection with underwriting discounts and commissions, and (ii) approximately
$1,024,000 was paid by us in connection with expenses, including legal,
printing and filing fees, in connection with the offering. There were no direct
or indirect payments to our directors or officers or to any person or entity.
We are currently investing the remaining net proceeds from the offering for
future use as additional working capital. Such remaining net proceeds have been
invested in highly liquid investments, such as commercial paper and U.S.
Government obligations, with an average maturity of twelve months or less.

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data set forth below are derived from our financial
statements. The statement of operations data for the years ended December 31,
1997 and 1998, and the balance sheet data as of December 31, 1997, 1998 and
1999 are derived from our audited financial statements not included in this
report. The statement of operations data for the years ended December 31, 1999,
2000 and 2001, and the balance sheet data as of December 31, 2000 and 2001 are
derived from our audited financial statements included in this report.
Historical results are not necessarily indicative of future results. The
selected financial data set forth below should be read in conjunction with our
financial statements, the related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included elsewhere
in this report.

Years Ended December 31,
-----------------------------------------------
1997 1998 1999 2000 2001
------- ------- -------- -------- ---------
(in thousands, except per share data)

Statement of Operations Data:
Product sales............................................... $ -- $ -- $ 25 $ 5,000 $ 71,105
License income.............................................. -- -- -- 500 750
Research grant revenue...................................... -- 60 60 3 --
------- ------- -------- -------- ---------
Total revenues.......................................... -- 60 85 5,503 71,855
------- ------- -------- -------- ---------
Cost of revenues............................................ -- -- -- 11,948 49,147
------- ------- -------- -------- ---------
Gross profit (loss)..................................... -- 60 85 (6,445) 22,708
------- ------- -------- -------- ---------
Operating expenses:
Research and development.................................. 977 3,056 7,672 12,019 16,103
Selling, general and administrative....................... 703 1,810 5,557 25,460 60,458
------- ------- -------- -------- ---------
Total operating expenses................................ 1,680 4,866 13,229 37,4790 76,561
------- ------- -------- -------- ---------
Loss from operations........................................ (1680) (4,806) (13,144) (43,924) (53,853)
Interest income, net........................................ 163 142 86 332 987
------- ------- -------- -------- ---------
Net loss.................................................... (1,517) (4,664) (13,058) (43,592) (52,866)
Deemed dividends related to beneficial conversion feature of
preferred stock............................................ -- -- -- (14,773) (26,783)
------- ------- -------- -------- ---------
Net loss attributable to common stockholders................ $(1,517) $(4,664) $(13,058) $(58,365) $ (79,649)
======= ======= ======== ======== =========
Net loss per common share, basic and diluted................ $ (1.66) $ (2.31) $ (4.32) $ (14.69) $ (6.70)
======= ======= ======== ======== =========
Weighted-average shares used in computing net loss per
common share, basic and diluted............................ 914 2,015 3,024 3,973 11,891
======= ======= ======== ======== =========

As of December 31,
-----------------------------------------------
1997 1998 1999 2000 2001
------- ------- -------- -------- ---------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents................................... $ 4,088 $11,438 $ 2,322 $ 12,532 $ 143,187
Working capital............................................. 3,595 10,956 792 4,240 128,408
Total assets................................................ 4,680 12,379 8,026 37,565 209,341
Deferred revenue............................................ 72 11 511 8,687 26,970
Long-term obligations, less current portion................. -- 520 3,321 7,994 4,255
Convertible preferred stock................................. 5,526 17,361 20,472 62,883 --
Deferred stock-based compensation, net...................... -- -- (1,244) (11,263) (20,995)
Accumulated deficit......................................... (1,410) (6,074) (19,132) (62,724) (115,589)
Total stockholders' equity (deficit)........................ (1,387) (6,047) (18,159) (59,848) 133,539

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

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

All percentage amounts and ratios were calculated using the underlying data
in thousands. Operating results for the year ended December 31, 2001, are not
necessarily indicative of the results that may be expected for any future
period.

Overview and Critical Accounting Policies

We incurred significant operating losses and negative cash flows from
operations in each full fiscal year since inception. We incurred net losses of
$13.1 million in 1999, $43.6 million in 2000 and $52.9 million in 2001. As of
December 31, 2001 we had an accumulated deficit of $115.6 million. We expect to
incur significant additional losses as we expand our sales and marketing
efforts and continue to develop new products.

Revenues are generated from sales of our FreeStyle System kit and from the
recurring sales of disposable FreeStyle test strips and lancets. Our return
policy allows end users in the United States and Canada to return FreeStyle
System kits to us for a full cash refund within 30 days of purchase. There are
no end-user return rights on sales of FreeStyle test strips and lancets. In
addition, our FreeStyle System kit and FreeStyle test strips currently have an
18 month shelf life, and retailers and wholesalers in the United States and
Canada can return these products to us up to six months beyond this expiration
date. As a result of these rights of return and the current unavailability of
historical trends in sales and product returns, we defer recognition of revenue
on sales of FreeStyle test strips until resold by the retailers and wholesalers
to end users, and we defer recognition of revenue on FreeStyle System kits
until 30 days after purchase by the end user. Because we lack a sufficient
historical basis from which we could estimate return rates, we are required to
rely on data estimates provided to us by third-party data providers in order to
recognize revenue from sales to end users by retailers and wholesalers. These
data estimates may cause imprecise revenue recognition, as these third-party
data providers

may not provide consistent, reliable data. We do not know how long we will be
required to rely on these estimates. However, we believe that we will have a
sufficient historical basis from which we can estimate return rates beginning
with the quarter ending September 30, 2002. For the first quarter in which we
use our own estimates for return rates, we anticipate that our deferred revenue
from product sales will decrease and we will experience a corresponding
increase in our recognized revenue from product sales. This one-time event
could cause a significant increase in our net revenues for the applicable
period.

Domestic sales to durable medical equipment suppliers do not have a return
right so we recognize revenue from these sales upon shipment. Similarly,
products distributed internationally, with the exception of shipments to
Canada, have no right of return, and we recognize revenue on these products
upon shipment. We recognize revenue on direct product sales over the telephone
or through our website to end users upon shipment for FreeStyle test strips and
lancets and 30 days after purchase on sales of FreeStyle System kits. Our
current sales terms to retailers and wholesalers provide for customer payment
within 60 days of shipment on initial orders and payment within 30 days for
subsequent orders. We perform ongoing credit evaluations of our customers'
financial condition and, generally, require no collateral from our customers.
We believe our terms to retailers, wholesalers and end users, including their
rights to return, are similar to our competitors' terms.

Manufacturers typically sell their glucose monitoring devices at substantial
discounts to list prices, offer customer rebates or provide free product
samples to expand their installed base of monitoring devices and thus increase
the market for their disposable test strips and lancets. We have been offering
and expect to continue to offer similar discounts and rebates on, and free
samples of, our FreeStyle System kits to establish an installed base of systems
from which we expect to generate recurring revenues from our disposable
FreeStyle test strips and lancets. Due to the recent commencement of our sales,
we do not have significant historical trends in rebates claimed by end users.
As a result, we record an allowance for 100% of the allowable rebate as a
reduction of revenues reported. As we accumulate trend data in rebates claimed,
we are likely to change the percentage of the allowable rebate.

The initial product mix of FreeStyle System kits when compared to disposable
FreeStyle test strips and lancets will negatively impact our gross margins
until we have established a sufficiently large installed base of users, as we
currently distribute the FreeStyle System kit at a financial loss due in part
to samples, discounts and rebates. In the event we establish an installed base
of systems, we expect to generate an increasing portion of our revenues through
recurring sales of our FreeStyle test strips.

Cost of revenues consists primarily of:

. payments to our manufacturing and distribution partners;

. expenses relating to our disposable test strip manufacturing;

. expenses relating to our internal operations;

. expenses relating to our five-year warranty on our FreeStyle meter;

. amortization of deferred stock-based compensation;

. royalties payable under technology licenses; and

. adjustment of FreeStyle System kit inventories to estimated net realizable
value.

We provide for the estimated cost of product warranties at the time revenue
is recognized. While we engage in extensive product quality programs and
processes, including actively monitoring and evaluating the quality of our
components suppliers, our warranty obligation is affected by product failure
rates, material usage, and service delivery costs incurred in correcting a
product failure. We also make estimates to reduce our FreeStyle System kit
inventories to estimated fair net realizable value. In doing so, the historical
costs of our FreeStyle System kit inventories are compared to realized product
revenues, reduced by rebates and estimated direct selling costs.

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

Research and development expenses include costs associated with the design,
development, testing and enhancement of our products. These costs consist
primarily of:

. salaries and related personnel expenses;

. fees paid to outside service providers;

. expenditures for purchases of laboratory supplies and clinical trials;

. amortization of deferred stock-based compensation; and

. overhead allocated to product development.

At the time we commenced commercial shipments in June 2000, we transitioned
the recording of manufacturing-related costs from research and development
expense to cost of revenues. All research and development costs are expensed as
incurred. Our research and development efforts are periodically subject to
significant non-recurring costs and fees that can cause significant variability
in our quarterly research and development expenses.

Selling, general and administrative expenses primarily consist of:

. salaries, commissions and related expenses for personnel engaged in sales,
marketing, customer service and administrative functions;

. costs associated with advertising, product sampling, trade shows,
promotional and other marketing activities;

. legal and regulatory expenses;

. amortization of deferred stock-based compensation; and

. general corporate expenses.

We estimate the uncollectability of our accounts receivable. In doing so, we
analyze historical bad debts, customer concentrations, customer
credit-worthiness, current economic trends and changes in customer payment
terms.

We have recorded deferred stock-based compensation in connection with stock
option grants and sales of stock to employees at exercise or sales prices below
the deemed fair market value of our common stock. Deferred stock-based
compensation for options granted to non-employees has been determined as the
fair value of the equity instruments issued. Deferred stock-based compensation
for options granted to non-employees is periodically remeasured as the
underlying options vest. As of December 31, 2001 we have recorded aggregate
deferred stock-based compensation of $28.5 million, of which $21.0 million will
be amortized to expense on a straight line basis through 2005. This amount is
being amortized over the respective vesting periods of these equity
instruments, which is typically four years. Stock-based compensation expense
has been allocated according to employees and their respective departments and
by function for non-employees.

In September 2000, we entered into a five-year exclusive distribution
agreement with Disetronic Group relating to the distribution of FreeStyle in
Germany, Switzerland, Denmark, Austria, Sweden, Finland, Norway and the
Netherlands. In February 2002, this agreement was amended to, among other
things, extend the term through December 31, 2006 and to add France, Italy and
Belgium to Disetronic's distribution territory.

Disetronic commenced sales in Germany and Sweden in May 2001 and since that
time has commenced sales in Norway, Finland, Austria, The Netherlands and
Denmark. In connection with this agreement, we received an advance payment on a
purchase order from Disetronic of $1.5 million, which we recognized in the
second quarter of 2001 as we shipped products.

In April 2001, we entered into a five-year exclusive distribution agreement
with Nipro Corporation relating to the distribution of FreeStyle in Japan.
Nipro launched FreeStyle in Japan in February, 2002. In connection with this
agreement, we received a $5.0 million payment from Nipro, which is being
recognized as revenue ratably over the term of the agreement commencing in
April 2001.

Results of Operations

Years Ended December 31, 1999, 2000 and 2001

Revenues. Revenues in 1999 principally related to research grants and the
sale of clinical evaluation units. Revenues recognized in 2000 totaled $5.5
million, principally consisting of product sales of FreeStyle System kits and
FreeStyle test strips, which commenced in June 2000. Revenues in 2000 also
included $0.5 million from a specific non-refundable negotiation fee related to
a potential distribution arrangement, which was never consummated. In 2000,
four of our customers, CVS, Walgreens, Wal-Mart and McKesson, individually
accounted for more than 10% and collectively accounted for approximately 53% of
our product shipments for that year. Revenues recognized in 2001 totaled $71.9
million, principally consisting of sales of FreeStyle System kits and FreeStyle
test strips. In 2001, one of our customers, McKesson, and our European
distributor, Disetronic, individually accounted for more than 10% and
collectively accounted for approximately 27% of our product shipments for that
year. As of December 31, 2001, deferred revenue, awaiting sale through to end
users and for the 30-day cash refund period on FreeStyle System kit sales to
lapse, was approximately $22.7 million. Revenues in 2001 also included $0.8
million related to the $5.0 million distribution agreement payment received
from Nipro.

Cost of revenues. There was no cost of revenues recorded in 1999. Cost of
revenues in 2000 was $11.9 million and was comprised of internal manufacturing
costs, purchase costs for FreeStyle System kits and FreeStyle lancets from our
contract manufacturing partners, costs of product warranties, royalties payable
under technology licenses, start-up production costs and a $3.5 million charge
to reduce FreeStyle System kit inventories to estimated net realizable value.
Amortization of deferred stock-based compensation reported in cost of revenues
for 2000 was insignificant. Prior to commencing commercial shipments of
FreeStyle in June 2000, costs associated with start-up manufacturing-related
activities, including stock-based compensation expense, were reported as
research and development expenses. There was no cost associated with the
license fee income earned in 2000. Cost of revenues in 2001 was $49.1 million,
attributable to product sales, as there was no cost associated with the license
fee income earned. The increase in cost of revenues from 2000 to 2001 is
primarily attributable to increased purchases of FreeStyle System kits and
FreeStyle lancets from our contract manufacturing partners. Amortization of
deferred stock-based compensation reported in cost of revenues for the year
ended December 31, 2001 was $0.5 million, as compared to an insignificant
amount in the prior year.

Research and development expenses. Research and development expenses
increased from $7.7 million in 1999 to $12.0 million in 2000 and to $16.1
million in 2001. The increase from 1999 to 2000 was primarily attributable to
increases of $1.6 million for materials and supplies used in product
development efforts, $1.1 million from hiring of additional personnel, a $0.5
million payment for the purchase of technology and license rights from E.
Heller & Co., which owns more than five percent of our stock, $0.4 million for
overhead costs associated with our new facility and $0.2 million for payments
to outside service providers. The technology and license rights purchased from
E. Heller & Co. concern the measurement of biochemicals other than glucose.
This technology is at an early stage of development, and it is currently
uncertain whether it will have commercial application. Amortization of deferred
stock-based compensation was $0.6 million for the year ended December 31, 2000.
Stock-based compensation expense for the corresponding period in 1999 was
insignificant.

The increase from 2000 to 2001 was primarily attributable to $1.6 million from
hiring additional personnel, $0.4 million spent on clinical trials and $2.7
million from increased spending on product development efforts. Prior to
commencing commercial shipments of FreeStyle in June 2000, costs associated
with start-up manufacturing activities were reported as research and
development expenses. These expenses, which occurred in the first half of 2000,
totaled $1.2 million, partially offsetting the increase in research and
development expenses for the year ended December 31, 2001 over research and
development expenses for the year ended December 31, 2000. Amortization of
deferred stock-based compensation was $1.3 million for the year ended December
31, 2001 as compared to $0.6 million in the prior year. We expect research and
development spending to increase over the next several years as we increase
clinical trials for our Continuous Glucose Monitoring System and expand our
research and development activities to support our current and future products.

Selling, general and administrative expenses. Selling, general and
administrative expenses increased from $5.6 million in 1999 to $25.5 million in
2000 and to $60.5 million in 2001. The increase from 1999 to 2000 was primarily
attributable to increases of $6.2 million for personnel costs, largely related
to recruiting and hiring our U.S. direct sales force, as well as expanding
marketing and business support functions, $4.6 million for advertising,
marketing activities and other spending associated with the launch of
FreeStyle, $2.8 million spent on the cost of product sampling, $1.5 million
spent on establishing customer service and support operations, $1.1 million for
overhead costs, $1.0 million for travel costs, largely related to our new sales
force, $0.9 million spent on professional fees relating to a proposed public
offering withdrawn in December 2000 and $0.5 million for legal fees for both
patent and general corporate matters. Amortization of deferred stock-based
compensation was $1.2 million for the year ended December 31, 2000. Stock-based
compensation expense for the corresponding period in 1999 was insignificant.
The increase from 2000 to 2001 was primarily attributable to increases of $8.3
million spent on product sampling, $10.1 million for marketing activities and
other spending associated with expanding distribution and developing consumer
awareness of FreeStyle, $8.0 million for personnel costs largely related to
expanding our U.S. direct sales force as well as marketing and business support
functions, $2.0 million spent for customer service and support operations, and
$1.7 million for travel costs, largely related to our sales force. Amortization
of deferred stock-based compensation was $3.8 million for the year ended
December 31, 2001, as compared to $1.2 million in the prior year. We expect our
selling, general and administrative expenses to increase as we increase product
sampling, expand our sales force, increase our marketing and promotional
activities, and operate as a public company.

Interest income, net. Net interest income increased from $0.1 million in
1999, to $0.3 million in 2000 and to $1.0 million in 2001. Interest income in
2000 from 1999 increased due to higher average cash and cash equivalents
balances, resulting from the net proceeds of a private equity offering
completed in February 2000. Interest expense for the same period increased to a
lesser extent, reflecting additional borrowings under available lines of
credit, amortization of debt issuance costs associated with warrants issued in
connection with lines of credit and capital lease obligations arising under a
particular sale and leaseback transaction. Interest income in 2001 from 2000
increased due to higher average cash, cash equivalents and investments
balances, resulting from the net proceeds of a private equity offering closed
in April 2001 and from the net proceeds of our initial public offering in
October 2001. Interest expense in 2001 remained comparable with 2000.

Provision for income taxes. We incurred net operating losses for the years
ended December 31, 1999, 2000 and 2001 and, accordingly, we did not pay any
federal or state income taxes. As of December 31, 2001, we had accumulated
approximately $65.6 million and $43.8 million in federal and state net
operating loss carryforwards, respectively, to reduce future taxable income. If
not utilized, the federal carryforward will expire in various amounts beginning
in 2012, and the state carryforward will expire in 2005. Our net operating loss
carryforwards are subject to annual limitation under Internal Revenue Code
Section 382 due to substantial changes in ownership. Changes have already
occurred on April 21, 1997 and February 23, 1999 as a result of our preferred
stock financings. We are currently evaluating whether our October 2001 initial
public offering resulted in a substantial change of ownership within the
meaning of Section 382. The annual limitations do not result in the expiration
of net operating losses prior to utilization. We have not recorded a benefit
from our net operating loss carryforwards because we believe that it is
uncertain that we will have sufficient income from future

operations to realize the carryforwards prior to their expiration. Accordingly,
we have established a valuation allowance against the deferred tax asset
arising from the carryforwards.

We also had federal and state research and development tax credit
carryforwards as of December 31, 2001 of approximately $0.8 million and $0.6
million, respectively. If not utilized, the federal research credit will expire
in various amounts beginning in 2012. The state research credit can be carried
forward indefinitely.

Dividends related to beneficial conversion feature of preferred
stock. Dividends relating to beneficial conversion of our preferred stock of
$14.8 million were recorded in the year ended December 31, 2000. These
dividends arose due to the issuance of 8,490,159 shares of Series C preferred
stock in February 2000 for net proceeds of $42.4 million. Dividends relating to
beneficial conversion of our preferred stock of $26.8 million were recorded in
the year ended December 31, 2001. These dividends arose due to the issuance of
6,643,371 shares of Series D preferred stock in January, February and April
2001 for net proceeds of $56.4 million.

Quarterly Results of Operations

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

Quarter Ended
---------------------------------------------------------------------------------
June 30, September 30, December 31, March 31, June 30, September 30, December 31,
2000 2000 2000 2001 2001 2001 2001
-------- ------------- ------------ --------- -------- ------------- ------------
(in thousands)
(unaudited)

Revenues.................. $ 11 $ 1,280 $ 3,712 $ 7,677 $ 17,847 $ 19,858 $ 26,473
Cost of revenues.......... 306 6,768 4,874 6,225 13,443 12,938 16,541
------- -------- -------- -------- -------- -------- --------
Gross profit (loss)....... (295) (5,488) (1,162) 1,452 4,404 6,920 9,932
------- -------- -------- -------- -------- -------- --------
Operating expenses:
Research and
development.............. 2,633 3,543 2,634 2,798 3,534 4,671 5,100
Selling, general and
administrative........... 5,443 5,573 10,112 11,033 15,810 15,250 18,365
------- -------- -------- -------- -------- -------- --------
Total operating expenses.. 8,076 9,116 12,746 13,831 19,344 19,921 23,465
------- -------- -------- -------- -------- -------- --------
Loss from operations...... (8,371) (14,604) (13,908) (12,379) (14,940) (13,001) (13,533)
Interest income (expense),
net...................... 218 11 (32) 199 187 76 525
------- -------- -------- -------- -------- -------- --------
Net loss.................. $(8,153) $(14,593) $(13,940) $(12,180) $(14,753) $(12,925) $(13,008)
======= ======== ======== ======== ======== ======== ========

Revenues. The increase in revenues beginning with the quarter ended
September 30, 2000 reflects increased market acceptance of FreeStyle since
commercial shipments commenced in June 2000.

Gross profit (loss). Gross profit (loss) is influenced by both sales volume
and the product mix between FreeStyle System kits and FreeStyle test strips, as
we currently distribute the FreeStyle System kit at a financial loss due in
part to samples, discounts and rebates. The gross loss for the quarter ended
September 30, 2000 was negatively impacted by a $3.5 million charge to reduce
FreeStyle System kit inventories to estimated net realizable value. The gross
profit for the four most recent quarters resulted from higher sales volume and
an increased percentage of FreeStyle test strip revenues versus FreeStyle
System kit revenues.

Operating expenses. Prior to commencing commercial shipments of FreeStyle
in June 2000, costs associated with start-up manufacturing activities were
reported as research and development expenses. These

expenses, which occurred in the first half of 2000, totaled $1.2 million.
Research and development expenses for the third quarter of 2000 included an
expense accrual in the amount $1.2 million related to incorporating engineering
modifications into FreeStyle. Selling, general and administrative expenses
increased in absolute dollars throughout 2000 and 2001, reflecting increased
personnel costs, including recruiting and hiring our U.S. direct sales force,
advertising, marketing and other spending associated with the launch of
FreeStyle. In addition, costs were incurred beginning in the fourth quarter of
2000 related to increases in product sampling to stimulate consumer adoption of
FreeStyle.

Liquidity and Capital Resources

On October 17, 2001 we consummated our initial public offering of common
stock in which we received net proceeds of $120.9 million. Previously, we have
financed our operations primarily through private placements of convertible
preferred stock resulting in net proceeds of $119.2 million. We have also
financed our operations through equipment financing arrangements and capital
leases with $8.2 million in principal outstanding at December 31, 2001. Our
current principal debt arrangements include both a $5.0 million subordinated
debt agreement at an effective interest rate of 22.3% per annum and a $2.5
million equipment line of credit at effective interest rates between 8.5% and
9.5% per annum with Comdisco Ventures, a $3.0 million equipment line of credit
at an effective rate of 7.3% with GE Healthcare Financial Services, and a $2.0
million senior loan and security agreement at an effective interest rate of
13.1% per annum with Phoenix Capital. These effective annual interest rates
include the amortization of the fair value of warrants issued to Comdisco
Ventures and Phoenix Capital. As of December 31, 2001, we had cash and cash
equivalents of $143.2 million.

Cash used in operations. Net cash used in operating activities was
approximately $11.8 million, $36.8 million, and $36.6 million for the years
ended December 31, 1999, 2000, and 2001, respectively. For these periods, net
cash used in operating activities resulted primarily from net losses. For the
year ended December 31, 2000, increases in accounts receivable and inventories,
which reflect commencement of commercial product shipments in June 2000, were
partially offset by increases in deferred revenue, accounts payable, and
accrued liabilities. For the year ended December 31, 2001, increases in
deferred revenues, accounts payable, and accrued liabilities exceeded the
increases in accounts receivable and inventories, reducing the net cash used in
operating activities in 2001.

Cash provided by or used in investing activities. Net cash used in
investing activities was approximately $3.3 million and $8.0 million for the
years ended December 31, 1999 and 2001, respectively. For these periods,
investing activities consisted of capital expenditures and in 2001 purchases of
investments. For the year ended December 31, 2000, net cash provided by
investing activities, totaling $0.6 million, included $2.7 million in proceeds
from the sale of capital assets under sale and leaseback transactions.

Cash provided by financing activities. Net cash provided by financing
activities was approximately $6.0 million, $46.4 million, and $175.2 million
for the years ended December 31, 1999, 2000 and 2001, respectively. The net
cash provided by financing activities was primarily attributable to the
proceeds from private placements of equity securities, proceeds from long-term
borrowings, and proceeds from initial public offering in October 2001.

We expect to have negative cash flows from operations for the next 12
months. We also expect increased sales and marketing expenses related to the
promotion of FreeStyle, increased research and development expenses, as well as
expenses for additional personnel and product enhancement efforts. Our future
capital requirements will depend on a number of factors, including market
acceptance of FreeStyle, the resources we devote to developing and supporting
our products, continued progress of our research and development of potential
products, the need to acquire licenses to technology and the availability of
other financing. Our capital expenditures for the year ended December 31, 2001
were $3.7 million, and we believe that our capital requirements for the next 12
months will increase as a result of expanding our facilities and our test strip
manufacturing capacity. We believe that our current cash, cash equivalents and
investment balances, together

with the revenue to be derived from sales of FreeStyle, will be sufficient to
fund our operations for at least the next 18 months. To the extent our capital
resources are insufficient to meet our future capital requirements, we will
need to raise additional capital or incur additional indebtedness to fund our
operations. Additional equity or debt financing, if required, may not be
available on acceptable terms, or at all. If we are unable to obtain additional
capital, we may be required to reduce our selling and marketing activities for
FreeStyle, delay, reduce the scope of or eliminate our research and development
programs, or relinquish rights to technologies or products that we might
otherwise seek to develop or commercialize. In the event that we do raise
additional equity financing, investors will be further diluted. In the event we
incur additional indebtedness to fund our operations, we may have to grant the
lender a security interest in our assets.

Inflation

The impact of inflation on our business has not been material to date.

Recently Issued Accounting Pronouncements

In July 2001, the FASB issued SFAS No. 141 "Business Combinations" ("SFAS
No. 141") which establishes financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, "Business Combinations," and
FASB Statement No. 38, "Accounting for Preacquisition Contingencies of
Purchased Enterprises". SFAS No. 141 requires that all business combinations be
accounted for using one method, the purchase method. The provisions of SFAS No.
141 apply to all business combinations initiated after June 30, 2001. Our
adoption of SFAS No. 141 did not have any impact on our financial statements.

In July 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets," ("SFAS No. 142") which establishes financial accounting and reporting
for acquired goodwill and other intangible assets and supersedes APB Opinion
No. 17, "Intangible Assets". SFAS No. 142 addresses how intangible assets that
are acquired individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in financial
statements upon their acquisition, and after they have been initially
recognized in the financial statements. The provisions of SFAS No. 142 are
effective for fiscal years beginning after December 15, 2001. We will adopt
SFAS No. 142 during the first quarter of fiscal 2002, and we do not expect it
to have a material impact on our financial reporting and related disclosures.

In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations," ("SFAS No. 143") which
is effective for us beginning in fiscal 2003. SFAS No. 143 requires that the
fair value of a liability for an asset retirement obligation be recognized in
the period in which it is incurred if a reasonable estimate of fair value can
be made, with the associated asset retirement costs capitalized as part of the
carrying amount of the long-lived asset. We do not except the adoption of SFAS
No. 143 to have a material impact on our financial position and results of
operations.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which is
effective for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal periods. SFAS No. 144 supersedes FASB Statement No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" and parts of APB Opinion No. 30 "Reporting and
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions relating to Extraordinary Items," ("Opinion 30"), however, SFAS
No. 144 retains the requirement of Opinion 30 to report discontinued operations
separately from continuing operations and extends that reporting to a component
of an entity that either has been disposed of (by sale, by abandonment, or in a
distribution to owners) or is classified as held for sale. SFAS No. 144
addresses financial accounting and reporting for the impairment of certain
long-lived assets and for long-lived assets to be disposed of. We do not expect
the adoption of SFAS No. 144 to have a material impact on our financial
position and results of operations.

FACTORS AFFECTING OPERATIONS AND FUTURE RESULTS

We have limited operating experience and a history of net losses and may never
achieve or maintain profitability.

We have a limited history of operations and have focused primarily on
research and development, product engineering, clinical trials and seeking FDA
regulatory clearance to market our products. We received FDA clearance for
FreeStyle, our first commercial product, in January 2000, and we commenced
commercial shipments in June 2000. We have generated only limited revenues from
the sale of our products to date and have incurred losses every year since
1997. We incurred losses of $13.1 million in 1999, $43.6 million in 2000 and
$52.9 million in 2001. As of December 31, 2001, we had an accumulated deficit
of approximately $115.6 million. It is possible that we will never generate
sufficient revenues from product sales to achieve profitability. Even if we do
achieve significant revenues from our product sales, we expect that increased
operating expenses will result in significant operating losses over the next
several quarters as we, among other things:

. expand our domestic and international selling and marketing activities as
we attempt to gain market share for FreeStyle;

. increase our research and development efforts to improve our existing
products and develop new products such as our Continuous Glucose
Monitoring System;

. perform clinical research and trials in an effort to obtain governmental
clearance and approval for the commercial sale of our Continuous Glucose
Monitoring System; and

. expand our facilities in Alameda, California.

We will need to significantly increase the revenues we receive from sales of
our products. We may be unable to do so, and therefore, may never achieve
profitability. Even if we do achieve profitability, we may not be able to
sustain or increase profitability on a quarterly or annual basis.

We have limited experience manufacturing our FreeStyle test strips in
substantial quantities, and if we are unable to purchase additional equipment
or are otherwise unable to meet customer demand, we may not improve our sales
growth sufficiently to achieve profitability.

To be successful, we must manufacture our FreeStyle test strips in
substantial quantities at acceptable costs. If we do not succeed in
manufacturing sufficient quantities of our test strips to meet customer demand,
we could lose customers and fail to acquire new customers, if they choose a
competitor's product because our product is not available. We currently
manufacture our FreeStyle test strips using a process with which we have
limited experience. Increasing demand since the launch of FreeStyle has
necessitated an increase in our test strip manufacturing capacity. In response,
we are now implementing a second manufacturing line at our facilities in
Alameda, California. The delay in receiving certain specialized equipment has
extended the date when we will be able to begin operations on the second line.
If we are unable to implement our second manufacturing line in a timely manner,
we would be unable to meet customer demand for our FreeStyle test strips, which
would adversely affect our financial results and could restrict our sales
growth sufficiently so that we do not achieve profitability. If demand for
FreeStyle increases further, we may need to purchase additional specialized
equipment with substantial lead times and obtain additional raw materials in
order to increase the output volume of our test strips.

We expect to derive substantially all of our future revenue from sales of
FreeStyle, a product we recently introduced, and this product could fail to
generate significant revenues and achieve market acceptance.

Currently, the primary products we market are the FreeStyle System kit,
FreeStyle lancets and FreeStyle test strips, all of which we commercially
introduced in June 2000. Our FreeStyle products are expected to account for
substantially all of our revenues for at least the next several years.
Accordingly, our success depends upon the acceptance by people with diabetes,
as well as health care providers and third-party payors of FreeStyle as a

preferred blood glucose self-monitoring device. As a relatively new company in
the area of glucose self-monitoring, we may have difficulty raising the brand
awareness necessary to generate interest in FreeStyle.

To date, only a limited number of people have used FreeStyle, and people
with diabetes or the medical community may not endorse FreeStyle as a preferred
blood glucose self-monitoring device. In addition, FreeStyle may not achieve
market acceptance on a timely basis, if at all, due to:

. the significant influence of established glucose monitoring products;

. the ability of some of our competitors to price products below a price at
which we can competitively manufacture and sell our products;

. the introduction or acceptance of competing products or technologies; and

. cost constraints.

Furthermore, FreeStyle may not encourage more active testing, and
participants in the glucose self-monitoring market may gravitate toward more
established brands. If we are unable to successfully market and sell our
FreeStyle products, we may not be able to generate significant revenues or
achieve profitability because we do not have alternative products.

In addition, to encourage market acceptance of our products, we currently
distribute the FreeStyle System kit at a financial loss through samples,
discounts and rebates. In order to generate sufficient revenues in the future,
we will therefore have to rely on recurring revenue from the repeated purchase
of our FreeStyle test strips. If FreeStyle does not gain sufficient market
share to generate significant recurring revenue from the sale of our test
strips, we may not achieve profitability.

We face competition from competitors with greater resources, which may make it
more difficult for us to achieve significant market penetration.

The market for medical devices is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. We compete directly with Roche Diagnostics
Corporation, LifeScan, Inc., a division of Johnson & Johnson, MediSense, a
division of Abbott Laboratories, and Bayer AG, which currently account for
approximately 90% of the worldwide sales of blood glucose self-monitoring
systems. Each of these companies is either publicly traded or a division of a
publicly-traded company, and enjoys several competitive advantages, including:

. significantly greater name recognition;

. established relations with health care professionals, customers and
third-party payors;

. additional lines of products, and the ability to offer rebates or bundle
products to offer higher discounts or incentives to gain a competitive
advantage;

. established distribution networks and relationships with retailers; and

. greater resources for product development, sales and marketing and patent
litigation.

These companies and others have developed and will continue to develop and
acquire new products that compete directly with our products. In addition, our
competitors spend significantly greater funds for the research, development,
promotion and sale of new and existing products. These resources can allow them
to respond more quickly to new or emerging technologies and changes in customer
requirements. For all the foregoing reasons, we may not be able to compete
successfully against our current and future competitors.

Because the medical device industry is litigious, we may be sued for allegedly
violating the intellectual property rights of others.

The medical technology industry has in the past been characterized by a
substantial amount of litigation and related administrative proceedings
regarding patents and intellectual property rights. In addition, major medical
device companies have used litigation against emerging growth companies as a
means of gaining a competitive advantage.

Should third parties file patent applications or be issued patents claiming
technology also claimed by us in pending applications, we may be required to
participate in interference proceedings in the U.S. Patent and Trademark Office
to determine the relative priorities of our inventions and the third parties'
inventions. We could also be required to participate in interference
proceedings involving our issued patents and pending applications of another
entity. An adverse outcome in an interference proceeding could require us to
cease using the technology or to license rights from prevailing third parties.

Third parties may claim we are using their patented inventions and may go to
court to stop us from engaging in our normal operations and activities. These
lawsuits are expensive to defend and conduct and would also consume and divert
the time and attention of our management. A court may decide that we are
infringing a third party's patents and may order us to cease the infringing
activity. The court could also order us to pay damages for the infringement.
These damages could be substantial and could harm our business, financial
condition and operating results. In September 2001, we received a letter from
the exclusive licensee of an issued patent alleging that FreeStyle infringes
the patent and requesting that we contact the licensee regarding sublicense
opportunities. We have evaluated the patent and have made contact with the
licensee to discuss a possible sublicense.

If we were unable to obtain, on reasonable commercial terms, any necessary
license following a determination of infringement or an adverse determination
in litigation or in interference or other administrative proceedings, we would
have to redesign our products to avoid infringing a third party's patent and
could temporarily or permanently have to discontinue manufacturing and selling
some of our products. If this were to occur, it would negatively impact future
sales.

If we fail to protect our intellectual property rights, our competitors may
take advantage of our ideas and compete directly against us.

We rely on patent protection, as well as a combination of copyright, trade
secret and trademark laws, and nondisclosure, confidentiality agreements and
other contractual restrictions to protect our proprietary technology. However,
these legal means afford only limited protection and may not adequately protect
our rights or permit us to gain or keep any competitive advantage. For example,
our patents may be challenged, invalidated or circumvented by third parties.
Our patent applications may not be issued as patents in a form that will be
advantageous to us. We may not be able to prevent the unauthorized disclosure
or use of our technical knowledge or other trade secrets by employees.
Furthermore, the laws of foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United States. Even if
our intellectual property rights are adequately protected, litigation may be
necessary to enforce our intellectual property rights, which could result in
substantial costs to us and result in a substantial diversion of management
attention. If our intellectual property is not adequately protected, our
competitors could use our intellectual property to enhance their products. This
would harm our competitive position, decrease our market share or otherwise
harm our business.

The prosecution and enforcement of patents licensed to us by third parties are
not within our control, and without these technologies, our products may not be
successful and our business would be harmed.

We rely on licenses to use various technologies that are material to our
business. We do not own the patents that underlie these licenses. The licenses
from Asulab, SA and Unilever PLC grant us the right under specific patents to
make and sell diagnostic devices for diabetes monitoring that contain the
inventions claimed in the

licensed patents. Our rights to use these technologies and employ the
inventions claimed in the licensed patents are subject to our licensors abiding
by the terms of those licenses. In addition, we do not control the prosecution
of the patents to which we hold licenses, and we do not control the strategy
for determining when any patents to which we hold licenses should be enforced.
Instead, we rely upon our licensors to determine the appropriate strategy for
prosecuting and enforcing those patents.

If we are unable to continue to develop innovative products in the glucose
monitoring market, our business would be harmed.

The glucose monitoring market is subject to rapid technological change and
product innovations. Our products are based on our proprietary technology, but
our competitors may succeed in developing or marketing products that will be
technologically superior to ours or be more competitive with regard to product
features, such as small sample size. In addition, over $44 billion is spent
annually on diabetes treatment and the National Institutes for Health and other
supporters of diabetes research are continually seeking ways to prevent or cure
diabetes. Therefore, our products may also be rendered obsolete by
technological breakthroughs in diabetes prevention, monitoring or treatment.

We are currently developing additional enhancements for FreeStyle, and we
are developing new products such as our Continuous Glucose Monitoring System.
Marketing of these products will require FDA and other regulatory clearances
and approvals. Development of these products will require additional research
and development expenditures. We may not be successful in developing, marketing
or manufacturing these new products. In addition, several of our competitors
are in various stages of development of products similar to our Continuous
Glucose Monitoring System, and the FDA has approved two of these products. If
any of our competitors succeeds in developing a commercially viable product for
continuous glucose monitoring and obtains government approval or successfully
commercializes its FDA-approved product, this could negatively affect our
future revenues.

We have limited sales and marketing experience and any failure to expand sales
of FreeStyle will negatively impact future revenues.

We currently have limited experience in marketing and selling our products.
We received regulatory clearance for our initial product in January 2000 and
commenced commercial shipments in June 2000. We currently sell our products in
the United States directly, using a sales organization that we assembled
following regulatory clearance. Our products require a complex marketing and
sales effort targeted at health care professionals, diabetes educators, people
with diabetes, pharmacists and national retailers. We significantly expanded
our sales and marketing teams in 2001, and we are continuing this expansion in
2002. We will face significant challenges and risks in training, managing and
retaining these teams, including managing geographically dispersed efforts and
adequately training our people in the use and benefits of our products. We may
not be able to hire sufficient additional personnel to increase demand for our
products. In addition, we have distribution arrangements for the sale of our
products internationally and are dependent upon the sales and marketing efforts
of our third-party distributors. These distributors may not commit the
necessary resources to effectively market and sell our products. Further, they
may not be successful in selling our products. Our financial condition would be
harmed if our marketing and sales efforts were unsuccessful.

If we fail to obtain or maintain necessary FDA clearances or approvals for
products, or if approvals are delayed, we will be unable to commercially
distribute and market our products in the United States.

Our products are medical devices that are subject to extensive regulation in
the United States and in foreign countries where we do business. Unless an
exemption applies, each medical device that we wish to market in the United
States must first receive either 510(k) clearance or premarket approval from
the FDA. Either process can be lengthy and expensive. The FDA's 510(k)
clearance process usually takes from four to twelve months from the date the
application is complete, but may take longer. Although we have obtained 510(k)
clearance for our

initial product, FreeStyle, our 510(k) clearance can be revoked if safety or
effectiveness problems develop. The premarket approval process is much more
costly, lengthy and uncertain. It generally takes from one to three years from
the date the application is complete or even longer. However, achieving a
completed application is a process that may take numerous clinical trials and
require the filing of amendments over time. Our Continuous Glucose Monitoring
System under development will require premarket approval. Therefore, even if
the product is successfully developed, it may not be commercially available for
a number of years. We may not be able to obtain additional clearances or
approvals in a timely fashion, or at all. Delays in obtaining clearance or
approval could adversely affect our revenues and profitability.

Modification to our marketed devices may require new 510(k) clearances or
premarket approvals or require us to cease marketing or recall the modified
devices until these clearances are obtained.

Any modification to an FDA cleared device that could significantly affect
its safety or effectiveness, or that would constitute a major change in its
intended use, requires a new FDA 510(k) clearance or possibly premarket
approval. The FDA requires every manufacturer to make this determination in the
first instance, but the FDA can review any such decision. We have modified
aspects of FreeStyle since receiving regulatory approval, but we believe that
new 510(k) clearances are not required. In the case of certain labeling changes
for FreeStyle, the FDA required a new 510(k) clearance which was obtained in
December 2001. We may make additional modifications to FreeStyle and future
products after they have received clearance or approval, and in appropriate
circumstances, determine that new clearance or approval is unnecessary. The FDA
may not agree with any of our decisions not to seek new clearance or approval.
If the FDA requires us to seek 510(k) clearance or premarket approval for any
modifications to a previously cleared product, we may be required to cease
marketing or recall the modified device until we obtain this clearance or
approval. Also, in these circumstances, we may be subject to significant
regulatory fines or penalties.

If our suppliers or we fail to comply with the FDA's Quality System Regulation,
our manufacturing operations could be delayed, and our product sales and
profitability could suffer.

Our manufacturing processes for our FreeStyle test strips, as well as the
manufacturing processes utilized by our suppliers of FreeStyle meters, lancing
devices, lancets and control solution, are required to comply with the FDA's
Quality System Regulation, which covers the methods and documentation of the
design, testing, production, control, quality assurance, labeling, packaging,
storage and shipping of our products. The FDA enforces the Quality System
Regulation through unannounced inspections. The manufacturing line for our
FreeStyle meters at Flextronics International USA Inc. has not been inspected
to date. If we or one of our suppliers fail a Quality System Regulation
inspection, our operations could be disrupted and our manufacturing delayed. If
we fail to take adequate corrective action in response to any FDA observations,
we could face various enforcement actions, which could include a shut-down of
our manufacturing operations and a recall of our products, which would cause
our product sales and profitability to suffer. Furthermore, our key component
suppliers may not currently be or may not continue to be in compliance with
applicable regulatory requirements.

Our products are subject to product recalls even after receiving FDA clearance
or approval, which would harm our reputation.

The FDA and similar governmental authorities in other countries have the
authority to require the recall of our products in the event of material
deficiencies or defects in design or manufacture. A government mandated or
voluntary recall by us could occur as a result of component failures,
manufacturing errors or design defects. Any recall of product would divert
managerial and financial resources and harm our reputation with customers.

We currently depend on single suppliers and manufacturers for our FreeStyle
products, and the loss of any of these suppliers or manufacturers could harm
our business.

Our FreeStyle meters, along with our FreeStyle lancing devices and lancets,
are each currently manufactured according to our specifications by single
third-party manufacturers. The meters, lancing devices

and lancets are manufactured from components purchased from outside suppliers,
and some of these components are currently single-sourced. Our FreeStyle test
strips, which we manufacture ourselves, are comprised of several components
obtained from single-source suppliers. In the event we are unable, for whatever
reason, to obtain components from suppliers, or if our contract manufacturers
are unable to meet our manufacturing requirements, we may not be able to obtain
components from alternate suppliers or engage an additional manufacturer in a
timely manner. Any disruption or delay in shipments of FreeStyle meters, test
strips, lancing devices or lancets could result in the loss of customers or the
failure to acquire new customers, if they choose a competitor's product because
our product is not available. Such a disruption or delay would negatively
affect our revenues.

We outsource several key parts of our operations and any interruption in the
services provided could prevent us from expanding our business.

We currently outsource several aspects of our business, including the
manufacture of FreeStyle meters, lancing devices and lancets, the functioning
of our procurement systems, and the operation of our customer service function.
Since outsourcing leaves us without direct control over these business
functions, interruptions in the services of our third-party providers may be
difficult or impossible to remedy in a timely fashion. In addition, we may be
unable to obtain the necessary resources from our third-party providers to meet
realized growth in our business.

Any adverse changes in reimbursement procedures by Medicare or other
third-party payors may limit our ability to market and sell our products.

In the United States, glucose self-monitoring devices and test strips are
generally covered by Medicare and other third-party payors, which provide for
reimbursement of all or part of the cost of the product. Medicare and other
third-party payors are increasingly scrutinizing whether to cover new products
and the level of reimbursement for covered products. FreeStyle is currently
being reimbursed through Medicare, Medicaid, open formulary plans and certain
preferred provider organizations.

International market acceptance of our products will depend, in part, upon
the availability of reimbursement within prevailing health care payment
systems. Reimbursement and health care payment systems in international markets
vary significantly by country, and include both government sponsored health
care and private insurance. We may not obtain international reimbursement
approvals in a timely manner, if at all. Our failure to receive international
reimbursement approvals may negatively impact market acceptance of our products
in the international markets in which those approvals are sought.

We believe that in the future, reimbursement will be subject to increased
restrictions both in the United States and in international markets.
Third-party reimbursement and coverage may not be available or adequate in
either the United States or international markets. Future legislation,
regulation or reimbursement policies of third-party payors may adversely affect
the demand for our existing products or our products currently under
development or our ability to sell our products on a profitable basis. The lack
of third-party payor coverage or the inadequacy of reimbursement could have a
material adverse effect on our business, financial condition and results of
operations.

We may have difficulty managing our growth.

We expect to continue to experience significant growth in the scope of our
operations and the number of our employees. This growth may continue to place a
significant strain on our management and operations. Our ability to manage this
growth will depend upon our ability to attract, hire and retain skilled
employees. Our success will also depend on the ability of our officers and key
employees to continue to implement and improve our operational and other
systems, to manage multiple, concurrent development projects and to hire, train
and manage our employees. Our future success is heavily dependent upon growth
and acceptance of new products. If we cannot scale our business appropriately
or otherwise adapt to anticipated growth and new product introduction, our
business, financial condition and results of operations will be adversely
affected.

Our success will depend on our ability to attract and retain key personnel and
scientific staff.

We believe our future success will depend upon our ability to successfully
manage our growth, including attracting and retaining scientists, engineers and
other highly skilled personnel. Our employees may terminate their employment
with us at any time and are not subject to employment contracts. Hiring
qualified management and technical personnel will be difficult due to the
limited number of qualified professionals. Competition for these types of
employees is intense in the field of diabetes monitoring and management. We
have in the past experienced difficulty in recruiting qualified personnel. If
we fail to attract and retain personnel, particularly management and technical
personnel, we may not be able to execute on our business plan.

Our products carry return policies that do not permit us to recognize revenue
from sales to retailers and wholesalers prior to resale to end users.

Our return policy allows end users in the United States and Canada to return
FreeStyle System kits to us for any reason for a full refund within 30 days of
purchase. In addition, our FreeStyle System kits and FreeStyle test strips
currently have an 18 month shelf life. Retailers and wholesalers in the United
States and Canada can return these products to us within six months after this
expiration date. If we experience significant returns from retailers,
wholesalers or end users, this could seriously harm our business and results of
operations. As a result of these rights to return and the unavailability of
historical return rates, we defer revenue recognition on sales of test strips
until resold by the retailers and wholesalers to end users, and we defer
revenue recognition on FreeStyle System kits until 30 days after purchase by
the end user.

Because we lack a sufficient historical basis from which we could estimate
return rates, we are required to rely on data estimates provided to us by
third-party data providers in order to recognize revenue from sales to end
users by retailers and wholesalers. These data estimates may cause imprecise
revenue recognition, as these third-party data providers may not provide
consistent, reliable data. Further, we do not know how long we will be required
to rely on these estimates, although we believe that we will have a sufficient
historical basis from which we can estimate return rates beginning with the
quarter ending September 30, 2002.

If we do not provide quality customer service, we would lose customers and our
operating results would suffer.

Our ability to provide superior customer service to our customers, health
care professionals and educators is critical. To effectively compete, we must
build strong brand awareness among our customers, much of which is based upon
personal referrals. In order to gain these referrals, we must provide customer
service representatives who are able and available to provide our customers
with answers to questions regarding our products. This will require us to
continue to build and maintain customer service operations, for which we
currently rely on a single third-party provider. We will require increased
staff at our third-party provider to further support growth in new customers.
Any failures or disruption to our customer services operations, or the
termination of our contract with our only third-party provider, could cause us
to lose customers.

We currently have only one distributor in Europe and one distributor in Japan,
and if these distributors are not successful or we are unable to attract
additional distributors, we may never realize significant international
revenues.

In September 2000, we entered into an agreement for the exclusive marketing
and sale of FreeStyle in several European countries, subject to regulatory
approval. In May 2001, our third-party distributor commercially introduced
FreeStyle in Germany and Sweden and has commercially introduced FreeStyle in
Finland, Austria, Norway, The Netherlands and Denmark since that time. In
February 2002, this agreement was expanded to include France, Italy and
Belgium. In April 2001, we entered into an agreement for the exclusive
marketing and sale of FreeStyle in Japan, subject to regulatory approval. In
February 2002, FreeStyle was launched in Japan. We will be dependent on these
distributors in those markets, and we will need to attract additional
distributors in

other markets. If our current or future third-party distributors do not
succeed, we may never realize significant international revenues.

Complying with international regulatory requirements is an expensive,
time-consuming process and approval is never certain.

International sales of our products are subject to strict regulatory
requirements. The review process varies from country to country, is typically
lengthy and expensive, and approval is never certain. We have the required
regulatory approvals to market FreeStyle in Europe, Japan, Canada and certain
countries in the Middle East. Failure to maintain current foreign approvals or
to receive and maintain approvals in other countries would prevent us from
expanding international sales of FreeStyle, which would negatively impact our
future revenues.

If we choose to acquire new and complimentary businesses, products or
technologies instead of developing them ourselves, we may be unable to complete
these acquisitions or to successfully integrate an acquired business or
technology in a cost-effective and non-disruptive manner.

Our success depends on our ability to continually enhance and broaden our
product offerings in response to changing technologies, customer demands and
competitive pressures. Accordingly, we may, in the future, acquire
complementary businesses, products, or technologies instead of developing them
ourselves. We do not know if we will be able to complete any acquisitions, or
whether we will be able to successfully integrate any acquired business,
operate it profitably or retain its key employees. Integrating any business,
product or technology we acquire could be expensive and time consuming, disrupt
our ongoing business and distract our management. If we are unable to integrate
any acquired entities, products or technologies effectively, our business will
suffer. In addition, any amortization of goodwill or other assets or charges
resulting from the costs of acquisitions could harm our business and operating
results.

If we become subject to product liability claims, we may be required to pay
damages that exceed our insurance coverage.

Our business exposes us to potential product liability claims that are
inherent in the testing, production, marketing and sale of human diagnostic
products. While we believe that we are reasonably insured against these risks,
we may not be able to obtain insurance in amounts or scope sufficient to
provide us with adequate coverage against all potential liabilities. Currently,
we maintain product liability insurance in the amount of $22.0 million. A
product liability claim in excess of our insurance coverage would have to be
paid out of cash reserves and would harm our reputation in the industry.

We are subject to additional risks associated with international operations.

We believe that a significant amount of our future revenues may come from
international sales, and these sales are subject to a number of risks. For
example, foreign regulatory agencies often establish requirements different
from those in the United States. Fluctuations in exchange rates of the U.S.
dollar against foreign currencies may affect demand for our products overseas.
In addition, our international sales may be adversely affected by export
license requirements, the imposition of governmental controls, political and
economic instability, trade restrictions, changes in tariffs and difficulties
in staffing and managing international operations.

If we require future capital, we may not be able to secure additional funding
in order to expand our operations and develop new products.

We may seek additional funds from public and private stock offerings,
borrowings under lease lines of credit or other sources. This additional
financing may not be available on a timely basis on terms acceptable to us, or
at all. This financing may be dilutive to stockholders or may require us to
grant a lender a security interest in our assets. The amount of money we will
need will depend on many factors, including:

. revenues generated by sales of FreeStyle and our future products, if any;

. expenses we incur in developing and selling our products;

. the commercial success of our research and development efforts; and

. the emergence of competing technological developments.

If adequate funds are not available, we may have to delay development or
commercialization of our products or license to third parties the rights to
commercialize products or technologies that we would otherwise seek to
commercialize. We also may have to reduce marketing, customer support or other
resources devoted to our products. Any of these results would harm our
financial condition.

We may have warranty claims that exceed our reserves.

FreeStyle meters carry a five-year warranty against defects in materials and
workmanship. We have established reserves for the liability associated with
product warranties. However, any unforeseen warranty exposure could adversely
affect our operating results.

All of our operations are currently conducted at a single location, and a
disaster at this facility is possible and could result in a prolonged
interruption of our business.

We currently conduct all our scientific, test strip manufacturing and
management activities at a single location in Alameda, California near known
earthquake fault zones. In addition, our facilities were built on fill material
dredged from the San Francisco Bay in the 1960s. Our sole supplier of FreeStyle
meters also currently manufactures these devices at a single facility in San
Jose, California near known earthquake fault zones. We have taken precautions
to safeguard our facilities, including insurance, health and safety protocols,
and off-site storage of computer data. However, a natural disaster, such as an
earthquake, fire or flood, could cause substantial delays in our operations,
damage or destroy our manufacturing equipment or inventory, and cause us to
incur additional expenses. A disaster could seriously harm our business and
adversely affect our reputation with customers. The insurance we maintain
against fires, floods, and earthquakes may not be adequate to cover our losses
in any particular case.

Power outages in California may adversely affect us.

We conduct all of our scientific, test strip manufacturing and management
activities in California and rely on a continuous power supply to conduct
operations. Our sole-source supplier of FreeStyle meters is currently
manufacturing our meters in a single facility that is also in California.
California has previously implemented, and may in the future have to implement,
rolling blackouts throughout the state. If blackouts interrupt our power
supply, we may be temporarily unable to continue operations at our facilities,
which includes the manufacture and production of our FreeStyle test strips.
Interruptions in our ability to continue operations at our facilities could
delay our shipments of FreeStyle test strips, delay the development of our
products, and disrupt communications with our customers, suppliers and
third-party manufacturing operations. Future interruptions could result in lost
revenue and damage our reputation, either of which could harm our business and
results of operations. Furthermore, past shortages in wholesale electricity
supplies have caused power prices to increase. If similar shortages occur in
the future, our operating expenses will likely increase, which will have a
negative effect on our operating results.

We may be liable for contamination or other harm caused by materials that we
use, and changes in environmental regulations could cause us to incur
additional expense.

Our research and development and clinical processes involve the use of
potentially harmful biological materials as well as hazardous materials. We are
subject to federal, state and local laws and regulations governing the use,
handling, storage and disposal of hazardous and biological materials and we
incur expenses relating to compliance with these laws and regulations. If
violations of environmental, health, and safety laws

occur, we could be held liable for damages, penalties and costs of remedial
actions. These expenses or this liability could have a significant negative
impact on our financial condition. We may violate environmental, health and
safety laws in the future as a result of human error, equipment failure, or
other causes. Environmental laws could become more stringent over time,
imposing greater compliance costs and increasing risks and penalties associated
with violations. We are subject to potentially conflicting and changing
regulatory agendas of political, business, and environmental groups. Changes to
or restrictions on permitting requirements or processes, hazardous or
biological material storage or handling might require an unplanned capital
investment and/or relocation. Compliance with new laws or regulations could
harm our business, financial condition and results of operations.

Our common stock has been and will likely continue to be subject to substantial
price and volume fluctuations, and the value of our stock could decline.

The market prices and trading volumes for emerging growth medical device
companies have been highly volatile and are likely to continue to be highly
volatile in the future. The following factors, in addition to other risk
factors described in this section, may have a significant impact on the market
price of our stock:

. volume and timing of orders for our products;

. monthly variations in market data relative to our competitors;

. our ability to develop, obtain regulatory clearance for, and market, new
and enhanced products on a timely basis;

. the announcement of new products or product enhancements by us or our
competitors;

. announcements of technological or medical innovations in the monitoring or
treatment of diabetes;

. product liability claims or other litigation;

. quarterly variations in our or our competitors' results of operations;

. changes in governmental regulations or in the status of our regulatory
approvals or applications;

. changes in the availability of third-party reimbursement in the United
States or other countries;

. changes in earnings estimates or recommendations by securities analysts;
and

. general market conditions and other factors, including factors unrelated
to our operating performance or the operating performance of our
competitors.

The sales of a substantial number of shares of our common stock, including
shares that will become eligible for sale in the near future, may adversely
affect the market price for our common stock

Sales of a significant number of shares of our common stock in the public
market or the market perception that these sales may occur, could negatively
affect the market price for our common stock. As of March 1, 2002, we had
39,542,380 shares of common stock outstanding. The 6,900,000 shares of our
common stock sold in our October 2001 initial public offering are freely
tradable. The remaining 32,642,380 of these shares are subject to a lock-up
agreement under which the holders of these shares have agreed not to sell or
otherwise dispose of their shares of common stock until after April 10, 2002.
Also, many of our employees, consultants and directors may exercise their stock
options in order to sell the stock underlying their options in the market under
a registration statement we have filed with the SEC. All of these shares will
be available for sale after April 10, 2002. In addition, U.S. Bancorp Piper
Jaffray Inc., the lead underwriter of our October 2001 initial public offering,
may waive these lock-up restrictions prior to the expiration of the lock-up
period without prior notice.

In addition, the holders of approximately 23.5 million shares of common
stock have rights, subject to some conditions, to require us to file
registration statements covering their shares or to include their shares in

registration statements that we may file for ourselves or other stockholders.
Furthermore, if we were to include in a company-initiated registration
statement shares held by those holders pursuant to the exercise of their
registration rights, those sales could impair our ability to raise needed
capital by depressing the price at which we could sell our common stock.

Our principal stockholders, executive officers, directors and director nominees
own a significant percentage of our stock, and as a result, the trading price
for our shares may be depressed and these stockholders can take actions that
may be adverse to investors' interests.

Our executive officers, directors, director nominees and entities affiliated
with them beneficially own, in the aggregate, approximately 43.7% of our common
stock as of March 1, 2002. This significant concentration of share ownership
may adversely affect the trading price for our common stock because investors
often perceive disadvantages in owning stock in companies with controlling
stockholders. These stockholders, acting together, will have the ability to
exert substantial influence over all matters requiring approval by our
stockholders, including the election and removal of directors and any proposed
merger, consolidation or sale of all or substantially all of our assets. In
addition, they could dictate the management of our business and affairs. This
concentration of ownership could have the effect of delaying, deferring or
preventing a change in control, or impeding a merger or consolidation, takeover
or other business combination that could be favorable to our investors.

Our charter documents and Delaware law may inhibit a takeover that stockholders
consider favorable and could also limit the market price of investors' stock.

Our certificate of incorporation and bylaws will contain provisions that
could delay or prevent a change in control of our company. Some of these
provisions:

. authorize the issuance of preferred stock which can be created and issued
by the board of directors without prior stockholder approval, commonly
referred to as "blank check" preferred stock, with rights senior to those
of common stock;

. prohibit stockholder actions by written consent; and

. provide for a classified board of directors.

In addition, we are governed by the provisions of Section 203 of Delaware
General Corporate Law. These provisions may prohibit stockholders owning 15% or
more of our outstanding voting stock from merging or combining with us. These
and other provisions in our amended and restated certificate of incorporation
and bylaws and under Delaware law could reduce the price that investors might
be willing to pay for shares of our common stock in the future and result in
the market price being lower than it would be without these provisions.

The liquidity of our common stock is uncertain since it has been publicly
traded for a short period of time and may have a limited market.

Prior to our initial public offering in October 2001, there was no public
market for our common stock. We cannot predict the extent to which investor
interest in our company will lead to the development of an active, liquid
trading market. Active trading markets generally result in lower price
volatility and more efficient execution of buy and sell orders for investors.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Although we transact our business in U.S. dollars, future fluctuations in
the value of the U.S. dollar may affect the price competitiveness of our
products. However, we do not believe that we currently have any significant
direct foreign currency exchange rate risk and have not hedged exposures
denominated in foreign currencies or any other derivative financial instruments.

The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our invested cash
without significantly increasing risk of loss. As of December 31, 2001, our
cash and cash equivalents consisted primarily of money market funds maintained
at one major U.S. financial institution. The recorded carrying amounts of cash
and cash equivalents approximate fair value due to their short-term maturities.
We do not believe that an increase in market rates would have any significant
negative impact on the realized value of our investments, but an increase in
market rates could negatively impact the interest expense associated with a
portion of our long-term debt. Substantially all of our long-term debt
obligations have a fixed rate of interest.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Financial Statements and Supplementary Data required by this Item are
set forth at the pages indicated in Item 14 of this report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning our directors and executive officers is incorporated
by reference to the sections entitled "Proposal No. 1: Election of Directors "
and "Management " contained in our definitive Proxy Statement with respect to
our 2002 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later than 120 days after the end of the fiscal year
covered by this report. Information concerning compliance with Section 16(a) of
the Securities Exchange Act of 1934 is incorporated by reference to the section
entitled "Section 16(a) Beneficial Ownership Reporting Compliance" contained in
our Proxy Statement.

ITEM 11. EXECUTIVE COMPENSATION

Information concerning executive compensation is incorporated by reference
to the sections entitled "Proposal No. 1: Election of Directors--Director
Compensation," "Compensation of Executive Officers--Summary Compensation
Table," "Compensation of Executive Officers--Option Grants in Last Fiscal
Year," "Compensation of Executive Officers--Aggregated Option Exercises in Last
Fiscal Year and Fiscal Year-End Option Values," and "Compensation of Executive
Officers--Change of Control and Severance Agreements" contained in our Proxy
Statement referred to in Item 10 above.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information concerning the security ownership of certain beneficial owners
and management is incorporated by reference to the section entitled "Common
Stock Ownership of Certain Beneficial Owners and Management" contained in our
definitive Proxy Statement referred to in Item 10 above.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning certain relationships is incorporated by reference to
the section entitled "Related-Party Transactions" contained in our definitive
Proxy Statement referred to in Item 10 above.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) The following documents are filed as part of this report:

(1) Financial Statements

Page
----

Report of Independent Accountants........................................................................ F-2
Balance Sheets as of December 31, 2001 and 2000.......................................................... F-3
Statements of Operations for each of the three years in the year ended December 31, 2001................. F-4
Statements of Stockholders' Equity (Deficit) for each of the three years in the year ended December 31,
2001................................................................................................... F-5
Statements of Cash Flows for each of the three years in the year ended December 31, 2001................. F-6
Notes to Financial Statements............................................................................ F-7

(2) Financial Statement Schedules

The following financial statement schedule of TheraSense for the
years ended December 31, 2001, 2000 and 1999 is filed as part of this
Annual Report and should be read in conjunction with the financial
statements of TheraSense:

Schedule II--Valuation and Qualifying Accounts........................................................... S-1

All other schedules are omitted because they are not applicable or the
required information is shown in financial statements or notes thereto.

(3) Exhibits

Exhibit
Number Description of Document
------ -----------------------

**3.1 Certificate of Incorporation of TheraSense, Inc., a Delaware corporation, as currently in effect

***3.2 Bylaws of TheraSense, Inc. as currently in effect

*4.1 Specimen Common Stock Certificate

10.1 1997 Stock Plan, as amended, and forms of agreements thereunder

*10.2 2001 Stock Plan and forms of agreements thereunder

*10.3 2001 Employee Stock Purchase Plan and forms of agreement thereunder

*10.4 Form of Director and Executive Officer Indemnification Agreement

*10.5 Employment Letter from TheraSense, Inc. to W. Mark Lortz, dated as of October 6, 1997

+*10.6 Technology Purchase Agreement between TheraSense and E. Heller & Co. dated as of October 10,
2000

+*10.7 Cooperative Development Agreement between TheraSense, Inc. and Facet Technologies LLC
(f/k/a Gainor Medical North America LLC), dated as of December 1, 1998

+*10.7(a) First Amendment to Cooperative Development Agreement between TheraSense, Inc. and Facet
Technologies LLC (f/k/a Gainor Medical North America LLC), effective June 1, 2001

+*10.7(b) Master Purchase Agreement between TheraSense, Inc. and Facet Technologies LLC effective June 1,
2001

*10.8 Standard Industrial/Commercial Single-Tenant Lease between TheraSense, Inc. and PlyProperties, a
Partnership, dated as of February 26, 1999, and addendum thereto

+*10.9 Master Purchase Agreement between TheraSense and Flextronics International USA, Inc., dated as
of November 3, 1999

Exhibit
Number Description of Document
------ -----------------------

+ *10.10 Assignment of Patent Rights and Technology by and among Board of Regents of the University of
Texas System, an agency of the State of Texas, Dr. Adam Heller, E. Heller & Company and
TheraSense Inc. dated August 1, 1991

+*10.11 First Amendment, dated March 19, 1998, to the Agreement entitled Assignment of Patent Rights
and Technology by and among Board of Regents of the University of Texas System, an agency of
the State of Texas, Dr. Adam Heller, E. Heller & Company and TheraSense Inc. dated August 1,
1991

+*10.12 License Agreement between TheraSense, Inc. and Asulab SA., dated February 23, 2000

+*10.13 Warehouse Distribution Contract between TheraSense, Inc. and Livingston Healthcare Service,
Inc., dated March 15, 2000

+*10.14 International Distributor Agreement between TheraSense, Inc. and Nipro Corporation, dated
April 1, 2001

+*10.15 International Distributor Agreement between TheraSense, Inc. and Disetronic Handels AG, dated
September 13, 2000

++10.15(a) Amendment No. 1 to International Distributor Agreement between TheraSense, Inc. and Disetronic
Handels AG, dated February 8, 2002

+*10.16 Management Services Agreement between TheraSense, Inc. and ICT Group, Inc., dated January 31,
2000

+*10.17 License Agreement between TheraSense, Inc. and Unilever PLC dated February 10, 2000

*10.18 Promissory Note dated March 5, 1999 for the principal aggregate amount of $72,495 issued by
W. Mark Lortz to TheraSense

*10.19 Promissory Note dated July 30, 1998 for the principal aggregate amount of $17,500 issued by
Charles T. Liamos to TheraSense

*10.20 Promissory Note dated March 5, 1999 for the principal aggregate amount of $15,187.50 issued by
Charles T. Liamos to TheraSense

10.20(a) Amendment to Promissory Note dated March 5, 1999 for the principal aggregate amount of
$15,187.50 issued by Charles T. Liamos to TheraSense, Inc.

*10.21 Promissory Note dated September 1, 1999 for the principal aggregate amount of $61,250 issued by
Charles T. Liamos to TheraSense

*10.22 Promissory Note dated December 1, 1997 for the principal aggregate amount of $62,650 issued by
W. Mark Lortz to TheraSense, Inc.

10.22(a) Amendment to Promissory Note dated December 1, 1997 for the principal aggregate amount of
$62,650 issued by W. Mark Lortz to TheraSense, Inc.

*10.23 Amended and Restated Investors Rights Agreement by and among holders of TheraSense Preferred
Stock and TheraSense, Inc., dated January 23, 2001, as amended

*10.24 First Amendment to the Agreement Entitled Sponsored Research Agreement No. UTA 98-0296
entered into as of October 10, 2000, by and between TheraSense, Inc. and the Board of Regents of the
University of Texas System on behalf of the University of Texas at Austin

*10.25 Form of Change of Control Agreement between TheraSense, Inc. and each Vice President of
TheraSense, Inc.

21.1 List of subsidiaries of TheraSense, Inc.

23.1 Consent of PricewaterhouseCoopers LLP, independent accountants

--------
* Incorporated by reference to the same exhibit filed with our Registration
Statement on Form S-1 (Registration No. 333-64456), which was declared
effective on October 11, 2001.
** Incorporated by reference to Exhibit 3.1(b) filed with our Registration
Statement on Form S-1 (Registration No. 333-64456), which was declared
effective on October 11, 2001.
*** Incorporated by reference to Exhibit 3.2(b) filed with our Registration
Statement on Form S-1 (Registration No. 333-64456), which was declared
effective on October 11, 2001.
+ Confidential treatment granted for portions of these exhibits.
++ Confidential treatment requested for portions of this exhibit.

(b) Reports on Forms 8-K.

TheraSense did not file any reports on Form 8-K during the period covered
by this report.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, on March 19, 2002.

THERASENSE, INC.

/S/ W. MARK LORTZ
--------------------------------
W. Mark Lortz
Chairman of the Board, President
and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below hereby constitutes and appoints W. Mark Lortz, Charles T. Liamos and
Robert D. Brownell, and each of them individually, as his attorney-in-fact,
each with full power of substitution, for him in any and all capacities, to
sign any and all amendments to this Report on Form 10-K, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
said attorney-in fact, or his substitutes, may do or cause to be done by virtue
hereof.

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

Signature Title Date
--------- ----- ----

/s/ W. MARK LORTZ Chairman of the Board, March 19, 2002
------------------------------ President, Chief Executive
W. Mark Lortz Officer(Principal Executive
Officer)

/s/ CHARLES T. LIAMOS Chief Operating Officer and March 19, 2002
------------------------------ Chief Financial
Charles T. Liamos Officer(Principal Financial
and Accounting Officer)

/s/ ANNETTE J. CAMPBELL-WHITE Director March 19, 2002
------------------------------
Annette J. Campbell-White

/s/ MARK J. GAINOR Director March 19, 2002
------------------------------
Mark J. Gainor

/s/ EPHRAIM HELLER Director March 19, 2002
------------------------------
Ephraim Heller

/s/ ROSS A. JAFFE, M.D. Director March 19, 2002
------------------------------
Ross A. Jaffe, M.D.

/s/ MICHAEL M. MCNAMARA Director March 19, 2002
------------------------------
Michael M. McNamara

/s/ ROBERT R. MOMSEN Director March 19, 2002
------------------------------
Robert R. Momsen

/s/ RICHARD P. THOMPSON Director March 19, 2002
------------------------------
Richard P. Thompson

THERASENSE, INC.

INDEX TO FINANCIAL STATEMENTS

Page
----

Report of Independent Accountants.............................................................................. F-2

Balance Sheets as of December 31, 2001 and 2000................................................................ F-3

Statements of Operations for each of the three years in the year ended December 31, 2001....................... F-4

Statements of Stockholders' Equity (Deficit) for each of the three years in the year ended December 31, 2001... F-5

Statements of Cash Flows for each of the three years in the year ended December 31, 2001....................... F-6

Notes to Financial Statements.................................................................................. F-7

F-1

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of TheraSense, Inc.

In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of TheraSense,
Inc. (the "Company") at December 31, 2000 and 2001 and the results of its
operations and its cash flows for each of the three years in the year ended
December 31, 2001 in conformity with accounting principles generally accepted
in the United States of America. In addition, in our opinion, the financial
statement schedule appearing under Item 14(a)(2) on page 40 presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

/s/ PRICEWATERHOUSECOOPERS LLP

San Jose, California
February 1, 2002

F-2

THERASENSE, INC.

BALANCE SHEETS

December 31
---------------------------
2000 2001
------------ -------------

ASSETS
Current assets:
Cash and cash equivalents...................................................... $ 12,532,474 $ 143,186,956
Accounts receivable, net of allowance for doubtful accounts of $150,000 in
2000 and $704,296 in 2001.................................................... 6,174,697 21,259,840
Inventories.................................................................... 3,493,777 6,649,416
Deferred cost of products sold................................................. 7,396,547 16,359,490
Prepaid expenses and other current assets...................................... 1,178,435 8,238,008
------------ -------------
Total current assets....................................................... 30,775,930 195,693,710
Investments....................................................................... -- 4,278,040
Property and equipment, net....................................................... 4,838,682 6,539,008
Other assets...................................................................... 1,950,303 2,829,848
------------ -------------
Total assets............................................................... $ 37,564,915 $ 209,340,606
============ =============

LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Accounts payable............................................................... $ 10,624,731 $ 20,223,406
Accrued liabilities............................................................ 4,421,512 19,363,446
Deferred revenue............................................................... 8,686,547 23,708,647
Current portion of capital lease obligations................................... 844,394 1,087,850
Current portion of borrowings under lines of credit............................ 1,958,958 2,902,106
------------ -------------
Total current liabilities.................................................. 26,536,142 67,285,455
Deferred revenue.................................................................. -- 3,261,341
Capital lease obligations, less current portion................................... 2,037,140 968,061
Borrowings under lines of credit, less current portion............................ 3,457,345 3,286,746
Convertible promissory note....................................................... 2,500,000 --
Other liabilities................................................................. -- 1,000,000
------------ -------------
Total liabilities.......................................................... 34,530,627 75,801,603
------------ -------------
Commitments and contingencies (Note 7)

Convertible preferred stock, $0.001 par value:
Authorized: 28,609,647 shares; Issued and outstanding: 20,078,780 shares
in 2000 and none in 2001 (Liquidation preference: $63,025,778 in 2000
and none in 2001)............................................................ 62,882,739 --
------------ -------------
Stockholders' equity (deficit):
Preferred stock: $0.001 par value; Authorized: 5,000,000 shares; none
issued or outstanding........................................................ -- --
Common stock: $0.001 par value:
Authorized: 200,000,000 shares; Issued and outstanding: 5,139,392 shares
in 2000 and 39,534,209 shares in 2001........................................ 5,140 39,535
Additional paid-in capital..................................................... 14,427,351 270,376,138
Notes receivable from stockholders............................................. (294,750) (292,051)
Deferred stock-based compensation, net......................................... (11,262,561) (20,995,455)
Accumulated deficit............................................................ (62,723,631) (115,589,164)
------------ -------------
Total stockholders' equity (deficit)....................................... (59,848,451) 133,539,003
------------ -------------
Total liabilities, convertible preferred stock and stockholders'
equity (deficit)...................................................... $ 37,564,915 $ 209,340,606
============ =============

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

F-3

THERASENSE, INC.

STATEMENTS OF OPERATIONS

Years Ended December 31,
----------------------------------------
1999 2000 2001
------------ ------------ ------------

Revenues:
Product sales............................................. $ 25,000 $ 5,000,250 $ 71,105,322
License income............................................ -- 500,000 750,000
Research grant revenue.................................... 60,296 3,000 --
------------ ------------ ------------
Total revenues........................................ 85,296 5,503,250 71,855,322
------------ ------------ ------------
Cost of revenues............................................. -- 11,948,283 49,147,207
------------ ------------ ------------
Gross profit (loss).......................................... 85,296 (6,445,033) 22,708,115
------------ ------------ ------------
Operating expenses:
Research and development.................................. 7,672,517 12,019,110 16,103,139
Selling, general and administrative....................... 5,556,708 25,460,349 60,457,638
------------ ------------ ------------
Total operating expenses.............................. 13,229,225 37,479,459 76,560,777
------------ ------------ ------------
Loss from operations......................................... (13,143,929) (43,924,492) (53,852,662)
Interest income.............................................. 295,307 1,488,049 2,178,743
Interest and other expense, net.............................. (209,100) (1,155,394) (1,191,614)
------------ ------------ ------------
Net loss..................................................... (13,057,722) (43,591,837) (52,865,533)
Deemed dividends related to beneficial conversion feature of
preferred stock............................................ -- (14,772,878) (26,782,911)
------------ ------------ ------------
Net loss attributable to common stockholders................. $(13,057,722) $(58,364,715) $(79,648,444)
============ ============ ============
Net loss per common share, basic and diluted................. $ (4.32) $ (14.69) $ (6.70)
============ ============ ============
Weighted-average shares used in computing net loss per common
share, basic and diluted................................... 3,023,636 3,973,250 11,890,566
============ ============ ============

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

F-4

THERASENSE, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

For the Years Ended December 31, 1999, 2000 and 2001

Notes Total
Common Stock Additional Receivable Deferred Stockholders'
------------------- Paid-In from Stock-based Accumulated Equity
Shares Amounts Capital Stockholders Compensation Deficit (Deficit)
---------- ------- ------------ ------------ ------------ ------------- -------------

Balances, January 1, 1999............. 4,582,750 $ 4,583 $ 160,923 $(138,425) $ -- $ (6,074,072) $ (6,046,991)
Exercise of stock options for cash and
in exchange for notes receivable
from stockholders.................... 394,182 394 198,566 (192,770) -- -- 6,190
Issuance of warrants to purchase
Series B preferred stock............. -- -- 819,760 -- -- -- 819,760
Deferred stock-based compensation..... -- -- 1,364,609 -- (1,364,609) -- --
Amortization of deferred stock-based
compensation......................... -- -- -- -- 120,191 -- 120,191
Net loss.............................. -- -- -- -- -- (13,057,722) (13,057,722)
---------- ------- ------------ --------- ------------ ------------- ------------
Balances, December 31, 1999........... 4,976,932 4,977 2,543,858 (331,195) (1,244,418) (19,131,794) (18,158,572)
Exercise of stock options for cash and
in exchange for notes receivable
from stockholders.................... 213,671 214 86,435 (6,068) -- -- 80,581
Repurchase of shares and cancellation
of stockholder note receivable....... (51,211) (51) (14,333) 14,384 -- -- --
Repayment of notes receivable from
stockholders......................... -- -- -- 28,129 -- -- 28,129
Deferred stock-based compensation..... -- -- 11,811,391 -- (11,811,391) -- --
Amortization of deferred stock-based
compensation......................... -- -- -- -- 1,793,248 -- 1,793,248
Beneficial conversion feature related
to issuance of Series C convertible
preferred stock...................... -- -- 14,772,878 -- -- -- 14,772,878
Deemed dividend related to beneficial
conversion feature of Series C
convertible preferred stock.......... -- -- (14,772,878) -- -- -- (14,772,878)
Net loss.............................. -- -- -- -- -- (43,591,837) (43,591,837)
---------- ------- ------------ --------- ------------ ------------- ------------
Balances, December 31, 2000........... 5,139,392 5,140 14,427,351 (294,750) (11,262,561) (62,723,631) (59,848,451)
Exercise of stock options for cash.... 300,918 301 523,243 -- -- -- 523,544
Beneficial conversion feature related
to issuance of Series D convertible
preferred stock...................... -- -- 26,782,911 -- -- -- 26,782,911
Deemed dividend related to beneficial
conversion feature of Series D
convertible preferred stock.......... -- -- (26,782,911) -- -- -- (26,782,911)
Issuance of common stock upon filing
of initial public offering, net of
issuance costs of $10,200,633........ 6,900,000 6,900 120,892,467 -- -- -- 120,899,367
Issuance of common stock upon
exercise of warrants................. 471,748 472 (472) -- -- -- --
Conversion of convertible preferred
stock into common stock.............. 26,722,151 26,722 119,219,103 -- -- -- 119,245,825
Repayment of notes receivable from
stockholders......................... -- -- -- 2,699 -- -- 2,699
Deferred stock-based compensation,
net of cancellations................. -- -- 15,314,446 -- (15,314,446) -- --
Amortization of deferred stock-based
compensation......................... -- -- -- -- 5,581,552 -- 5,581,552
Net loss.............................. -- -- -- -- -- (52,865,533) (52,865,533)
---------- ------- ------------ --------- ------------ ------------- ------------
Balances, December 31, 2001........... 39,534,209 $39,535 $270,376,138 $(292,051) $(20,995,455) $(115,589,164) $133,539,003
========== ======= ============ ========= ============ ============= ============

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

F-5

THERASENSE, INC.

STATEMENTS OF CASH FLOW

Years Ended December 31,
----------------------------------------
1999 2000 2001
------------ ------------ ------------

Cash flows from operating activities:
Net loss...................................................................... $(13,057,722) $(43,591,837) $(52,865,533)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization.............................................. 569,074 1,546,556 2,001,254
Provision for doubtful accounts............................................ -- 150,000 576,431
Amortization of debt issuance costs........................................ 74,268 268,489 268,492
Loss on disposal and sales of property and equipment....................... 132 5,637 13,605
Amortization of deferred stock-based compensation.......................... 120,191 1,793,248 5,581,552
Changes in operating assets and liabilities:
Accounts receivable..................................................... (25,000) (6,299,697) (15,661,574)
Inventories............................................................. -- (3,493,777) (3,155,639)
Deferred cost of products sold.......................................... -- (7,396,547) (8,962,943)
Prepaid expenses and other current assets............................... (773,699) (342,430) (7,059,573)
Other assets............................................................ (98,711) (1,374,589) (1,148,037)
Accounts payable........................................................ 549,291 9,946,047 9,598,675
Accrued and other liabilities........................................... 350,766 3,836,352 15,941,934
Deferred revenue........................................................ 500,000 8,175,206 18,283,441
------------ ------------ ------------
Net cash used in operating activities................................ (11,791,410) (36,777,342) (36,587,915)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of investments...................................................... -- -- (4,278,040)
Purchases of property and equipment........................................... (3,323,407) (2,088,594) (3,684,414)
Proceeds from sale of property and equipment.................................. -- 2,666,374 6,000
------------ ------------ ------------
Net cash provided by (used in) investing activities........................ (3,323,407) 577,780 (7,956,454)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of convertible preferred stock, net.................... 3,110,471 42,410,926 53,863,086
Proceeds from issuance of common stock and exercise of stock
options...................................................................... 6,190 80,581 121,422,911
Proceeds from lines of credit................................................. 3,090,953 3,000,000 3,000,000
Proceeds from convertible promissory note..................................... -- 2,500,000 --
Principal payments on capital lease obligations............................... (37,410) (417,393) (862,394)
Principal payments on lines of credit......................................... (171,163) (1,192,631) (2,227,451)
Repayment of notes receivable from stockholders............................... -- 28,129 2,699
------------ ------------ ------------
Net cash provided by financing activities.................................. 5,999,041 46,409,612 175,198,851
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents.............................. (9,115,776) 10,210,050 130,654,482
Cash and cash equivalents, beginning of year...................................... 11,438,200 2,322,424 12,532,474
------------ ------------ ------------
Cash and cash equivalents, end of year............................................ $ 2,322,424 $ 12,532,474 $143,186,956
============ ============ ============
Noncash financing activities:
Common stock issued for notes receivable from stockholders.................... $ 192,770 $ 6,068 $ --
Repurchase of restricted common stock and cancellation of notes
receivable................................................................... $ -- $ 14,384 $ --
Issuance of warrants to purchase Series B preferred stock in connection
with borrowings under lines of credit........................................ $ 819,760 $ -- $ --
Conversion of promissory note into Series D preferred stock................... $ -- $ -- $ 2,500,000
Acquisition of property and equipment under capital lease..................... $ 366,133 $ 2,970,204 $ 36,771
Deferred stock-based compensation............................................. $ 1,364,609 $ 11,811,391 $ 15,314,446
Supplemental disclosure of cash flow information:
Cash paid for interest........................................................ $ 134,833 $ 881,265 $ 909,517

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

F-6

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS

NOTE 1--FORMATION AND BUSINESS OF THE COMPANY:

TheraSense, L.L.C. was formed in the state of California on April 3, 1996.
TheraSense, Inc. was incorporated in the state of California on December 6,
1996. In April 1997, all assets and liabilities of TheraSense, L.L.C. were
transferred to TheraSense, Inc. TheraSense, L.L.C. and TheraSense, Inc. are
collectively referred to as the "Company." In September 2000, the Company's
Board of Directors authorized the reincorporation of the Company in the state
of Delaware, which was approved by the stockholders in October 2000. In
conjunction with the reincorporation, the Company's Board of Directors approved
a one-for-two reverse stock split of its common and convertible preferred
stock, which was approved by the stockholders in October 2000. All convertible
preferred and common stock data and common stock option plan information in
these financial statements has been restated to reflect the split. In addition,
the conversion prices of the Company's preferred stock have also been adjusted
to reflect the effect of the split.

The Company develops and sells easy to use glucose self-monitoring systems
that dramatically reduce the pain of testing for people with diabetes.

NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Use of estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America require
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.

Cash and cash equivalents

The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.

Investments

Investments with maturities of less than one year are considered to be
short-term. All investments are classified as available-for-sale securities and
are recorded at market value using the specific identification method.
Unrealized gains and losses are reflected in accumulated other comprehensive
income (loss). Realized gains and losses on investments are reported in
earnings and are derived using the specific identification method for
determining the cost of securities sold.

Fair value of financial instruments

For financial instruments consisting of cash and cash equivalents, accounts
receivable, accounts payable and accrued liabilities included in the Company's
financial statements, the carrying amounts approximate fair value due to their
short maturities. Investments are reported at market value. As of December 31,
2001, the carrying value of borrowings under lines of credit and capital lease
obligations, including the current portion, was $8,244,763 and the estimated
fair value was $8,415,382. The estimated fair value was determined based on
borrowing rates currently available to the Company. As of December 31, 2000,
the carrying value of these debt obligations approximated estimated fair value.

F-7

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Inventories

Inventories are stated at the lower of cost (principally standard cost,
which approximates actual cost on a first-in, first-out basis) or market value.

Property and equipment

Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally three to five years.
Amortization of leased assets and leasehold improvements is computed using the
straight-line method over the shorter of the remaining lease term or the
estimated useful life of the related assets, typically three to seven years.
Upon sale or retirement of assets, the cost and related accumulated
depreciation and amortization are removed from the balance sheet and the
resulting gain or loss is reflected in operations.

Impairment of long-lived assets

The Company reviews long-lived assets for impairment, whenever events or
changes in circumstances indicate that the carrying amount of an asset might
not be recoverable. When such an event occurs, management determines whether
there has been an impairment by comparing the anticipated undiscounted future
net cash flows to the related asset's carrying value. If an asset is considered
impaired, the asset is written down to fair value, which is determined based
either on discounted cash flows or appraised values, depending on the nature of
the asset.

Concentration of credit risk and other risks and uncertainties

As of December 31, 2000 and 2001, the Company's accounts receivable derived
from revenue earned from customers located in the United States of America was
100% and 82% of the total, respectively. Revenues earned from the Company's two
principal International Distributors are on an open account basis; whereas, the
remaining International Customers' accounts receivable balances are
collateralized by irrevocable letters of credit. The Company performs ongoing
credit evaluations of its customers' financial condition and, generally,
requires no collateral from its domestic customers.

Three customers individually accounted for greater than 10% of total
revenues and accounted for 100% of total revenues in aggregate for the year
ended December 31, 1999. All revenues were generated from research grants and
clinical product shipments.

Revenues from four customers individually accounted for greater than 10% of
gross revenues and accounted for 53% of gross revenues in aggregate for the
year ended December 31, 2000. Three customers accounted for 29%, 15% and 11% of
total accounts receivable at December 31, 2000.

Revenues from two customers individually accounted for greater than 10% of
gross revenues and accounted for 27% of gross revenues in aggregate for the
year ended December 31, 2001. Two customers accounted for 14% and 10% of total
accounts receivable at December 31, 2001.

The Company's products require clearance or approval from the Food and Drug
Administration ("FDA") and other international regulatory agencies prior to
commercial sales. The Company's products may not receive the necessary
approvals. If the regulatory approvals for the Company's products are denied or
delayed, it may have a material adverse impact on the Company. In January 2000,
the Company received FDA approval for its first product, FreeStyle.

F-8

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

The Company is subject to risks common to companies in the medical device
industry. These risks include, but are not limited to, new technological
innovations, dependence on key personnel, protection of proprietary technology,
compliance with government regulations, uncertainty of market acceptance of
products, product liability and the need to obtain additional financing.

The Company subcontracts the manufacturing of its FreeStyle meters through
one subcontractor and subcontracts the manufacturing of the FreeStyle lancet
devices through one subcontractor. The Company believes that there are a number
of alternative contract manufacturers that could produce the Company's
products, but in the event of a reduction or interruption of supply, it could
take a significant period of time to qualify an alternative subcontractor and
commence manufacturing. The effect of such reduction or interruption in supply
on results of operations would be material.

Revenue recognition

The Company recognizes revenue in accordance with Staff Accounting Bulletin
No. 101, "Revenue Recognition in Financial Statements." Product revenues are
generated from sales of the Company's FreeStyle System kit and from the
recurring sales of disposable FreeStyle test strips and lancets. The Company's
return policy allows end users in the United States of America and Canada to
return FreeStyle System kits to the Company for a full cash refund within 30
days of purchase. There are no end-user return rights on sales of disposable
FreeStyle test strips and lancets. In addition, the Company's FreeStyle System
kit and FreeStyle test strips currently have an 18 month shelf life, and
retailers and wholesalers in the United States of America and Canada can return
these products to the Company up to six months beyond this expiration date. As
a result of these rights of return and the current unavailability of historical
trends in sales and product returns, the Company defers recognition of revenues
and the related cost of revenues on sales of FreeStyle test strips until resold
by the retailers and wholesalers to end users, and the Company defers
recognition of revenues and the related cost of revenues on FreeStyle System
kits until 30 days after purchase by the end user. At that time, the Company
recognizes revenues net of allowances for customer rebates and coupons. Because
the Company lacks a sufficient historical basis from which to estimate return
rates, the Company is required to rely on data estimates provided to the
Company by third-party data providers in order to recognize revenue from sales
to end users by retailers and wholesalers. In addition, due to the lack of
significant historical trends in rebates claimed by end users, the Company is
accruing 100% of the allowable rebate.

In September 2000, the Company entered into an agreement for the exclusive
distribution of FreeStyle products in certain European countries and the
nonexclusive distribution to certain of the distributor's existing customers in
North America. Under the terms of the agreement, the Company received a $1.5
million nonrefundable pre-payment, which was deferred and was credited as
revenues were recognized. In April 2001, the Company entered into an agreement
for the exclusive distribution of FreeStyle products in Japan through April
2006. Under the terms of the agreement, the Company received a $5.0 million
noncreditable up-front payment, which was deferred and is being recognized as
revenue ratably over the term of the agreement. If the agreement is terminated
prior to the expiration of its term, under limited circumstances, the Company
would be obligated to a return of a portion of the up-front payment for each
full-year remaining in the initial term. Products shipped to the Company's
distributors do not have a right of return although end users in North America
are allowed to return FreeStyle System kits within 30 days of purchase.

The Company's FreeStyle System kits and disposable FreeStyle test strips and
lancets shipped internationally, except for Canada, have no right of return,
and the Company recognizes revenue on these products upon shipment. The Company
recognizes revenue on direct product sales over the telephone or through the
Company's website to end users upon shipment for FreeStyle test strips and
lancets and 30 days after purchase on sales of FreeStyle System kits.

F-9

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

The Company recognizes license and other up-front fees on a ratable basis
over the term of the respective agreement. Any amounts received in advance of
performance are recorded as deferred revenue. All revenues recognized to date
are not refundable.

Research and development grant agreements provide for periodic payments in
support of the Company's research activities. Grant revenue is recognized as
earned based on actual costs incurred or as milestones are achieved. All
revenues recognized to date are not refundable if the relevant research effort
is not successful.

Research and development

Research and development costs are charged to operations as incurred.
Research grant revenue projects are funded under agreements with third parties
and the costs related to these activities are included in research and
development expense.

Advertising costs

Advertising costs, included in selling, general and administrative expenses,
are expensed as incurred. No expenses were incurred in 1999. Advertising
expense in 2000 and 2001 was $1,878,396 and $4,903,023, respectively.

Income taxes

The Company accounts for income taxes under the liability method whereby
deferred tax asset or liability account balances are calculated at the balance
sheet date using current tax laws and rates in effect for the year in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts
expected to be realized.

Segments

The Company operates in one business segment. As of December 31, 2000 and
2001, all long-lived assets are maintained in the United States of America. All
revenue was generated in the United States of America during the years ended
December 31, 1999 and 2000. During 2001, 17% of gross revenue was from
international shipments.

Stock-based compensation

The Company uses the intrinsic value method of Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," and
Financial Accounting Standards Board Interpretation No. 44 ("FIN 44")
"Accounting for Certain Transactions Involving Stock Compensation, an
Interpretation of APB No. 25," in accounting for its employee stock options,
and presents disclosure of pro forma information required under SFAS No. 123,
"Accounting for Stock-Based Compensation."

The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF") Issue 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 require that such equity instruments are recorded at their
fair value on the measurement date. The measurement of stock-based compensation
is subject to periodic adjustment as the underlying equity instruments vest.

F-10

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Net loss per common share

Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted-average number of vested common shares
outstanding for the period. Diluted net loss per share is computed giving
effect to all potential dilutive common stock, including options, warrants,
convertible promissory notes and convertible preferred stock. Options,
warrants, common stock subject to repurchase and convertible preferred stock
were not included in the computation of diluted net loss per share because the
effect would be antidilutive.

A reconciliation of the numerator and denominator used in the calculation of
basic and diluted net loss per common share follows:

Years Ended December 31,
----------------------------------------
1999 2000 2001
------------ ------------ ------------

Numerator:
Net loss.................................................. $(13,057,722) $(43,591,837) $(52,865,533)
Deemed dividends related to beneficial conversion feature
of preferred stock...................................... -- (14,772,878) (26,782,911)
------------ ------------ ------------
Net loss attributable to common stockholders................. $(13,057,722) $(58,364,715) $(79,648,444)
============ ============ ============
Denominator:
Weighted-average common stock outstanding................. 4,840,006 5,060,774 12,306,456
Less: Weighted-average shares subject to repurchase....... (1,816,370) (1,087,524) (415,890)
------------ ------------ ------------
Weighted-average shares used in computing basic and diluted
net loss per common share.................................. 3,023,636 3,973,250 11,890,566
============ ============ ============

The following outstanding options, common stock subject to repurchase,
convertible preferred stock and warrants were excluded from the computation of
diluted net loss per share attributable to common stockholders as they had an
antidilutive effect:

December 31,
-------------------------------
1999 2000 2001
---------- ---------- ---------

Options to purchase common stock.......................................... 1,644,468 4,201,599 6,511,531
Common stock subject to repurchase........................................ 1,562,751 612,297 175,924
Convertible preferred stock............................................... 11,588,621 20,078,780 --
Warrants.................................................................. 521,013 521,013 3,809
Convertible promissory notes.............................................. -- 294,118 --

Reclassification

Certain amounts in the prior year financial statements have been
reclassified to conform to the current year's presentation. The
reclassification had no impact on the previously reported net loss.

Recent accounting pronouncements

In July 2001, the FASB issued SFAS No. 141 "Business Combinations" ("SFAS
No. 141") which establishes financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, "Business Combinations," and
FASB Statement No. 38, "Accounting for Preacquisition Contingencies of
Purchased Enterprises". SFAS No. 141 requires that all business combinations be
accounted for using one method, the purchase method. The provisions of SFAS No.
141 apply to all business combinations initiated after June 30, 2001. The
adoption of SFAS No. 141 had no impact on the Company's financial statements.

F-11

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

In July 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets," ("SFAS No. 142") which establishes financial accounting and reporting
for acquired goodwill and other intangible assets and supersedes APB Opinion
No. 17, "Intangible Assets". SFAS No. 142 addresses how intangible assets that
are acquired individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in financial
statements upon their acquisition, and after they have been initially
recognized in the financial statements. The provisions of SFAS No. 142 are
effective for fiscal years beginning after December 15, 2001. The Company will
adopt SFAS No. 142 during the first quarter of fiscal 2002, and the adoption of
SFAS No. 142 is expected to have no material impact on financial reporting and
related disclosures of the Company.

In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations," ("SFAS No. 143") which
is effective for the Company beginning in fiscal 2003. SFAS No. 143 requires
that the fair value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made, with the associated asset retirement costs capitalized
as part of the carrying amount of the long-lived asset. The Company does not
except the adoption of SFAS No. 143 to have a material impact on the Company's
financial position and results of operations.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"), which is
effective for fiscal years beginning after December 15, 2001 and interim
periods within those fiscal periods. SFAS No. 144 supersedes FASB Statement No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of" and parts of APB Opinion No. 30 "Reporting and
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions relating to Extraordinary Items," ("Opinion 30"), however, SFAS
No. 144 retains the requirement of Opinion 30 to report discontinued operations
separately from continuing operations and extends that reporting to a component
of an entity that either has been disposed of (by sale, by abandonment, or in a
distribution to owners) or is classified as held for sale. SFAS No. 144
addresses financial accounting and reporting for the impairment of certain
long-lived assets and for long-lived assets to be disposed of. The Company does
not expect the adoption of SFAS No. 144 to have a material impact on the
Company's financial position and results of operations.

NOTE 3--CASH, CASH EQUIVALENTS AND INVESTMENTS:

Cash, cash equivalents and investments consisted of the following:

December 31,
------------------------
2000 2001
----------- ------------

Cash and cash equivalents:
Cash...................................... $ 811,633 $ 912,721
Certificate of deposit.................... 10,000 400,000
Money market funds........................ 11,710,841 98,517,965
Commercial paper.......................... -- 12,036,270
Corporate bonds........................... -- 9,000,000
Municipal securities...................... -- 22,320,000
----------- ------------
$12,532,474 $143,186,956
=========== ============
Investments:
Corporate bonds (maturity March 14, 2003). $ -- $ 4,278,040
----------- ------------
$ -- $ 4,278,040
=========== ============

F-12

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

As of December 31, 2001, the market value of investments approximated cost.
Accordingly, there was no unrealized gains or losses reported in accumulated
other comprehensive income (loss).

NOTE 4--BALANCE SHEET ACCOUNTS:

Inventories consisted of the following:

December 31,
---------------------
2000 2001
---------- ----------

Raw materials................ $1,175,408 $2,089,705
Work-in-process.............. 782,838 2,673,336
Finished goods............... 1,535,531 1,886,375
---------- ----------
$3,493,777 $6,649,416
========== ==========

Property and equipment consisted of the following:

December 31,
------------------------
2000 2001
----------- -----------

Manufacturing equipment................ $ 2,082,398 $ 4,391,255
Office equipment....................... 580,017 772,901
Laboratory equipment................... 1,162,101 1,291,340
Computer equipment..................... 1,294,610 1,758,393
Tooling................................ 788,040 1,202,937
Leasehold improvements................. 1,051,983 1,209,359
----------- -----------
6,959,149 10,626,185
Less: Accumulated depreciation and
amortization......................... (2,120,467) (4,087,177)
----------- -----------
$ 4,838,682 $ 6,539,008
=========== ===========

Other assets consisted of the following:

December 31,
---------------------
2000 2001
---------- ----------

Licenses, net......................................... $ -- $1,720,833
Deposits.............................................. 578,136 709,782
Debt issuance costs, net.............................. 477,003 208,511
Manufacturing equipment deposits...................... 709,845 160,165
Other................................................. 185,319 30,557
---------- ----------
$1,950,303 $2,829,848
========== ==========

F-13

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Accrued liabilities consisted of the following:

December 31,
----------------------
2000 2001
---------- -----------

Salaries and related expense................ $ 783,853 $ 5,630,741
Rebates..................................... 758,965 5,096,433
Marketing costs............................. 182,917 3,782,602
Professional and other outside services..... 645,687 1,548,562
Royalties................................... 383,651 1,508,334
Warranties.................................. 269,392 1,282,215
Distributor prepayment...................... 1,343,147 --
Other liabilities........................... 53,900 514,559
---------- -----------
$4,421,512 $19,363,446
========== ===========

NOTE 5--BORROWINGS UNDER LINES OF CREDIT:

During 1999, the Company entered into a subordinated debt agreement with a
lending company under which the Company could borrow up to $5,000,000 for
equipment purchases prior to July 7, 2000. In December 1999 and January and
July 2000, the Company executed $2,000,000, $2,000,000 and $1,000,000
promissory notes under this agreement, respectively. The notes accrue interest
at an annual rate of 11.5% and are each due in thirty-six monthly installments.
All borrowings under this agreement are collateralized by the equipment
purchased. In connection with this agreement, the Company issued warrants to
purchase 380,952 shares of Series B preferred stock (Note 9). The effective
annual interest rate, including warrant amortization, is 22.3%.

During 1999, the Company entered into a senior loan and security agreement
with a lending company to borrow up to $2,000,000 for equipment purchases prior
to December 31, 1999. The Company executed promissory notes under this
agreement for $253,864, $253,055 and $262,625. Principal and interest are
payable in consecutive monthly installments, each of which are equal to 1.0% of
the principal sum for months one through twelve and 3.075% of the principal sum
for months thirteen through forty-eight, yielding an annual interest rate of
8.7%. All borrowings under this agreement are collateralized by the equipment
purchased. In connection with this agreement, the Company issued warrants to
purchase 38,094 shares of Series B preferred stock (Note 9). The effective
annual interest rate, including warrant amortization, is 13.1%.

During 2001, the Company entered into an equipment line of credit agreement
to borrow $3,000,000 for equipment purchases. The line of credit accrues
interest at an annual rate of 7.28% and both principal and interest are payable
in sixty monthly equal payments. All borrowings under this agreement are
collateralized by the equipment purchased. As of December 31, 2001, the funds
for this agreement were held in escrow by a third party, the Company has
included the $3,000,000 in prepaid expenses and other current assets.

As of December 31, 2001, aggregate future principal payments under the lines
of credit are as follows:

2002........................................ $ 2,902,106
2003........................................ 1,369,649
2004........................................ 593,252
2005........................................ 637,912
2006........................................ 685,933
-----------
6,188,852
Less: Current portion....................... (2,902,106)
-----------
$ 3,286,746
===========

F-14

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

NOTE 6--CONVERTIBLE PROMISSORY NOTE:

NOTE 7--COMMITMENTS AND CONTINGENCIES:

Facility lease

The Company leases its facilities under various operating lease agreements
which expire up through April 2009. The Company has the option to terminate one
of the lease agreements in April 2006. Under the terms of one of the
agreements, the initial base monthly rent shall be adjusted as specified under
the terms of the agreement and every two and one half years based on changes in
the Consumer Price Index by amounts not to be less than 5.0%, nor to exceed
7.5%, over each two and one half year period. The remaining lease agreements do
not contain any provisions for future rental adjustments. At the expiration of
one of the lease terms, the Company has the option to extend the facility lease
for an additional five years. As of December 31, 2001, aggregate future minimum
facility lease payments are as follows:

2002.............................. $1,196,450
2003.............................. 1,128,120
2004.............................. 978,049
2005.............................. 864,972
2006.............................. 872,186
Thereafter........................ 2,119,174
----------
$7,158,951
==========

Rent expense for the years ended December 31, 1999, 2000 and 2001 was
$619,766, $674,959 and $1,023,090, respectively.

Office equipment leases

The Company leases certain computer and office equipment under operating
lease agreements which expire through June 2005. As of December 31, 2001,
aggregate future minimum lease payments are as follows:

2002.............................. $325,988
2003.............................. 185,036
2004.............................. 12,768
2005.............................. 6,384
--------
$530,176
========

Capital lease obligations

During 1999 and 2000, the Company acquired office furniture under capital
lease agreements. Payments, comprising both principal and interest, are due in
thirty-six equal monthly installments through October 2003.

F-15

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

During February 2000, the Company entered into a sale and leaseback
transaction whereby the Company sold and leased back under capital lease
agreements, assets with a net book value of $1,607,557 for total proceeds of
$1,603,769, recognizing a loss on the sale of $3,788. In addition, the Company
leased $153,579 of computer equipment under a capital lease agreement.
Payments, comprising both principal and interest, are due in thirty-six to
forty-eight monthly installments through April 2004.

During April 2000, the Company entered into sale and leaseback transaction
whereby the Company sold and leased back under capital lease agreements, assets
with a net book value of $1,062,605 for an equal amount of total proceeds. In
addition, the Company financed $126,756 of property and equipment purchases
under capital lease agreements. Payments, comprising both principal and
interest, are due in forty-eight equal monthly installments through March 2004.

Property and equipment acquired under capital leases consisted of the
following:

December 31,
-----------------------
2000 2001
---------- -----------

Manufacturing equipment........... $1,099,009 $ 1,099,009
Leasehold improvements............ 863,891 863,891
Office equipment.................. 400,750 437,521
Tooling........................... 340,083 340,083
Computer equipment................ 332,610 332,610
Laboratory equipment.............. 298,069 298,069
---------- -----------
3,334,412 3,371,183
Less: Accumulated amortization.... (844,691) (1,787,881)
---------- -----------
$2,489,721 $ 1,583,302
========== ===========

As of December 31, 2001, aggregate future minimum lease payments are as
follows:

2002........................................ $ 1,202,557
2003........................................ 812,935
2004........................................ 180,249
-----------
Minimum payments............................ 2,195,741
Less: Amount representing interest.......... (139,830)
-----------
Principal amount of minimum payments........ 2,055,911
Less: Current portion....................... (1,087,850)
-----------
$ 968,061
===========

Licensing agreements

The Company has entered into several licensing agreements with various
universities, institutions and companies under which it obtained rights to
certain patents, patent applications, and other technology. As of December 31,
2001, aggregate future minimum payments pursuant to these agreements are as
follows:

2002........................................ $1,045,000
2003........................................ 1,120,000
2004........................................ 1,120,000
2005........................................ 620,000
----------
$3,905,000
==========

F-16

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

In addition to the payments summarized above, the Company is required to
make royalty payments based upon a percentage of net sales of any products
developed from certain of the licensed technologies. These royalties, which are
creditable against the minimum payments summarized above, are expensed to cost
of revenues upon product shipment.

In December 1998, the Company entered into an agreement with Facet
Technologies, LLC, formerly Gainor Medical North America LLC ("Facet
Technologies"), whereby the Company is obligated to pay royalties, based upon a
fixed fee per FreeStyle System kit shipped, to Facet Technologies of up to
$2,800,000 in exchange for research and development services provided by Facet
Technologies. For the years ended December 31, 1999, 2000 and 2001, none,
$331,578 and $1,101,506 of royalties have been expensed to cost of revenues,
respectively. As of December 31, 2000 and 2001, the Company has accrued
$331,578 and $1,101,506, respectively, of royalties relating to this agreement.

As of December 31, 2000 and 2001, the Company has included $1,050,000 and
$1,196,666, respectively, of an annual $2,000,000 paid-up licensing fee in
prepaid expenses and other current assets. These license fee payments are being
amortized ratably to cost of revenues over the annual term of the license. At
the Company's option, the Company can extend this non-exclusive paid-up
licensing agreement with future license payments.

During 2001, the Company entered into two licensing agreements which provide
fully paid-up licenses for use of certain technologies in current and future
products. As of December 31, 2001, the cost of these licenses totaling
$1,850,000 less accumulated amortization of $129,167 is included in other
assets and is being amortized ratably to cost of revenues over 5 years, the
estimated useful lives of licensed technologies.

Contingencies

From time to time, the Company may become involved in litigation relating to
claims arising from the ordinary course of business. Management is not
currently aware of any matters that will have a material adverse affect on the
financial position, results of operations or cash flows of the Company.

NOTE 8--INITIAL PUBLIC OFFERING:

On October 17, 2001, the Company closed its initial public offering in which
it sold 6,900,000 shares of common stock at $19.00 per share for net proceeds
of approximately $120,899,367, net of underwriting discounts, commissions and
other offering costs. Immediately prior to the closing of the initial public
offering, all the Company's convertible preferred stock automatically converted
into 26,722,151 shares of common stock.

NOTE 9--CONVERTIBLE PREFERRED STOCK:

Under the Company's Certificate of Incorporation, as amended, the Company's
convertible preferred stock is issuable in series.

As of December 31, 1999, the convertible preferred stock consisted of the
following:

Number of
Number of Shares Proceeds, Net Liquidation Annual
Shares Issued and of Issuance Preference Dividends
Authorized Outstanding Costs Per Share Per Share
---------- ----------- ------------- ----------- ---------

Series A 4,500,123 4,445,770 $ 5,525,502 $1.254 $0.10
Series B 7,609,524 7,142,851 14,946,311 $2.100 $0.16
---------- ---------- -----------
12,109,647 11,588,621 $20,471,813
========== ========== ===========

F-17

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

As of December 31, 2000, the convertible preferred stock consisted of the
following:

Series A 4,500,123 4,445,770 $ 5,525,502 $1.254 $0.10
Series B 7,609,524 7,142,851 14,946,311 $2.100 $0.16
Series C 8,500,000 8,490,159 42,410,926 $5.000 $0.40
---------- ---------- -----------
20,609,647 20,078,780 $62,882,739
========== ========== ===========

As of December 31, 2001, there was no convertible preferred stock
outstanding. All preferred stock was converted to common stock upon the closing
of the Company's initial public offering.

Warrants

During April 1997, the Company issued warrants to purchase 54,348 shares of
its Series A convertible preferred stock at $1.84 per share in connection with
the Series A preferred stock financing. The warrants are exercisable at any
time and expire on December 31, 2001. During October 2001, 54,348 warrants were
exercised in a cashless transaction resulting in the issuance of 49,084 shares
of common stock.

During August 1998, the Company issued warrants to purchase 47,619 shares of
its Series B convertible preferred stock at $2.10 per share in connection with
the execution of an equipment line of credit agreement. The warrants are
exercisable at any time and expire in August 2008 or five years from the
effective date of the Company's initial public offering, whichever is earlier.
During November 2001, 47,619 warrants were exercised in a cashless transaction
resulting in the issuance of 43,540 shares of common stock.

The fair value of the above warrants was calculated using the Black-Scholes
pricing model and deemed to be immaterial.

During April 1999, the Company issued warrants to purchase 38,094 shares of
Series B convertible preferred stock at $2.10 per share in connection with the
execution of a senior loan and security agreement. The warrants are exercisable
at any time and expire in April 2007 or five years from the effective date of
the Company's initial public offering, whichever is later. The fair value of
the warrants calculated using the Black-Scholes pricing model, of $57,167, has
been reflected as a debt issuance cost included in other assets and amortized
as interest expense over the life of the line of credit. During October 2001,
34,285 warrants were exercised in a cashless transaction resulting in the
issuance of 30,495 shares of common stock.

During October 1999, the Company issued warrants to purchase a total of
380,952 shares of Series B convertible preferred stock at $2.10 per share in
connection with the execution of a subordinated debt agreement. The warrants
are exercisable at any time and expire in October 2009 or five years from the
effective date of the Company's initial public offering, whichever is earlier.
The fair value of the warrants calculated using the Black-Scholes pricing
model, of $762,593, has been reflected as a debt issuance cost included in
other assets and amortized as interest expense over the life of the line of
credit. During October 2001, 380,952 warrants were exercised in a cashless
transaction resulting in the issuance of 348,629 shares of common stock.

F-18

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

NOTE 10--STOCKHOLDERS' EQUITY (DEFICIT):

Preferred stock

In October 2001, the Board of Directors approved an amendment to the
Company's certificate of incorporation to authorize 5,000,000 shares of
undesignated preferred stock, for which the Board of Directors is authorized to
fix the designation, powers, preferences and rights and an increase in the
authorized number of shares of common stock to 200,000,000 shares.

Common stock

Each share of common stock is entitled to one vote. The holders of common
stock are also entitled to receive dividends whenever funds are legally
available and when declared by the Board of Directors, subject to the prior
rights of holders of all convertible preferred stock.

The Company has issued a total of 3,525,000 shares of common stock under
restrictive stock purchase agreements, under which the Company has the option
to repurchase unvested shares of stock upon the termination of employment or
services to the Company. The number of shares subject to repurchase is
generally reduced by 1/48th of the initial number subject to repurchase for
each month that the holder continues to serve as a consultant, employee or
director. As of December 31, 2000 and December 31, 2001, 206,836 and no shares
of common stock are subject to repurchase, respectively.

Incentive Stock Plans

2001 Stock Plan

In June 2001, the Board of Directors and stockholders adopted the 2001 Stock
Plan ("2001 Plan"). The 2001 Plan, which will terminate no later than 2011,
provides for the granting of incentive stock options to employees and
nonstatutory stock options to employees, directors and consultants. 6,500,000
shares of common stock are reserved for issuance plus any shares which have
been reserved but not issued under the 1997 Stock Plan, plus any shares
returned thereafter. The 1997 Stock Plan was cancelled upon the effectiveness
of the 2001 Plan. In addition, the number of shares available for issuance will
be increased on the first day of each fiscal year, commencing in 2002, by an
amount equal to the lesser of (i) 2,500,000, (ii) 5.0% of the outstanding
shares of common stock on the last day of the preceding fiscal year or (iii) an
amount as determined by the Board of Directors.

Under the terms of the 2001 Plan, each newly-elected non-employee director
will be granted a nonstatutory option to purchase 30,000 shares of common stock
which vests annually over a three year period. Thereafter, on an annual basis,
on the date of the annual stockholder meeting, commencing in 2002, each
non-employee director will be granted a nonstatutory option to purchase 5,000
shares of common stock which vests after one year. The exercise price of an
option shall not be less than 100% of the fair market value of the common stock
on the date of grant and the term shall not exceed 10 years.

1997 Stock Plan

In March 1997, the Company approved the 1997 Stock Option Plan (the "Plan")
under which the officers of the Company are authorized to enter into stock
option agreements with selected individuals. The Board of Directors has the
authority to determine to whom options will be granted, the number of shares,
the term and exercise price (which cannot be less than estimated fair market
value at date of grant for incentive stock options or 85% of estimated fair
market value for nonqualified stock options). If an employee owns stock
representing

F-19

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

more than 10% of the outstanding shares, the price of each share shall be at
least 110% of estimated fair market value, as determined by the Board of
Directors. Options granted under the Plan generally become exercisable 1/4 on
the first anniversary of the vesting commencement date and an additional 1/48
of the total number of shares subject to the option shares shall become
exercisable monthly thereafter until all of the shares have become exercisable.
In certain cases unvested options have been exercised and the Company has
retained a repurchase right upon termination of the holder's status as an
employee or consultant. The repurchase right lapses over time in the same
manner as the option would have become exercisable. At December 31, 2000 and
2001, 405,461 and 175,924 shares of common stock were subject to the Company's
repurchase rights, respectively. The options have a maximum term of ten years.

Activity under the Plans are as follows:

Outstanding Options
-------------------------------------
Shares Weighted
Available Number Average
for Grant of Shares Exercise Price
---------- --------- --------------

Balances, December 31, 1998............ 548,123 502,094 $ 0.24
Additional shares reserved.......... 1,500,000 -- --
Options granted..................... (1,568,245) 1,568,245 $ 0.77
Options exercised................... -- (394,182) $ 0.50
Options canceled.................... 31,689 (31,689) $ 0.33
---------- ---------
Balances, December 31, 1999............ 511,567 1,644,468 $ 0.68
Additional shares reserved.......... 2,670,865 -- --
Options granted..................... (2,922,596) 2,922,596 $ 4.01
Options exercised................... -- (213,671) $ 0.41
Options canceled/shares repurchased. 203,004 (151,794) $ 1.55
---------- ---------
Balances, December 31, 2000............ 462,840 4,201,599 $ 2.98
Additional shares reserved.......... 8,500,000 -- --
Options granted..................... (2,949,000) 2,949,000 $11.83
Options exercised................... -- (300,918) $ 1.74
Options canceled.................... 338,150 (338,150) $ 2.87
---------- ---------
Balances, December 31, 2001............ 6,351,990 6,511,531 $ 7.05
========== =========

The options outstanding and exercisable by exercise price range at December
31, 2001 are as follows:

Outstanding Options Options Exercisable
------------------------------------------- ----------------------------
Weighted Average
Remaining
Range of Number Contractual Options Weighted Average
Exercise Price Outstanding Life (Years) Exercisable Exercise Price
-------------- ----------- ---------------- ----------- ----------------

$ 0.00-$ 2.41 974,510 7.3 588,525 $ 0.66
$ 2.42-$ 4.82 1,558,307 8.3 662,752 $ 3.34
$ 4.83-$ 7.24 2,123,741 9.0 428,415 $ 5.27
$ 7.25-$ 9.65 1,035,623 9.6 76,882 $ 9.00
$ 9.65-$19.30 148,800 9.3 -- --
$19.31-$24.12 670,550 9.9 7,915 $24.02
--------- ---------
6,511,531 8.8 1,764,489 $ 3.26
========= =========

F-20

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

Stock-based compensation

The Company has adopted the disclosure only provisions of SFAS No. 123. In
accordance with the provisions of SFAS No. 123, the Company's filing of a
registration statement with the Securities and Exchange Commission in October
2000 required that the fair value of all options granted after that date be
calculated using the Black-Scholes option pricing model and contain an expected
volatility factor as an assumption. The Company previously calculated the fair
value of each option on the date of grant using the minimum value method as
prescribed by SFAS No. 123. The assumptions used are as follows:

Years Ended December 31,
-----------------------
1999 2000 2001
---- ---- ----

Risk-free interest rate...... 5.55% 5.21% 5.47%
Expected life (in years)..... 4 4 4
Dividend yield............... -- -- --
Expected volatility.......... -- 70% 70%

Had compensation costs been determined based upon the fair value at the
grant date, consistent with the methodology prescribed under SFAS No. 123, the
Company's pro forma net loss and pro forma basic and diluted net loss per share
under SFAS No. 123 would have been as follows:

Years Ended December 31,
----------------------------------------
1999 2000 2001
------------ ------------ ------------

Net loss attributable to common stockholders--
as reported................................. $(13,057,722) $(58,364,715) $(79,648,444)
Net loss attributable to common stockholders--
pro forma................................... $(13,101,987) $(59,150,002) $(83,851,573)
Net loss per common share, basic and diluted--
as reported................................. $ (4.32) $ (14.69) $ (6.70)
Net loss per common share, basic and diluted--
pro forma................................... $ (4.33) $ (14.89) $ (7.05)

The weighted-average per share grant date fair value of options granted
during the years ended December 31, 1999, 2000 and 2001 was $0.15, $0.76 and
$3.66, respectively.

Deferred stock-based compensation

During 1999, 2000 and 2001, the Company issued options to certain employees
under the Plan with exercise prices below the deemed fair market value of the
Company's common stock at the date of grant. In accordance with the
requirements of APB 25, the Company has recorded deferred stock-based
compensation for the difference between the exercise price of the stock options
and the deemed fair market value of the Company's stock at the date of grant.
This deferred stock-based compensation is amortized to expense on a straight
line basis over the period during which the Company's right to repurchase the
stock lapses or the options become vested, generally four years. During the
years ended December 31, 1999, 2000, and 2001, the Company had recorded
deferred stock-based compensation related to these options in the amounts of
$1,118,400, $11,008,675 and $13,122,276, net of cancellations, respectively, of
which $76,121, $1,501,948 and $4,700,211 had been amortized to expense during
1999, 2000, and 2001, respectively.

Stock-based compensation expense related to stock options granted to
non-employees is recognized on a straight line basis, as the stock options are
earned. During the years ended December 31, 1999, 2000 and 2001,

F-21

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

the Company granted options to purchase 73,000, 13,250 and 29,500 shares of
common stock to non-employees, respectively. The Company believes that the fair
value of the stock options is more reliably measurable than the fair value of
the services received. The fair value of the stock options granted is
calculated at each reporting date using the Black-Scholes option pricing model
as prescribed by SFAS No. 123 using the following assumptions:

Years Ended December 31,
-----------------------
1999 2000 2001
---- ---- ----

Risk-free interest rate. 6.05% 5.75% 5.42%
Expected life (in years) 10 10 10
Dividend yield.......... -- -- --
Expected volatility..... 70% 70% 70%

The stock-based compensation expense will fluctuate as the fair market value
of the common stock fluctuates. In connection with the grant of stock options
to non-employees, the Company recorded deferred stock-based compensation of
$246,209, $802,716 and $2,192,170 for the years ended December 31, 1999, 2000
and 2001, respectively, of which $44,070, $291,300 and $881,341 has been
amortized to expense in 1999, 2000 and 2001, respectively.

Note receivable from stockholders

During 1999 and 2000, the Company sold common stock to certain of its
officers in exchange for full recourse notes receivable. The notes are
non-interest bearing, have due dates through September 2003, and are
collateralized by the underlying shares of common stock.

2001 Employee Stock Purchase Plan

In June 2001, the Board of Directors and stockholders adopted the 2001
Employee Stock Purchase Plan ("2001 ESPP"), under which eligible employees are
permitted to purchase common stock at a discount through payroll deductions.
1,000,000 shares of common stock are reserved for issuance and will be
increased on the first day of each fiscal year, commencing in 2002, by an
amount equal to the lesser of (i) 1,000,000, (ii) 1.5% of the outstanding
shares of common stock on such date or (iii) an amount as determined by the
Board of Directors.

The 2001 ESPP contains consecutive, overlapping twenty-four month offering
periods. Each offering period includes four six-month purchase periods. The
price of the common stock purchased shall be 85% of the lower of the fair
market value of the common stock at the beginning of an offering period or at
the end of a purchase period. The initial offering period commenced on October
11, 2001, the effective date of the Company's initial public offering.

NOTE 11--INCOME TAXES:

At December 31, 2001, the Company has approximately $65.6 million and $43.8
million in federal and state net operating loss carryforwards, respectively, to
reduce future taxable income. The federal carryforwards have expiration dates
beginning in 2012 and the state carryforwards will expire in 2005, in each case
if not utilized.

At December 31, 2001, the Company had research credit carryforwards of
approximately $803,000 and $643,000 for federal and state income tax purposes,
respectively. If not utilized, the federal carryforwards will expire in various
amounts beginning in 2012. The state research credit can be carried forward
indefinitely.

F-22

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

The Tax Reform Act of 1986 limits the use of net operating loss and tax
credit carryforwards in the case of an "ownership change" of a corporation.
Ownership changes, as defined, have already occurred on April 21, 1997 and
February 23, 1999 as a result of the Company's preferred stock financings. In
accordance with Internal Revenue Code Section 382, such losses are subject to
annual limitation. The annual limitations did not result in the expiration of
net operating losses prior to utilization.

Temporary differences and carryforwards which gave rise to significant
portions of deferred tax assets and liabilities are as follows:

December 31,
--------------------------
2000 2001
------------ ------------

Net operating loss carryforwards........................... $ 17,047,000 $ 26,846,000
Research and development tax credit carryforwards.......... 1,228,000 1,439,000
Deferred revenue........................................... 3,456,000 10,743,000
Accruals and reserves not currently deductible for tax
purposes................................................. 2,145,000 5,002,000
Capitalized start-up costs................................. 348,000 209,000
Depreciation and amortization.............................. 189,000 123,000
------------ ------------
24,413,000 42,362,000
Valuation allowance........................................ (24,413,000) (42,362,000)
------------ ------------
$ -- $ --
============ ============

The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.

NOTE 12--RELATED PARTIES:

Since April 1997, Dr. Adam Heller, the Chief Scientific Advisor, has
performed consulting services for the Company. The terms of the consulting
agreement provide that the Company pay Dr. Heller a consulting fee of $1,200
per day, plus reimbursement for travel and business expenses. The agreement has
a term of one year with automatic one year renewals. The agreement is
terminable by the Company or Dr. Heller upon thirty days written notice. Dr.
Adam Heller is the father of Ephriam Heller, Co-Founder, Vice President of
Business Development and Director. During 1999, 2000 and 2001, the Company paid
Dr. Heller $85,760, $110,141 and $121,196, respectively, in connection with
this agreement. As of December 31, 2000 and 2001, the Company had no accrued
liabilities relating to Dr. Heller's consulting services.

Pursuant to an agreement with Facet Technologies entered into in December
1998, Facet Technologies has provided development services for the FreeStyle
lancing device and related products. In exchange for such services, the Company
granted Facet Technologies the exclusive right to manufacture the FreeStyle
lancing device for a period of seven years from the date of the agreement. A
former principal of Facet Technologies is a member of the Company's Board of
Directors. During 1999, 2000 and 2001, Facet Technologies provided development
services of approximately $200,000, $300,000 and $900,000, respectively, and
purchases from Facet Technologies totaled $4,675, $402,356 and $1,697,377,
respectively. In addition, $27,799 and $111,477 is included in accounts payable
as of December 31, 2000 and 2001, respectively, and $331,578 and $555,286 is
included in accrued liabilities as of December 31, 2000 and 2001, respectively,
in connection with this agreement.

In November 1999, the Company entered into an agreement with Flextronics
International ("Flextronics") related to the manufacturing of the FreeStyle
meter. The Company's contract with Flextronics expires in

F-23

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

November 2005, and is renewable annually thereafter. A member of the Company's
Board of Directors is also President, Americas Operations of Flextronics.
During 1999, 2000 and 2001, the Company purchased $261,195, $20,639,858 and
$40,047,640 under this agreement, respectively. In addition, $4,045,179 and
$5,252,134 are included in accounts payable as of December 31, 2000 and 2001,
respectively, and $314,107 and $993,276 are included in accrued liabilities as
of December 31, 2000 and 2001, respectively, relating to this agreement. As of
December 31, 2000 and 2001, Flextronics owed the Company $545,200 and
$3,121,750, respectively for raw materials purchased.

In October 2000, the Company entered into a Technology Purchase Agreement
with E. Heller & Co. The agreement includes a covenant not to compete for three
years and provides for the transfer and assignment of several licenses and
rights to the Company in exchange for $500,000. The portion of the payment
attributable to the covenant not to compete, of $50,000, has been capitalized
and is being amortized to research and development expense on a straight-line
basis over the three-year term. Based upon the early stage of development and
the uncertainty as to the feasibility of the technology and its alternative
uses, the remaining acquisition cost was immediately expensed to research and
development. E. Heller & Co. is controlled by one of the Company's founders,
who is also a Vice President of the Company and a member of the Company's Board
of Directors.

In September 2000, the Company entered into an International Distributor
Agreement with Disetronic Handels A.G. relating to the distribution of
FreeStyle in Germany, Switzerland, Denmark, Austria, Sweden, Finland, Norway
and the Netherlands. In February 2002, the agreement was amended to, among
other things, expand Disetronic's European territory to include France, Italy
and Belgium. Under terms of the agreement, as amended, Disetronic will have
exclusive responsibility for sales, marketing and customer service in its
territory in Europe. In addition, Disetronic is also entitled to market
FreeStyle to its pump users in North America. The initial term of the
Disetronic agreement, as amended, ends on December 31, 2006. At the end of the
initial term, the agreement will automatically renew for additional two-year
terms unless one of the parties provides written notice of termination at least
one year prior to the end of the then-current term. Under the terms of the
agreement, the Company received a $1.5 million nonrefundable pre-payment, which
was deferred and credited as revenues were recognized. Disetronic is required
to meet specific minimum purchase requirements or the Company may terminate the
agreement. Disetronic beneficially owns greater than 5% of the Company's
outstanding shares of capital stock.

NOTE 13--EMPLOYEE BENEFIT PLAN:

In October 1997, the Company adopted a defined contribution retirement plan
(the "Plan"), which qualifies under Section 401(k) of the Internal Revenue Code
of 1996. The Plan covers essentially all employees. Eligible employees may make
voluntary contributions to the Plan up to 15% of their annual compensation,
subject to statutory annual limitations, and the employer is allowed to make
discretionary contributions. The Company has made no contributions to date.

F-24

THERASENSE, INC.

NOTES TO FINANCIAL STATEMENTS--(Continued)

NOTE 14--QUARTERLY FINANCIAL DATA (UNAUDITED):

Quarter Ended
------------------------------------------------------------------------------------------------
March 31, June 30, September 30, December 31, March 31, June 30, September 30,
2000 2000 2000 2000 2001 2001 2001
------------ ----------- ------------- ------------ ------------ ------------ -------------

Revenues................ $ 500,000 $ 11,251 $ 1,279,879 $ 3,712,120 $ 7,677,456 $ 17,846,317 $ 19,858,533
Cost of revenues........ -- 306,132 6,767,913 4,874,238 6,225,646 13,442,423 12,938,677
------------ ----------- ------------ ------------ ------------ ------------ ------------
Gross profit (loss)..... 500,000 (294,881) (5,488,034) (1,162,118) 1,451,810 4,403,894 6,919,856
Net loss................ (6,905,768) (8,153,065) (14,593,274) (13,939,730) (12,180,463) (14,752,966) (12,924,515)
------------ ----------- ------------ ------------ ------------ ------------ ------------
Deemed dividends
related to beneficial
conversion of
preferred stock........ (14,772,878) -- -- -- (23,302,349) (3,480,562) --
------------ ----------- ------------ ------------ ------------ ------------ ------------
Net loss attributable to
common stock
holders................ (21,678,646) (8,153,065) (14,593,274) (13,939,730) (35,482,812) (18,233,528) (12,924,515)
============ =========== ============ ============ ============ ============ ============
Net loss per common
share.................. $ (6.12) $ (2.11) $ (3.56) $ (3.16) $ (7.62) $ (3.74) $ (2.53)
============ =========== ============ ============ ============ ============ ============

December 31,
2001
------------

Revenues................ $ 26,473,016
Cost of revenues........ 16,540,461
------------
Gross profit (loss)..... 9,932,555
Net loss................ (13,007,589)
------------
Deemed dividends
related to beneficial
conversion of
preferred stock........ --
------------
Net loss attributable to
common stock
holders................ (13,007,589)
============
Net loss per common
share.................. $ (0.40)
============

F-25

SCHEDULE II

THERASENSE, INC.

VALUATION AND QUALIFYING ACCOUNTS

FOR THE YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
(IN THOUSANDS)

Balance at Charged to Balance
Beginning Costs and at End
Description of Year Expenses Deductions of Year
----------- ---------- ---------- ---------- -------

Allowance for doubtful accounts receivable:
Fiscal year ended 1999.................. $ -- -- -- $ --
Fiscal year ended 2000.................. $ -- 150 -- $ 150
Fiscal year ended 2001.................. $ 150 576 (22) $ 704

Allowance for inventories valuation:
Fiscal year ended 1999.................. $ -- -- -- $ --
Fiscal year ended 2000.................. $ -- 3,528 (657) $2,871
Fiscal year ended 2001.................. $2,871 -- (1,603) $1,268

S-1