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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

OR

For the transition period from              to             

Commission File Number 000-23541

NANOGEN, INC.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (858) 410-4600

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

Preferred Stock Purchase Rights

(Title of Class)

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.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

The aggregate market value of the voting stock held by non-affiliates of the registrant based upon the closing sale price of the common stock on June 30, 2004 (the last day of the registrant’s most recently completed second fiscal quarter), as reported on the Nasdaq National Market was approximately $198,412,160. Shares of common stock held by each executive officer and director and by each person (including shares beneficially owned by Citigroup, Inc.) who owns 10 percent or more of the outstanding common stock have been excluded in such calculation as such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the registrant’s common stock was 47,708,407 as of March 1, 2005.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for its annual meeting of stockholders to be held in 2005 are incorporated by reference in Part III of this Form 10-K.

Table of Contents

NANOGEN, INC.

TABLE OF CONTENTS

FORM 10-K

For the Year Ended December 31, 2004

INDEX

Table of Contents

PART I

Trademarks and trade names

NANOGEN^®, NanoChip^™, Eclipse^® MGB^™, MGB Eclipse^™, Eclipse^® Dark Quencher, Super A^™, Super T^™, Super G^™, Redmond Red^™, Yakima Yellow^™, Smarter DNA^™, DxPress^™, Nexus D_x^™, StatusFirst^™ and our other logos and trademarks are the property of Nanogen Incorporated. All other brand names or trademarks appearing in this Annual Report on Form 10-K are the property of their respective holders. Use or display by us of other parties’ trademarks, trade dress or products in this Annual Report is not intended to, and does not imply a relationship with, or endorsements or sponsorship of, us by the trademark or trade dress owners.

Forward Looking Statement

This Form 10-K and the information incorporated herein by reference contain forward-looking statements that involve a number of risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Although our forward-looking statements reflect the good faith judgment of our management, these statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from results and outcomes discussed in the forward-looking statements.

Forward-looking statements can be identified by the use of forward-looking words such as “believes,” “expects,” “hopes,” “may,” “will,” “plan,” “intends,” “estimates,” “could,” “should,” “would,” “continue,” “seeks,” “pro forma” or “anticipates,” or other similar words (including their use in the negative), or by discussions of future matters such as the development of new products, technology enhancements, possible changes in legislation and other statements that are not historical. In addition, to the extent statements in this report involve, without limitation, our expectations for growth, estimates of future revenue, expenses, profit, cash flows, balance sheet items or any other guidance for future periods, these statements are forward looking statements. These statements include but are not limited to statements under the captions “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as other sections in this report. You should be aware that the occurrence of any of the events discussed under the heading “Item 1. Business—Risk Factors” and elsewhere in this Annual Report could substantially harm our business, results of operations and financial condition. If any of these events occurs, the trading price of our common stock could decline and you could lose all or a part of the value of your shares of our common stock.

The cautionary statements made in this Annual Report are intended to be applicable to all related forward-looking statements wherever they may appear in this Annual Report. We urge you not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report.

Item 1. Business

Overview

We were founded with an enduring vision to improve the quality of healthcare by introducing advanced human diagnostic products that will provide higher quality of information in a shorter period of time to our customers in the research, clinical laboratory or point-of-care markets. We intend to turn this vision into reality by continuing to develop new diagnostic products or by acquiring other companies and complementary products that will expand and accelerate our entry into rapidly growing diagnostic markets. We began a targeted acquisition strategy during 2004 that is expected to result in a broad product line of advanced diagnostic products. The combination of internally developed products plus acquired products addressing large markets should provide the stimulus for significant revenue acceleration in 2005 and beyond.

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The company has historically generated revenues through contract research, grants and licenses and through commercializing molecular diagnostic research tools, such as the Molecular Biology Workstation and NanoChip^® Cartridge (collectively, the “NanoChip^® System”) and related Analyte Specific Reagents (ASRs) for the clinical and laboratory research market. In November 2004 we introduced our second generation molecular diagnostic instrument, the NanoChip^® 400. This platform is expected to ship in 2005 and is designed to serve the clinical laboratory market by offering faster throughput and simpler operating procedures. The new system offers a 400-site cartridge utilizing our unique and patented micro-array technology that will allow customers the flexibility to adjust panels from single-to-multiple arrays to fit their requirements.

We expanded both our product lines and addressable markets during the past year with the acquisitions of SynX Pharma in April 2004 and of Epoch Biosciences in December 2004. These combinations will accelerate our entry into the point-of-care market and deepen our penetration of the research and clinical laboratory markets, respectively.

SynX Pharma is developing a product that will test for congestive heart failure (CHF) by measuring levels of NT-proBNP in patients. FDA submission of this product for a 510k approval is expected during 2005. SynX researchers are continuing research and development work in the cardiovascular field including development of a test for the diagnosis of stroke. SynX received patents during 2004 in both the US and in Europe for the diagnosis of stroke. SynX is also developing a test for diagnosis of traumatic brain injury. We expect that the SynX product line will accelerate our entry into the point-of-care market place by providing time-sensitive information to emergency room or urgent care settings.

The acquisition of Epoch Biosciences late in 2004 will have an immediate effect on revenues during 2005. Epoch has a number of proprietary products for genomic analysis as well as molecular and infectious disease diagnostics for the real-time polymerase chain reaction (PCR) market. We also acquired Epoch’s revenue stream of royalties from companies in the research, diagnostics and industrial markets that have licensed Epoch technologies.

Collectively, our existing products along with the products acquired from SynX and Epoch, are expected to significantly increase our revenues during 2005 and provide us with a strong revenue base for the following years. One of our key goals in broadening our product line both organically and through acquisition is to have a definable path to profitability that will help us emerge as a leader in the growing field of advanced diagnostics.

We were incorporated under the laws of the state of Delaware and our stock is listed on the Nasdaq National Market under the symbol “NGEN”. Our corporate offices are located at 10398 Pacific Center Court, San Diego, California 92121. Our main telephone number is 858-410-4600.

We make available through our internet website our code of business conduct and ethics, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Our Internet address is www.nanogen.com. The information contained in, or that can be accessed through, our website is not part of this Annual Report.

Technology

Increased awareness of the role of genes in regulating the functions of living organisms has generated a worldwide effort to identify and sequence genes and genomes of many organisms, including the estimated three billion nucleic acid base pairs that comprise the human genome. In June 2000, the effort led by the Human Genome Project (sponsored by the Department of Energy and the National Institutes of Health) resulted in a first complete draft of the human genome sequence.

Genomics research investigates the role of specific genes and gene expression in disease. This research will ultimately lead to a new healthcare paradigm where disease is understood at the molecular level. We believe that

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this change will lead to the introduction of new therapies, the development of targeted therapeutics and an abundance of new screening tests that will, in turn, shift the focus of medicine to be increasingly proactive as well as being increasingly specific to the individual patient. Therefore, we have developed tools for both simple and complex testing that render genetic information accessible to researchers and clinicians.

The Molecular Biology Workstation and NanoChip^® 400 product platforms are advanced diagnostic systems designed for complex genetic testing with the ability to perform multiple tests on multiple gene markers at the same time. Molecular and infectious disease products developed by Epoch use the real-time, PCR format that is more applicable for simpler, single-test analysis. These tests run on platforms that are sold by other companies. The two product lines address different, yet complimentary needs of the research and clinical laboratory market thereby providing the company with a broader product line to offer its customers.

The company’s technologies are also being applied to infectious disease diagnostic products. The area of infectious disease includes bacteria, fungi, and viruses that all contain nucleic acids detectable by the molecular diagnostic methods we have developed for human genes. With our acquisition of Epoch, we currently offer multiple infectious disease ASRs to the real-time PCR clinical laboratory marketplace. Further, through our collaboration with Prodesse, Inc., we are working to commercialize multiplexed ASRs for infectious disease detection.

SynX Pharma has discovered or licensed a series of proteomic markers related to cardiovascular, stroke, brain injury and various metabolic diseases. Their research is expected to result in a pipeline of immunoassay products that we may develop or licensed to others for development in specific markets.

Customers

The market for our molecular diagnostic systems and reagents includes customers in research institutions, clinical research laboratories and high complexity CLIA certified laboratories. In the United States, the Food and Drug Administration (the FDA) regulates most diagnostic tests and in vitro reagents marketed as test kits as medical devices. The FDA also considers ASRs to be medical devices. ASRs are exempt from pre-market approval requirements; however, the FDA restricts the sale of these products to those clinical laboratories that are certified under the Clinical Laboratory Improvement Amendments of 1988, known as CLIA. Customers for our diagnostics technology and products therefore include:

With our acquisition of SynX Pharma, we are entering the point-of-care diagnostic market with devices that detect the levels of proteins that may cause or be correlated with diseases. Our technology is moving these tests from the clinical reference lab to near patient settings such as the hospital lab or emergency room. Ease of use and rapid availability of information is critical to these customers. Our point-of-care customers are reached through a network of distributors.

Products

We have three categories of advanced diagnostic products: 1) real-time ASRs, 2) microarray instrument platforms and related ASRs, and 3) point-of-care tests.

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1) Real-time ASRs

Real-time PCR analysis is widely used in a variety of research and clinical laboratories to test for single markers or mutations. The products, assumed in our acquisition of Epoch, operate on instrument systems sold by other companies.

MGB Eclipse^™ Detection Reagents—MGB Eclipse Detection Reagents consist of ready-to-use 20X probe and primer mixes for amplifying and detecting disease-specific genetic sequences. For MGB Eclipse Detection Reagents targeting infectious disease agents, pathogen-specific probe and primer mixes are bi-plexed with a probe and primers specific for an Internal Control. Internal Control and disease-specific Positive Control template products are sold separately as an option for incorporation into laboratory-defined assay quality assurance protocols. MGB Eclipse Detection Reagents targeted to disease-associated gene expression are bi-plexed with a probe and primers for amplifying and detecting a reference gene for increased accuracy. MGB Eclipse Detection Reagents for disease-associated single nucleotide polymorphisms (SNPs) consist of a bi-plexed mix of probes specific for each of two genetic variants along with primers for amplification and detection using post-PCR dissociation or melt curve analysis.

We currently offer MGB Eclipse Detection Reagents for infectious disease and genetic testing targets.

2) Microarray Instrument Platforms and related ASRs

Microarray-based testing is preferred in applications involving multiple gene markers or mutations. The largest markets for these products involve testing for respiratory viruses, mutations associated with cystic fibrosis, Factor V/II and pharmacogenomic tests. Our Molecular Biology Workstation and the recently announced NanoChip^® 400 (our second generation product) are designed to address the requirements of this market.

Despite recent advances in technology, many molecular testing methodologies are too specialized or inflexible to be used for the varied needs of the diagnostics or research laboratory. Many of the current tools were designed for large-scale data generation and the automation of repetitious tasks required for high throughput discovery research. These technologies fall primarily into three categories: high-density arrays; high throughput sequencing and SNP discovery tools; and gel-based methods. While these technologies have certain advantages, they also have significant drawbacks that inhibit their broad applicability across the life sciences market, particularly in the molecular diagnostics market. Therefore, we are seeking to establish the NanoChip^® System as the preferred platform for complex detection of genetic mutations and to develop applications for clinical laboratory use.

Both the NanoChip^® 400 and Molecular Biology Workstation consist of a consumable cartridge containing a proprietary semiconductor microchip (“the NanoChip^® Electronic Microarray”), a fluidic and optical instrument, and imbedded software that can be programmed by the end-user to control all aspects of microchip operations including processing, detection and reporting. The system has been designed so that once programmed, the end-user need only insert a consumable cartridge into the instrument and all subsequent steps may be handled automatically under computer control.

Our first generation platform, the Molecular Biology Workstation has an installed base of approximately 100 units. It provides research-oriented customers with the ability to electronically control up to 100 tests per cartridge. Electronic control enables rapid transport, concentration and hybridization on our arrays and will permit unused test sites to be saved for future assays, enabling full chip utilization. This feature represents a significant differentiator over other microarrary technologies.

Our next generation NanoChip^® 400 System, now in early customer testing, will streamline user workflow and should permit the testing of up to 400 sites per cartridge. The NanoChip^® 400 has a new architecture which eliminates the need for user handling of cartridges and reagents during instrument operation. It also offers a significantly smaller footprint that is more attractive to clinical lab customers. We believe the automation and ease-of-use of the NanoChip^® 400 System better meets the requirements of the clinical diagnostic market.

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We sell not only the NanoChip^® System and Cartridges, but also ASRs and other reagents that our customers can use to develop, validate and perform specific molecular tests. We have developed multiple ASRs that enable researchers and high complexity CLIA certified laboratory customers to develop, validate and run specific assays on our Molecular Biology Workstation system. The ASRs available include Factor V/II, ApoE, CFTR, and in the European market: Connexin26 and beta thalmassemia.

3) Point-of-care market

Our point-of-care product development pipeline is primarily focused on cardiac and central nervous system disorders such as Congestive Heart Failure (CHF) and Stroke. Heart and stroke related disorders are the number one and three causes of death in the United States, respectively. Nearly 5 million Americans have congestive heart failure and 550,000 new cases are diagnosed each year; the estimated direct and indirect cost of heart failure is $26.5 billion. About 700,000 Americans will have a stroke this year, of which 500,000 are first attacks and 200,000 are recurrent attacks. Stroke is a leading cause of severe, long-term disability; in 2004 the estimated direct and indirect cost of stroke was $53.6 billion¹. When a physician can specifically diagnose CHF or stroke at the point-of-care facility, more effective treatment may be administered.

With our acquisition of SynX in 2004, we acquired a pipeline of potential diagnostic products based on detecting proteins associated with CHF, stroke or other conditions. From this pipeline we are developing point-of-care diagnostic tests for highly specific protein markers that play a role in assisting the early diagnosis and monitoring of the diseases. Our technology is moving these tests from the clinical reference lab to near patient settings such as the hospital laboratory or emergency room. Our current products in the point-of-care market include:

Point-of-care products in the commercialization / launch phase 2005

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Our Growth Strategy

We will continue to develop and market advanced diagnostic products that address large and growing markets. We plan to establish our leadership position in the advanced diagnostics arena by leveraging our technologies and knowledge base to identify business opportunities that will allow us to increase our critical mass and accelerate our progress in the marketplace. We will continue to invest in the internal development of new diagnostic products as well as seek to acquire additional entities or product lines which are complementary to our existing product portfolio.

New products expected to contribute significantly to product revenue during 2005 include the NanoChip^® 400 and related ASRs for infectious disease and for testing for mutations in the CFTR gene, the StatusFirst^™ congestive heart failure product, and several real-time ASRs. In addition, the Epoch acquisition will contribute significant royalty revenues from existing relationships. Unlike previous years where revenue was derived from a single product family, revenue in 2005 is expected to result from multiple product families and sources in multiple markets.

We have two different approaches to address the molecular diagnostics market. First, we have focused on penetrating the high value, complex testing requirements of the molecular diagnostics market by creating an open platform that can help automate laboratory testing. We continually seek to increase the installed base of the NanoChip^® Systems and to establish our platform as the preferred system for the molecular diagnostics industry in order to reap the benefits of the higher margin profits on consumables such as the NanoChip^® Cartridges, ASRs and other products. The NanoChip^® System’s open architecture facilitates development of molecular tests by our customers and collaborators, driving the growth in assay development far beyond our internal capacities. The NanoChip^® System could transform molecular diagnostics by delivering speed, efficiency and accuracy on a robust platform. As this market area grows and our market share increases, the NanoChip^® System could generate multiple revenue sources that will fuel next generation systems and revenue growth. Second, we develop and offer single marker ASRs in a real-time format. These products address genetic as well as infectious disease tests and run on instruments sold by other companies. Often times, our clinical laboratory customer already owns the real-time testing instrument needed to run our test. By offering both of these approaches to molecular diagnostics, we can provide the clinical research laboratory or CLIA laboratory with the range of products they need to perform simple to complex genetic and infectious disease tests.

We believe point-of-care products offer a strong growth opportunity. Emergency rooms and urgent care units represent a significant market for rapid point-of-care testing for cardiovascular and neurological conditions. With our recent acquisition of SynX, we plan to obtain European, Canadian and U.S. regulatory clearance for our NT-pro BNP CHF diagnostic product and enter the point-of-care market. Together with our partner, PBM, we plan to launch the CHF product in major markets around the world.

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Products and Applications in Research and Development

Below is a brief description of some of our future products and applications currently in research and development by us or with our collaborators.

Array-based ASRs:

The Next Generation of NanoChip^® System

We have developed the second generation of the NanoChip^® System, the NanoChip^® 400, which is expected to be released in 2005. The second generation system will be more compact, have increased test density, have improved functionality and accuracy and be less costly in order to access a broader market for molecular-based testing. Our scientists will pursue opportunities to develop and validate new protocols, ASRs and products for use on the NanoChip^® System, while customers may create and validate new “home brew” assays by taking advantage of the flexible format of the NanoChip^® System.

We also intend to pursue new opportunities utilizing electronics beyond the current microchip concept. For example, future technologies may include integration of sample processing and DNA amplification. The NanoChip^® System may be designed to provide analysis of other charged molecules and antigen-antibody, enzyme substrate, cell-receptor, and cell-separation techniques. The NanoChip^® System eventually may also become a portable lab-on-a-chip for use in the field, away from the laboratory bench.

We believe there is potential for our technology in the field of infectious disease diagnostics. Our plan is to develop automated tests to replace the manual and time-intensive procedures used in hospitals and reference laboratories. The role of the clinical microbiology laboratory is to detect and identify disease causing microorganisms and to determine antibiotic sensitivity. To accomplish this task, colonies of microorganisms from patient specimens are grown, or cultured, in various growth media. Following colony growth, various direct and indirect techniques are utilized to determine the identity and, as required, the sensitivity of the microorganism to specific antibiotics. Using currently available technologies, the entire process may take days or weeks to complete. In the meantime, a patient requiring immediate therapy must often be treated by the clinician empirically. Upon receipt of the diagnostic analysis from the laboratory, the initial patient treatment protocol may need to be modified in order to treat the patient more effectively.

Because a particular infectious episode may be caused by one of many microorganisms or several microorganisms together, multiple tests are required to determine the correct diagnosis. “Single analyte” (one at a time) DNA probe diagnostic tests, which were first introduced to the marketplace in the mid-1980’s, have been unsuccessful in displacing many culture-based diagnostic tests, in part due to their inability to identify several organisms simultaneously. Our technology addresses these shortcomings by allowing the simultaneous analysis of multiple microorganisms from a single patient sample. We believe our technology and integrated system may speed the time-to-result for diagnostic tests and offer our customers the opportunity to lower their costs and improve productivity by automating all or a significant portion of their labor-intensive testing.

Point-of-care

We are currently developing, and expect to launch in 2005, our Status First^™ Congestive Heart Failure (CHF) point-of-care test which will give a quantitative reading of NT-proBNP, a marker for CHF, a chronic disease that affects millions of patients each year. Using the Status First NT-proBNP CHF test in conjunction with a reader in an emergency room or near-patient setting will enable physicians to diagnose patients presenting with CHF symptoms according to class 1 through IV (NYHA guidelines) and differentiate between heart failure and other disorders in patients who present with shortness of breath. With this information the physician can more quickly determine the ideal treatment regimen for a particular patient. The StatusFirst^™ product will provide a 15 minute test.

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During 2004 we received both a United States and a European patent related to the detection of stroke and the differentiation of stroke types. We are currently developing a product for the diagnosis of stroke with the intent to commercialize it in the future. We believe that the stroke product will address a significant market in the emergency room and urgent care setting.

We are also developing the Nexus D_X^™ Traumatic Brain Injury point-of-care test that measures several protein markers which are released into the blood stream following traumatic brain injury. Currently, there is no reliable biochemical test available for traumatic brain injury. The Nexus D_X^™ Traumatic Brain Injury test results could provide important information to assist clinicians in determining the appropriate management of brain trauma patients.

Biodefense

We began work on biodefense-related technology for the United States Government in 1995. The work expanded to include three past government grants to support biowarfare detection efforts (one DARPA grant and two DUST grants).

Specific development efforts have included a prototype portable field-based detection device and an integrated micro-laboratory and assay protocol to analyze simulated biowarfare targets. We also developed assays aimed at detection of specific biowarfare agents and infectious diseases and a self-contained portable system capable of performing on-chip non-PCR amplification and detection of potential biowarfare threats. We currently do not anticipate significant additional development work in the area of Biodefense although we continue to evaluate potential government grant projects.

Nanotechnology

Our proprietary nanotechnology and molecular tools may provide a technological foundation for the effective use of nanocomponents in many diverse applications. We currently have nanotechnology patents that were assembled through the pioneering research of Dr. Michael Heller, a founder of Nanogen and currently at the University of California, San Diego. We plan to realize value from our nanotechnology patents through use in biomedical applications or through licensing or partnering opportunities. We have been issued several key nanotechnology patents that relate to the electronic fabrication of micro and nanoscale devices including the following patents that were issued during 2004:

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Forensics

Short terminal repeats (STRs) are the genetic sequences chosen by the U.S. government and various foreign governments to populate their national criminal identification databases. Some foreign researchers and governments are also beginning to examine certain SNPs to develop such databases. These databases are intended to provide nationwide tools for identifying repeat criminals by comparing a given piece of evidence or sample from a suspect with the sequences stored in the database. Currently, we have four European customers working on forensic applications.

Our research collaborations in the area of forensic applications have allowed us to further develop existing technology and explore new technology. Prior grants from the National Institute of Justice have involved sponsored research for forensic applications, such as the development of a portable system for human identification at the crime scene and the development of on-chip amplification. We do not currently anticipate spending significant additional development resources in the forensics area. However, several of our customers may continue to develop their own applications using our technology.

Pharmacogenomics

Pharmacogenomics is the science of individualizing therapy based on genetic differences among patients. Certain genes have been shown to be required for the breakdown and elimination of drugs in the body (pharmacokinetics). Changes in these genes can result in an inability to process certain kinds of drugs, which can lead to a buildup of toxic chemicals in the body. Other genetic changes can result in extremely rapid breakdown of a drug, limiting the drug’s effectiveness. By determining a patient’s genetic profile prior to prescribing a drug, a physician can reduce the potential for serious or fatal side effects. We believe that the ability of our technology to screen simultaneously for various changes in a patient’s DNA has wide applicability to pharmacogenomics.

Increasingly, pharmaceutical and biotechnology companies are developing therapeutics by targeting specific biological molecules. This approach contrasts traditional pharmaceutical development, in which therapeutics were developed against disease models rather than against specific genetic targets. Changes in the genetic sequence of these target molecules may enable segregation of patient populations into likely responders and non-responders. Such segregation could decrease the cost of clinical trials during drug development, and decrease the likelihood of adverse events once a drug is approved and commercialized. Our NanoChip^® System may provide pharmaceutical and biotechnology companies with the ability to identify important genetic variations early in the drug development process, and create “companion diagnostic” assays that could be used to identify those likely to receive the maximum benefit from treatment.

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Research and Development

As of January 31, 2005, we had 78 full-time and temporary employees in research and development. Our research and development expenses were $18 million in 2004, $18 million in 2003 and $21 million in 2002. These research and development expenses have been directed toward developing innovative new products in areas of significant market opportunity. Most of our research and development has been conducted at our facilities in San Diego CA, Bothell WA, or Toronto, Canada or in collaboration with various partners.

Sales and Marketing

Molecular diagnostic products

We sell our molecular diagnostic products including our microarray platforms, array-based ASRs and real-time ASRs in the United States through our own direct sales force. As of January 31, 2005, our sales force consisted of a staff of approximately 44 sales, marketing and technical support representatives. These representatives principally focus on large CLIA certified laboratories including clinical research laboratories, reference laboratories and public health laboratories. We continually educate our sales representatives on the technical, clinical and economic merits of our products.

We sell custom real-time MGB Eclipse^™ Probe Systems directly to the research market through a specialized direct sales force into the United States. Our MGB Eclipse^™ Online Design and Ordering consists of assay design and order processing software to facilitate delivery of custom assays starting with the submission of a customer’s target genetic sequence of interest. MGB Eclipse^™ Online Design and Ordering is also used to identify new potential customers for MGB Eclipse^™ By Design. Products that incorporate our MGB Eclipse Probe Systems for the gene expression market are also sold on a worldwide basis by QIAGEN N.V., who offer their customers custom and catalogue probe systems as part of its QuantiTect^™ Gene Expression Assays product line.

Our sales representatives are able to recommend the appropriate business solution to meet the needs of our customers by presenting multiple technology and instrumentation options. Sales representatives are trained to find new market opportunities, provide diagnostic solutions to address unmet customer needs, and to provide comprehensive after-sale product support. In addition, our field technical support group provides thorough training and ongoing technical support for our products.

All sales to customers outside the United States are made through distributors or agents. We currently have 12 distributors addressing the European and middle-east markets. In the future, we plan to add additional distributors to address the major Asian markets. To support our commercial efforts in Europe, in August 2000 we established Nanogen Europe B.V., a company with limited liability, in The Netherlands. This wholly-owned subsidiary operates as our primary European sales, marketing and technical support office. In December 2004, we terminated our agreement with Transgenomic, Inc. for the distribution of our array-based products in certain European countries. We have since appointed new distribution partners to replace Transgenomic.

We are building our own internal services organization. This field service organization will provide initial installation, on going technical support and warranty and maintenance work as needed.

Point-of-care

All sales to customers for point-of-care products are made through distributors or agents. We currently have distributors addressing 28 European and middle east countries. In the future, we plan to add additional distributors to address the major Asian markets. Nanogen Europe B.V., our wholly-owned subsidiary, operates as our primary European sales, marketing and technical support office for point-of-care customers. In North America, initial distribution of the CHF product will be managed by our partner, PBM. They will develop a

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distribution network that complements their current sales capabilities to access hospital and emergency laboratories. We select distributors based on their prior experience in the point-of-care medical diagnostic device sector and their knowledge of cardiovascular products. We believe each distributor will be responsible for the distribution and marketing of the full range of our point-of-care products.

Collaborations and Strategic Arrangements

We intend to continue to enter into collaborations to expand applications of our technology platforms and to accelerate the commercialization of products. We will pursue additional collaborations in various forms, including research and development agreements, licensing agreements and joint ventures. These collaborations permit integration of the technologies and resources of our partners with our technologies, while allowing us to pursue diagnostics and other opportunities outside the scope of these collaborations.

We are currently involved in the following corporate collaborations:

Prodesse

In September 2003, we entered into a collaboration agreement with Prodesse, Inc. to develop automated, highly sensitive microarray products to detect a number of infectious disease agents, including influenza, adenovirus, and atypical pneumonia agents. The collaboration will integrate Prodesse’s proprietary multiplex amplification technology with the automated NanoChip^® System; we will jointly develop and market gene-based testing products to health care and clinical reference labs.

Hitachi—Manufacturing Agreement

In January 2000, the Company executed an agreement with Hitachi, Ltd., for the full-scale commercial manufacturing and distribution of the NanoChip^® Molecular Biology Workstation in specified research markets. Hitachi, Ltd.’s Instrument Group provides technology and technical support to aid in the manufacturing of the NanoChip^® Molecular Biology Workstation’s components.

Pursuant to the agreement, Hitachi, Ltd. has the right to be the sole distributor of NanoChip^® Molecular Biology Workstations in Japan. Under this arrangement, the Company receives a royalty for NanoChip^® Molecular Biology Workstations sold by Hitachi, Ltd. in Japan. The Company retained the right to distribute, directly or through others, NanoChip^® Molecular Biology Workstations outside of Japan. In addition, the Company manufactures NanoChip^® Cartridges at its San Diego, California facility for distribution worldwide. The Company also retained the right to form other manufacturing and distribution agreements. Pursuant to our manufacturing agreement with Hitachi, the Company had been required to provide annual purchase commitments to Hitachi for the first generation NanoChip^® Workstations. As of December 31, 2004, the Company had fulfilled its purchase commitments for the first generation NanoChip^® Workstations.

In June 2003, the Company entered into another manufacturing agreement with Hitachi for the manufacture of the NanoChip^® 400, the second generation instrument, which was developed under the collaborative research agreement (described below). Pursuant to the 2003 manufacturing agreement, Hitachi will manufacture the NanoChip^® 400 exclusively for the Company for worldwide distribution. Hitachi has the right to distribute the NanoChip^® 400 in Japan on a royalty bearing basis. The Company is required to meet certain annual purchase commitments for the new instrument. As of December 31, 2004, the Company had a purchase obligation of $590,000 through February 28, 2005.

Hitachi—Research Collaboration Agreement

In July 2000, the Company executed a ten-year agreement with Hitachi, Ltd., Nissei Sangyo Co. Ltd. and Hitachi Instruments Service Co. Ltd. of Japan (collectively, “Hitachi”) to develop, manufacture and distribute

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additional potential products based on the parties’ proprietary technologies, potentially including, among other things, reduced-size instruments for genetic testing, integrated amplification and point-of-care detection. Pursuant to the terms of the agreement, Hitachi and the Company each may contribute cash over the ten-year period toward the research and development efforts of the Company. At a minimum, the Company is required to contribute on an annual basis funding for its own general technology development in an amount equal to or greater than payments made by Hitachi. In addition, the Company is liable to repay to Hitachi fifty percent of all funding provided by Hitachi over an indefinite period of time. Repayment amounts are determined as a percentage of the Company’s gross NanoChip^® Cartridge sales until the liability is paid in full. Furthermore, Hitachi made an equity investment in the Company by purchasing 74,590 shares of the Company’s common stock worth approximately $2.0 million pursuant to a private sale by the Company based on a per share price of $26.813 (the fair market value as of the signing date of the Hitachi agreement).

In August 2003, the Company received written notice from Hitachi to exercise its right to terminate the collaborative research agreement in accordance with the terms of the agreement. Hitachi’s exercise of its right to terminate this agreement does not accelerate the repayment due Hitachi for the fifty percent of Hitachi provided funding, which is reflected as a $4.9 million long-term obligation in our December 31, 2004 balance sheet. Based on joint discussions, we and Hitachi have determined to focus their joint efforts on the development and manufacture of the NanoChip^® 400. We and Hitachi continue to be jointly responsible for development of the NanoChip^® 400. Hitachi is responsible for world-wide manufacturing of the instrument. We are responsible for development of assays and for marketing and sales except in Japan.

Princeton Biomeditech (PBM)

SynX Pharma and PBM have a long standing relationship that includes the joint development and marketing of point-of-care tests. Under this arrangement, PBM is responsible for the development and manufacturing of the CHF product including the management of the OEM development of a quantitative reader. SynX Pharma is responsible for the development of reagents and clinical data. PBM will distribute the CHF product and reader in the United States and SynX will distribute the CHF product and reader outside the United States. The parties will divide revenues based on sales levels in the specific geographies. The parties may jointly develop future products.

Government Grants

In 2004, we continued work under a number of biodefense-related technology grants for the United States Government. In the latter part of 2002, we received an additional $1.7 million grant from the National Institute of Justice (“NIJ”) to continue an earlier NIJ grant for the development of a forensics detection system for the identification of certain relevant SNPs and STRs and we received a grant from the National Institute of Health for $162,000 for the development of a sample preparation system for the detection of certain biological agents.

Specific development efforts include a prototype portable field-based detection device and an integrated micro-laboratory and assay protocol to analyze simulated biowarfare targets. Also under development are assays aimed at detection of specific biowarfare agents and infectious diseases and a self-contained portable system capable of performing on-chip non-PCR amplification and detection of potential biowarfare threats.

Also, in 2003, we received Phase II and Phase III grants totaling approximately $858,000 from the National Institutes of Health to develop on-chip SDA amplification techniques. The first grant for $147,000 is for the development of a 3-D DEP cell/pathogen separation system, and the second grant for $711,000 is for the development of a new isothermal on-chip SDA assay.

We believe that the actions we are taking to develop our product platform for use in molecular diagnostics are directly portable and complementary to what we are doing in the biowarfare arena for the U.S. Army and for the NIH. As a result, we believe that our government and commercial programs complement one another.

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Patents and Proprietary Technology Rights

We consider the protection of our proprietary technologies and products to be important element in the success of our business. As of December 31, 2004, we had 111 issued U.S. patents and numerous foreign patents expiring at varying dates and a number of pending patent applications filed in the U.S. and abroad. In addition to pursuing patents and patent applications relating to our platform technology, we have and may enter into other license arrangements to obtain rights to third-party intellectual property where appropriate.

Our licensors’ patent applications may not be issued. Issued patents may not be found valid if challenged. In addition, intellectual property rights licensed by us may not be successfully integrated into commercial products. Others may independently develop similar technologies or duplicate any technology developed by us. Because of the extensive time required for development, testing, and regulatory review of a potential product, it is possible that, before any of our products can be commercialized, any related patent may expire or remain in existence for only a short period following commercialization, thus reducing any advantage of the patent, which could adversely affect our ability to protect future product development and, consequently, our business, financial condition and results of operations.

We seek to protect our inventions through filing U.S. patents and foreign counterpart applications in selected other countries. Because patent applications in the U.S. are maintained in secrecy for at least eighteen months after the applications are filed and since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first to make the inventions covered by each of our issued or pending patent applications or that we were the first to file for protection of inventions set forth in such patent applications. Our planned or potential products may be covered by third-party patents or other intellectual property rights, in which case continued development and marketing of the products would require a license. Required licenses may not be available to us on commercially acceptable terms, if at all. If we do not obtain these licenses, we could encounter delays in product introductions while we attempt to design around the patents, or could find that the development, manufacture or sale of products requiring these licenses is foreclosed.

We are aware of U.S. and European patents and patent applications owned by Oxford Gene Technology (“OGT”). We have opposed one allowed European Patent that had broad claims to array technology for analyzing a predetermined polynucleotide sequence. OGT’s position with respect to the opposed patent is that the claims relate to what it terms the “diagnostic mode.” Those claims have now been narrowed before the Opposition Division to the point that, if these claims remain final before the European Patent Office, we believe they would not be infringed by our technology. In the Oral Proceedings before the Opposition Division on November 13, 14, and 15, 2001, the Division determined that the claims’ language must be limited to arrays with ‘smooth, impermeable’ surfaces. The case is currently on appeal. If the decision of the Opposition Division is successfully appealed by OGT and the original claims are reinstated, or if an application relating to arrays issued in another country with claims as broad as the original European patent, we could be subject to infringement accusations that could delay or preclude sales of some or all of our anticipated diagnostic products.

We may rely on trade secrets to protect our technology. Trade secrets are difficult to protect. We seek to protect our proprietary technology and processes by confidentiality agreements with our employees and certain consultants and contractors. These agreements may be breached, we may not have adequate remedies for any breach and our trade secrets may otherwise become known or be independently discovered by competitors. To the extent that our employees or our consultants or contractors use intellectual property owned by others in their work for us, disputes may also arise as to the rights in related or resulting know-how and inventions.

Competition

The medical diagnostics and biotechnology industries are subject to intense competition. Our competitors in the United States and abroad are numerous and include, among others, diagnostic, health care, pharmaceutical and biotechnology companies.

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Many of our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we do. Moreover, many of our competitors offer broader product lines and have greater brand recognition than we do, and offer price discounts as a competitive tactic. In addition, there can be no assurance that competitors, many of which have made substantial investments in competing technologies, will not prevent, limit or interfere with our ability to make, use or sell our products either in the United States or in international markets.

In the markets for clinical molecular diagnostic products, a number of companies including Roche, ABI, Celera Diagnostics and Third Wave compete with us for product sales, primarily on the basis of technology, quality, reputation, accuracy, ease of use, price, reliability, the timing of new product introductions and product line offerings. In markets outside of the United States, other factors, including local distribution systems, complex regulatory environments and differing medical philosophies and product preferences, influence competition as well. In the congestive heart failure (“CHF”) market, for which we plan to begin selling product in 2005, Biosite, Inc. currently has a competitive FDA-approved test. Although we believe that our CHF product will have commercial advantages over the competing test, they may be able to develop technologies that are as effective as, or more effective, or easier to interpret or less expensive than, those offered by us, which would render our product uncompetitive or obsolete.

Government Regulation

Currently our NanoChip^® System is marketed for the detection of known sequences in the U.S. and primarily distributed for research use in Europe. The ASRs under development and commercially available are manufactured and distributed in the U.S. pursuant to 21CFR 864.4020 (which delineates the Class II and III ASRs, and otherwise exempts from the 510(k)/PMA requirements ASRs distributed to (1) in vitro diagnostic manufacturers or (2) organizations that use the reagents to make tests for purposes other than providing diagnostic information to patients and practitioners) and 21 C.F.R. § 809.30 (which places limitations on the distribution, labeling, advertising, and promotion of ASRs). Future short term plans include distribution of these reagents for research use in Europe with eventual CE marking of the next generation system under the European IVDMDD regulations.

For our initial commercial markets, the biomedical research market and the high complexity CLIA certified laboratory market, we may not need FDA or other regulatory clearances for our NanoChip^® System and certain ASRs prior to marketing. The FDA has recently communicated, however, that certain microarray devices that qualify as ASRs by regulation, may nonetheless lose their Class I, 510(k)-exempt status by operation of other provisions of the Federal Food, Drug and Cosmetic Act (21 U.S.C. § 360(1)) and FDA regulations (21 C.F.R. § 864.9), i.e., if the microarray “is intended for a use which is of substantial importance in preventing impairment of human health” or it “presents a potential unreasonable risk of illness or injury.” It is unclear what the impact of these FDA communications and determinations will be on us and our current and future products. We have not applied for FDA or other regulatory clearances with respect to any of our products under development. We anticipate, however, that the manufacturing, labeling, distribution and marketing of some or all of the diagnostic products we may develop and seek to commercialize in the future will be subject to regulation in the U.S. and in other countries. In addition to clinical diagnostic markets, we also may pursue forensic, agricultural, environmental, laboratory and industrial applications for our products which may be subject to different government regulation. Aspects of our manufacturing and marketing activities may also be subject to federal, state and local regulation by various governmental authorities.

In the U.S., the FDA regulates, as medical devices, most diagnostic tests and in vitro reagents that are marketed as finished test kits and equipment. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates the preclinical and clinical testing, design, manufacture, labeling, distribution and promotion of medical devices. We will not be able to commence marketing or commercial sales in the U.S. of our new medical devices that require pre-market authorization until we receive clearance or approval from the FDA, which can be a lengthy, expensive, and uncertain process. Noncompliance

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with applicable requirements can result in, among other things, Warning Letters, administrative or judicially imposed sanctions such as injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance (510(k)) or premarket approval (PMA) for devices, withdrawal of marketing clearances or approvals, or criminal prosecution.

In the U.S., medical devices are generally classified into one of three classes (i.e., Class I, II or III) on the basis of the controls deemed necessary by the FDA to reasonably ensure the safety and effectiveness of the product. Generally, Class I devices are subject to general controls (e.g., labeling, postmarket controls, Medical Device Reporting and adherence to Quality System Regulations, or QSR). Generally, Class II devices are subject to general and special controls (e.g., performance standards, premarket notification and postmarket surveillance). Generally, Class III devices are new technology or high-risk devices which must receive premarket approval by the FDA to ensure their safety and effectiveness (e.g., life-sustaining, life-supporting, and implantable devices or new devices which have been found not to be substantially equivalent to legally marketed devices). Before a device can be introduced in the market, the manufacturer must generally obtain FDA clearance of a 510(k) notification or approval of a PMA application. Our products will vary significantly in the degree of regulatory approvals required. We believe that certain of our products labeled for research, genomics, drug discovery and industrial applications may not require regulatory approvals or clearance. Some in vitro diagnostic products will require 510(k) clearances, while other diagnostic and genetic testing products will require PMA approvals.

A 510(k) clearance will generally only be granted if the information submitted to the FDA establishes that the device is “substantially equivalent” to a legally marketed predicate device. For any devices that are cleared through the 510(k) process, significant modifications or enhancements in the design or intended use that could significantly affect safety or effectiveness will require new 510(k) submissions. It generally takes at least three to six months or more from submission to obtain 510(k) premarket clearance, but the process may take longer if FDA requests more data or research. The FDA may determine that we must adhere to the more costly, lengthy, and burdensome PMA approval process for our potential products.

The Premarket Approval (“PMA”) application process is more expensive, burdensome, and lengthy than the 510(k) clearance process. A PMA must establish the safety and effectiveness of the device to the FDA’s satisfaction, which typically requires extensive data, including but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate the safety and effectiveness of the device. Although clinical investigations of most devices are subject to the investigational device exemption requirements, clinical investigations of non significant risk in vitro diagnostic tests, such as certain of our products and products under development, are exempt from the investigational device exemption (“IDE”) requirements, including the need to obtain the FDA’s prior approval. We believe certain of our diagnostics are non significant risk devices because the testing is noninvasive, does not require an invasive sampling procedure that presents a significant risk, does not introduce energy into the subject, and is not used as a diagnostic procedure without confirmation by another medically established test or procedure. To fall within this exemption to the IDE requirement, the in vitro diagnostic tests must be labeled for research use only or investigational use only, and distribution and due diligence controls must be established by the company to assure that IVDs distributed for research or clinical investigation are used only for those purposes.

After a PMA is accepted for filing, the FDA begins its review of the submitted information, which generally takes between one and two years. During this review period, the FDA may request additional information or clarification of information already provided, as well as conduct a pre-approval inspection of the manufacturing facility. If we are not in compliance with Quality System Regulations (“QSRs”) applicable to manufacturing, we will not receive PMA approval. 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. Significant modifications to the design, labeling or manufacturing process of a PMA-approved device may require approval by the FDA of a PMA supplement. We may not be able to obtain necessary approvals on a timely basis, if at all, and delays in obtaining or failure to obtain such approvals, the loss of previously obtained approvals, or failure to comply with existing or future regulatory requirements could have a material adverse effect on our business, financial condition and results of operations.

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Manufacturers of medical devices marketed in the U.S. are required to adhere to the QSR requirements (formerly Good Manufacturing Practices), which include testing, control and documentation requirements. Manufacturers must also comply with Medical Device Reporting requirements that a manufacturer report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and would be likely to cause or contribute to a death or serious injury upon recurrence. Medical device labeling and promotional activities are subject to scrutiny by the FDA and, in many circumstances, by the Federal Trade Commission. FDA enforcement policy prohibits the marketing of unapproved devices or marketing approved medical devices for unapproved uses.

We may become subject to routine inspection by the FDA and certain state agencies for compliance with QSR requirements, medical device reporting requirements and other applicable regulations (and state equivalent requirements). The QSR requirements include design controls for which there is a relatively high cost of compliance. We may incur significant costs to comply with laws and regulations in the future and these laws and regulations may have a material adverse effect upon our business, financial condition and results of operation.

Any of our customers using our potential future diagnostic devices for clinical use in the U.S. may be regulated under the Clinical Laboratory Improvement Act of 1988 (“CLIA”). CLIA is intended to ensure the quality and reliability of clinical laboratories in the U.S. by mandating specific standards in the areas of personnel qualification, administration, participation in proficiency testing, patient test management, quality control, quality assurance and inspections. The regulations promulgated under CLIA establish three levels of diagnostic tests (“waived,” “moderately complex” and “highly complex”), and the standards applicable to a clinical laboratory depend on the level of the tests it performs. CLIA requirements may prevent some clinical laboratories from using our diagnostic products. Therefore, CLIA regulations and future administrative interpretations of CLIA may have a material adverse impact on us by limiting the potential market for our products.

There can be no assurance that new legislation will not impose additional costs or lengthen review times for our products.

Additionally, should we develop food pathogen products, they will be subject to the regulations of various domestic and foreign government agencies which regulate food safety and food adulteration, including the U.S. Department of Agriculture.

Manufacturing and raw materials

In July 2000, we executed a ten-year agreement with Hitachi, Ltd., Nissei Sangyo Co. Ltd. and Hitachi Instruments Service Co. Ltd. of Japan to develop, manufacture and distribute products based on the parties’ proprietary technologies. In June 2003, we entered into another manufacturing agreement with Hitachi for the manufacture of our second generation clinical instrument. Hitachi has exclusive manufacturing rights and distribution rights in Japan. We have retained exclusive rights pursuant to each agreement to manufacture the NanoChip^® Cartridges.

Pursuant to the manufacturing agreements each party is obligated to provide the other with certain notice periods if such party determines to curtail or terminate the manufacturing relationship. Nevertheless, while alternative manufacturers of our Workstations and other products exist, a lengthy process would be required to negotiate and begin work under a manufacturing agreement with a new manufacturer which could disrupt our manufacturing process and harm revenues from NanoChip^® product sales.

We manufacture MGB Eclipse Probe Systems, modified bases, fluorescent dyes, quencher, and chemical intermediate products in our facility in Bothell, Washington. We have registered the facility used for manufacturing our diagnostics products with the United States Food and Drug Administration, or FDA, as a Device Manufacturer and we believe we are in compliance with the FDA’s quality system requirements. Additionally, we use contract manufacturers to synthesize component chemical reagents when appropriate.

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We purchase raw materials essential to our business in the ordinary course of business from numerous suppliers. Substantially all the raw materials used for our commercial manufacturing of oligonucleotides, assay systems and other reagent products are available from multiple sources; however, other raw materials for supply contract and OEM manufacturing are proprietary products of other companies. Raw materials may be rejected if they do not meet manufacturing specifications, are contaminated and/or have other failures. A material shortage, contamination, or failure could adversely impact the commercial manufacturing of our products and related revenues.

Quality Systems

We have implemented modern quality systems and concepts throughout the organization. Our regulatory department supervises our quality systems and is responsible for assuring compliance with all applicable regulations, standards and internal policies. Our senior management team is actively involved in setting quality policies and managing internal regulatory and monitoring external quality performance.

Our regulatory, quality and government affairs department has successfully led us through multiple quality and compliance audits by the FDA, foreign governments and customers.

Geographic Area Financial Information

For financial information concerning the geographic areas in which we operate, see Note 14, Geographic Sales and Significant Customers to the consolidated Financial Statements.

Employees

As of December 31, 2004, we had 202 employees of whom 40 hold Ph.D. degrees and 22 hold other advanced degrees. Approximately 78 are involved in research and development, 48 in operations, manufacturing and quality assurance, 44 in sales and marketing, and 32 in finance, legal and other administrative functions. Our success will depend in large part upon our ability to attract and retain employees. We face competition in this regard from other companies, research and academic institutions, government entities and other organizations. None of our employees are covered by a collective bargaining agreement.

Factors That May Affect Results

If our products are not successfully developed or commercialized, we could be forced to curtail or cease operations.

We are at an early stage of development. As of December 31, 2004, we had only a limited product offering that includes our NanoChip^® System (which consists of our NanoChip^® Molecular Biology Workstation and NanoChip^® Cartridge), NanoChip^® Cartridge, various ASRs for detection of gene mutations associated with diseases such as cystic fibrosis, general purpose reagents and accessories to facilitate assay and protocol development and validation on the NanoChip^® Platform and through our acquisition of SynX, point-of-care diagnostic tests for myocardial infarction and drugs of abuse. We announced our second-generation instrument, the NanoChip^® 400, in October 2004. This new instrument is expected to begin shipping in 2005. All of our other platforms and ASRs and other potential products are under development. Our NanoChip^® System, ASRs or our other products may not be successfully developed or commercialized on a timely basis, or at all. If we are unable, for technological or other reasons, to complete the development, introduction or scale-up of manufacturing of our new products, or if our products do not achieve a significant level of market acceptance, we would be forced to curtail or cease operations.

We are also party to transactions known as reagent rentals and cost-per-test agreements. Under these types of transactions, we place a NanoChip^® System at a customer site with no upfront cost to the customer. The value of

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the instrument is typically recaptured through a contracted stream of future reagent sales, sold at a premium to cover the cost of the system. Many of our reagent rentals and cost-per-test agreements entered into as of December 31, 2004 require customer acceptance of our CFTR ASRs as a pre-condition to the customer’s commitment to purchase reagents. Our CFTR ASRs may be utilized by customers to develop and validate tests for the detection of mutations in the CFTR gene associated with cystic fibrosis. These reagent rentals and cost-per-test agreements might have an adverse impact on our short-term instrument sales revenue and cash flow as the revenues and cash received under these agreements are over the life of the contract, as reagents are shipped to the customer. Our success will depend upon our ability to continue to overcome significant technological challenges and successfully introduce our products into the marketplace. A number of applications envisioned by us may require significant enhancements to our basic technology platform. There can be no assurance that we can successfully develop such enhancements.

Lack of market acceptance of our products and technology would harm us.

Although we have developed a number of products as discussed above, we may not be able to further develop these products or to develop other commercially viable products. Even if we develop a product, it may not be accepted in the marketplace. If we are unable to achieve market acceptance, we will not be able to generate sufficient product revenue to become profitable. We may also be forced to carry greater inventories of our products for longer periods than we may have anticipated. If we are unable to sell the inventory of our products in a timely fashion and at anticipated price levels, we may not become profitable. In addition, we may have to take accounting charges and reduce the value of our product inventory to its net realizable value. In the years ended December 31 2004, 2003 and 2002 we took accounting charges of approximately $3.7 million, $908,000 and $1.1 million, respectively, to reduce product inventory to its estimated net realizable value. If actual future demand or market conditions are less favorable than those currently projected by us, additional inventory write-downs may be required. Market acceptance will depend on many factors, including our ability to:

In addition, our technology platform could be harmed by limited funding available for product and technology acquisitions by our customers, internal obstacles to customer approvals of purchases of our products and market conditions in general.

Performance issues with our products may also harm market acceptance of our products and reduce our revenues. During the year ended December 31, 2004, we experienced performance issues with our CFTR ASR which negatively impacted our revenue. Certain of the clinical research laboratories using our CFTR ASR experienced validation rates and repeat rates which were not satisfactory, increasing their costs and labor associated with the tests. We are in the process of making improvements to our CFTR ASR to address these issues. Nonetheless, we may not be able to address these issues to the satisfaction of our clinical laboratory customers and they may decide to adopt alternative products or may not resume purchases of our CFTR ASR.

Commercialization of some of our potential products depends on collaborations with others. If our collaborators are not successful or if we are unable to find collaborators in the future, we may not be able to develop these products.

Our strategy for the research, development and commercialization of some of our products requires us to enter into contractual arrangements with corporate collaborators, joint venture partners, licensors, licensees and others. Our success depends in part upon the performance by these collaboration partners and potential collaboration partners of their responsibilities under these arrangements. Some collaborators may not perform their obligations

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as we expect, and we may not derive any revenue or other benefits from these arrangements. We do not know whether our collaborations will successfully develop and market any products under our respective agreements. Moreover, some of our collaborators are also researching competing technologies targeted by our collaborative programs.

Our NanoChip^® System instruments, including Molecular Biology Workstation and the second-generation NanoChip^® 400, are manufactured by Hitachi. As such our success in the micro-array based diagnostics market is largely dependent upon Hitachi’s ability to perform under our manufacturing agreement. In October 2001, SynX entered into a development and manufacturing agreement with Princeton BioMeditech Corporation (“PBM”) which granted PBM exclusive rights to develop and manufacture certain point-of-care products of SynX, as well as rights to share in the profits of such products. As a result, our success in the point-of-care market is dependent upon PBM’s ability to perform under the agreement.

We may be unsuccessful in entering into other collaborative arrangements to develop and commercialize our products. In addition, disputes may arise over ownership rights to intellectual property, know-how or technologies developed with our collaborators.

We recently announced our second-generation instrument system. The transition to new products subjects us to risks and uncertainties, including increased risks of excess or obsolete inventory and inventory related write-downs.

In October 2004, we announced our second-generation instrument system, the NanoChip^® 400. This new instrument is expected to begin shipping in 2005. Risks inherent in the transition to our second-generation system and other new products we may release in the future include:

If any of these risks occur, our revenues could decline and our financial condition could be harmed.

If our acquisitions are unsuccessful, our business may be harmed.

As part of our business strategy, we have acquired companies, technologies and product lines to complement our internally developed products. We expect that acquisitions will remain a part of our growth strategy going forward. Acquisitions involve numerous risks, including the following:

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Any of these factors could have a negative impact on our business, results of operations or financing position.

Future acquisitions could also result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities and/or amortization expenses related to certain intangible assets and increased operating expenses, which could adversely affect our results of operations and financial condition. In addition, to the extent that the economic benefits associated with any of our acquisitions diminish in the future, we may be required to record additional write downs of goodwill, intangible assets or other assets associated with such acquisitions, which would adversely affect our operating results.

We may not realize the benefits that we anticipate from our recent acquisitions of Epoch Biosciences, Inc. and SynX Pharma Inc. due to integration and other challenges.

We completed two significant acquisitions in 2004: the acquisition of SynX Pharma Inc. in April 2004 and Epoch Biosciences, Inc. in December 2004. We expect that the SynX product line will accelerate our entry into the point-of-care market and we expect that the acquisition of Epoch will have an immediate effect on our revenues during 2005. However, we cannot be certain that we will achieve these and other benefits which we currently expect from these acquisitions. The process of integrating these acquired companies requires significant efforts and expenditures, including the coordination of information technologies, research and development, sales and marketing, administration and manufacturing. Combining our product offerings is a complex and lengthy process involving a number of steps in which we will seek to achieve increasing degrees of integration of our products. Additionally, SynX is located in Canada and Epoch is located in Washington, and because our facilities are physically separated, it may be difficult for us to communicate effectively with, manage and integrate these employees and operations with the rest of the Company. If we are not able to integrate the operations of these acquired companies and businesses successfully, we may not be able to meet our expectations of future results of operations.

Factors that will affect the success of these acquisitions and any future acquisitions include:

Even if we are able to successfully integrate our acquired operations, we may never realize the anticipated benefits of the SynX and Epoch acquisitions, or any other acquisition. Our failure to achieve these benefits and synergies could have a material adverse effect on our business, results of operations and financial condition.

We have a history of net losses. We expect to continue to incur net losses and we may not achieve or maintain profitability.

Since our inception, we have incurred cumulative net losses which, as of December 31, 2004, total approximately $215.2 million. Moreover, our negative cash flow and losses from operations will continue for the foreseeable future. We may never generate sufficient product revenue to become profitable. We also expect to have quarter-to-quarter fluctuations in revenues, expenses and losses, which fluctuations could be significant. The amount and timing of product revenue recognition and cash flow may depend on whether potential customers for the NanoChip^® System choose to enter into sales, reagent rentals, cost-per-test or development site transactions. We believe our future operating results may be subject to quarterly fluctuations due to a variety of factors, including, but not limited to, market acceptance of the second generation NanoChip^® 400 System, acquisitions, and potential other products under development, including the CHF product and diagnostics related to infectious disease, the type of acquisition program our potential customers may choose, whether and when

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new products are successfully developed and introduced by us or our competitors, and the achievement of milestones under our collaborative agreements with Hitachi and various government agencies. The recognition of revenue under contracts, grants and sponsored research agreements will be subject to significant fluctuations in both timing and amount and therefore our results of operations for any period may not be comparable to the results of operations for any other period.

To develop and sell our products successfully, we may need to increase our spending levels in research and development, as well as in selling, marketing and administration. We may have to incur these increased spending levels before knowing whether our products can be sold successfully.

Changes in financial accounting standards related to stock option expenses are expected to have a significant effect on our reported results.

The FASB recently issued a revised standard that requires that we record compensation expense in the statement of operations for employee stock options using the fair value method. The adoption of the new standard is expected to have a significant effect on our reported earnings, although it will not affect our cash flows, and could adversely impact our ability to provide accurate guidance on our future reported financial results due to the variability of the factors used to establish the value of stock options. As a result, the adoption of the new standard in the third quarter of fiscal 2005 could negatively affect our stock price and our stock price volatility.

We will need additional capital in the future. If additional capital is not available, we may have to curtail or cease operations.

We will need to raise more money to continue the research and development necessary to further develop our current products to bring our products to market and to further our manufacturing and marketing capabilities. We may seek additional funds through public and private stock offerings, arrangements with corporate partners, borrowings under lease lines of credit or other sources. If we can not raise more money, we will have to reduce our capital expenditures, scale back our development of new products, reduce our workforce and seek to license to others products or technologies that we otherwise would seek to commercialize ourselves. The amount of money we will need will depend on many factors, including among others:

Additional capital may not be available on terms acceptable to us, or at all. Any additional equity financing would likely be dilutive to stockholders, and debt financing, if available, may include restrictive covenants and require significant collateral.

Competing technologies may adversely affect us.

We expect to encounter intense competition from a number of companies that offer products in our targeted application areas. We anticipate that our competitors in these areas will include:

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If we are successful in developing products in these areas, we will face competition from established companies and numerous development-stage companies that continually enter these markets. In many instances, our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than us. Moreover, these competitors may offer broader product lines and have greater name recognition than us and may offer discounts as a competitive tactic.

In addition, several development-stage companies are currently making or developing products that compete with or will compete with our potential products. Our competitors may succeed in developing, obtaining approval from the U.S. Food and Drug Administration (“FDA”) or marketing technologies or products that are more effective or commercially attractive than our current or potential products or that render our technologies and current or potential products obsolete.

As these companies develop their technologies, they may develop proprietary positions that may prevent us from successfully commercializing products.

Also, we may not have the financial resources, technical expertise or marketing, distribution or support capabilities to compete successfully in the future.

The uncertainty of patent and proprietary technology protection may adversely affect us.

Our success will depend in part on obtaining and maintaining meaningful patent protection on our inventions, technologies and discoveries. Our ability to compete effectively will depend on our ability to develop and maintain proprietary aspects of our technology, and to operate without infringing the proprietary rights of others, or to obtain rights to third-party proprietary rights, if necessary. Our pending patent applications may not result in the issuance of patents. Our patent applications may not have priority over others’ applications, and even if issued, our patents may not offer protection against competitors with similar technologies. Any patents issued to us may be challenged, invalidated or circumvented, and the rights created thereunder may not afford us a competitive advantage.

We also rely upon trade secrets, technical know-how and continuing inventions to develop and maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose our technology and we may not be able to meaningfully protect our trade secrets, or be capable of protecting our rights to our trade secrets. We seek to protect our technology and patents, in part, by confidentiality agreements with our employees and contractors. Our employees may breach their existing Proprietary Information, Inventions, and Dispute Resolution Agreements and these agreements may not protect our intellectual property. This could have a material adverse effect on us.

Our products could infringe on the intellectual property rights of others, which may subject us to future litigation and cause us to be unable to license technology from third parties.

Our commercial success also depends in part on us neither infringing valid, enforceable patents or proprietary rights of third parties, nor breaching any licenses that may relate to our technologies and products. We are aware of other third-party patents that may relate to our technology. It is possible that we may unintentionally infringe these patents or other patents or proprietary rights of third parties. We may in the future receive notices claiming infringement from third parties as well as invitations to take licenses under third-party patents. Any legal action

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against us or our collaborative partners claiming damages and seeking to enjoin commercial activities relating to our products and processes affected by third-party rights may require us or our collaborative partners to obtain licenses in order to continue to manufacture or market the affected products and processes. In addition, these actions may subject us to potential liability for damages. We or our collaborative partners may not prevail in an action and any license required under a patent may not be made available on commercially acceptable terms, or at all.

There are many U.S. and foreign patents and patent applications held by third parties in our areas of interest, and we believe that there may be significant other litigation in the industry regarding patent and other intellectual property rights. Additional litigation could result in substantial costs and the diversion of management’s efforts regardless of the result of the litigation. Additionally, the defense and prosecution of interference proceedings before the U.S. Patent and Trademark Office, or (“USPTO”), and related administrative proceedings would result in substantial expense to us and significant diversion of effort by our technical and management personnel. One such interference has recently been declared between U.S., Patent 6,461,828 owned by our Canadian subsidiary, SynX, and a patent application owned by Biosite Incorporated (“Biosite”). The count of the interference is directed to a method for predicting cardiac mortality in a patient using pairs of biological markers. Among the markers within the scope of the count are pro-BNP and troponin I, markers which are the basis of a product being developed by SynX for the prognosis of congestive heart failure. Even though Biosite is the senior party in the interference because of its earlier filing date, we believe that we will be able to prove an earlier date of invention and thus prevail in the interference. However, if Biosite prevails it may obtain a patent having claims corresponding exactly or closely to the count of the interference. If that were to occur, we would be precluded from marketing in the United States a product for predicting cardiac mortality using the markers within the scope of any claim obtained by Biosite. We may in the future become subject to other USPTO interference proceedings to determine the priority of inventions. In addition, laws of some foreign countries do not protect intellectual property to the same extent as do laws in the U.S., which may subject us to additional difficulties in protecting our intellectual property in those countries.

We are aware of U.S. and European patents and patent applications owned by Oxford Gene Technologies (“Oxford Gene”). We have opposed one allowed European patent that had broad claims to array technology for analyzing a predetermined polynucleotide sequence. Oxford Gene’s position with respect to the opposed patent is that the claims relate to what it terms the “diagnostic mode.” Those claims have now been narrowed before the Opposition Division of the European Patent Office to the point that, if these claims remain final before the European Patent Office, we believe they would not be infringed by our technology. In the oral proceedings before the Opposition Division on November 13, 14, and 15, 2001, the Division determined that the claims’ language must be limited to arrays with “smooth, impermeable” surfaces. The case is currently on appeal. If the decision of the Opposition Division is successfully appealed by Oxford Gene and the original claims are reinstated, or if an application relating to arrays is issued in another country with claims as broad as the original European patent, we could be subject to infringement accusations that could delay or preclude sales of some or all of our anticipated diagnostic products.

We may continue to be involved in intellectual property litigation that may be costly, time-consuming and may impact our competitive position.

In December 2002, Oxford Gene filed a complaint against us in the United States District Court for the District of Delaware claiming that we infringe U.S. Patent No. 6,054,270 entitled “Analytical Polynucleotide Sequences.” In April 2003, we filed an answer to the complaint that denied that we infringe this patent. In October 2003, we entered into a settlement agreement with Oxford Gene pursuant to which the lawsuit was dismissed by Oxford Gene without prejudice. If the litigation were to be reinitiated, significant attorneys’ costs and fees could result. Although it is our position that Oxford Gene’s assertions of infringement have no merit, neither the outcome of any further litigation nor the amount and range of potential fees can be assessed. No assurances can be given that we would prevail in any future lawsuits or that we could successfully defend ourselves against any future claims.

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The regulatory approval process is expensive, time consuming, uncertain and may prevent us from obtaining or maintaining required approvals for the commercialization of our products.

The manufacturing, labeling, distribution and marketing of any diagnostic products we may develop will be subject to regulation in the U.S. and other countries. These regulations could subject us to several problems such as:

In the U.S., the FDA, regulates as medical devices most test systems, kits and reagents that are marketed for human in vitro diagnostic use. Pursuant to the Federal Food, Drug, and Cosmetic Act, the FDA regulates the preclinical and clinical testing, design, safety, effectiveness, manufacture, labeling, distribution and promotion of medical devices. We will not be able to commence marketing or commercial sales in the U.S. of these products until we receive an exemption, clearance or approval from the FDA, which can be a lengthy, expensive and uncertain process. We have not applied for FDA or other regulatory approvals with respect to any of our current products or products under development. We may experience difficulties that could delay or prevent the successful development, introduction and marketing of proposed products. Regulatory clearance or approval of any proposed products may not be granted by the FDA or foreign regulatory authorities on a timely basis, if at all. Noncompliance with applicable FDA requirements can result in:

The FDA also has the authority to request the recall, repair, replacement or refund of the cost of any regulated device that may eventually be manufactured or distributed by us. Any devices manufactured or distributed by us pursuant to FDA clearance or approvals are subject to thorough and continuing regulation by the FDA and certain state agencies, including the California Department of Health Services.

Our dependence on suppliers for materials could impair our ability to manufacture our products.

Outside vendors provide key components and raw materials used by us, Hitachi and PBM in the manufacture of our products. Although we believe that alternative sources for these components and raw materials are available, any supply interruption in a limited or sole source component or raw material would harm our and Hitachi’s ability to manufacture our products until a new source of supply is identified and qualified, including qualification under applicable FDA regulations. In addition, an uncorrected defect or supplier’s variation in a component or raw material, either unknown to us, Hitachi or PBM or incompatible with our, Hitachi or PBM’s manufacturing processes, could harm our, Hitachi or PBM’s ability to manufacture our products. We, Hitachi or PBM may not be able to find a sufficient alternative supplier in a reasonable time period, or on commercially reasonable terms, if at all. If we, Hitachi or PBM fail to obtain a supplier for the manufacture of components of our products, we may be forced to curtail or cease operations.

If we are unable to manufacture products on a commercial scale, our business may suffer.

Hitachi manufactures our NanoChip^® System, including the second-generation NanoChip^® 400, we manufacture our NanoChip^® Cartridges, our ASRs and most of our other products, and PBM manufactures our

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point-of-care products. We, Hitachi and PBM rely on subcontractors to manufacture the limited quantities of microchips and other components we require for use by and sale to our customers, as well as for internal and collaborative purposes. Manufacturing, supply and quality control problems may arise as we, Hitachi or PBM either alone, together or with subcontractors, attempt to further scale up manufacturing procedures or to manufacture new products. We, Hitachi or PBM may not be able to scale-up in a timely manner or at a commercially reasonable cost. Problems could lead to delays or pose a threat to the ultimate commercialization of our products and cause us to fail.

We, Hitachi or PBM or any of our contract manufacturers could encounter manufacturing difficulties, including those relating to:

Our manufacturing facilities and those of Hitachi and PBM and any other of our contract manufacturers are or will be subject to periodic regulatory inspections by the FDA and other federal, state and international regulatory agencies and these facilities are or may become subject to Quality System Regulation, or QSR, requirements of the FDA. If we, Hitachi, PBM or our third-party manufacturers, fail to maintain facilities in accordance with QSR regulations, other international quality standards or other regulatory requirements, then the manufacture process could be suspended or terminated which would harm us.

Lead times for obtaining materials and components for our products and the manufacturing and introduction of our products may vary significantly which could lead to excess inventory levels as well as shortages of critical components and products if our supply and demand forecasts are inaccurate.

We anticipate that our products, including our ASRs and most of our other products will be manufactured and introduced by us and third parties, if any, based on forecasted demand and that we will seek to purchase components and materials in anticipation of the actual receipt of purchase orders from our customers. Lead times for materials and components to be included in our products vary significantly and may depend on factors such as the business practices of each specific supplier and the terms of the particular contracts, as well as the overall market demand for such materials and components at any given time. Also, we often rely on our own and third party forecasted demand for various products and the accuracy of such forecasts may depend on a number of factors, including but not limited to, government reports and recommendations for certain genetic testing, regulatory burdens, competitive products, the nature and effectiveness of our products, the timing and extent of the introduction of our products into the marketplace and other factors. If the forecasts are inaccurate, we could experience fluctuations in excess inventory of our products, or shortages of critical components or products, either of which could cause our business to suffer.

We currently rely on one manufacturer of our Workstation and for certain future generations of the Workstation and other hardware products, one manufacturer for our point-of-care products, and only we manufacture our NanoChip^® Cartridges, and our ASRs and most of our other products, which may delay the manufacture and shipment of our products to customers.

We have signed an exclusive manufacturing agreement with Hitachi to manufacture our second generation NanoChip^® 400 workstations and other hardware products to be developed. We have retained exclusive rights pursuant to each agreement to manufacture the NanoChip^® Cartridges. Pursuant to the manufacturing agreements and the collaboration agreement, each party is obligated to provide the other with certain notice periods if such party determines to curtail or terminate the manufacturing relationship. Nevertheless, while alternative manufacturers of our Workstation and other products currently exist, a lengthy process would be required to negotiate and begin work under a manufacturing agreement with a new manufacturer which could disrupt our manufacturing process and harm our business.

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The number of our sales and marketing employees may not result in corresponding numbers of sales or placements of the NanoChip^® System, the sale of ASRs, point-of-care diagnostic products or other products

As of December 31, 2004, we had 44 total employees in our worldwide sales and marketing group.

Developing, training and monitoring this sales and marketing force has required and will further require capital and time expenditures by us and certain of our employees. The size of our sales and marketing force may not result in corresponding numbers of sales or placements of the NanoChip^® System nor increased product revenues associated with such sales or placements or our ASRs, point-of-care diagnostic products or other products. We may be required to increase or decrease the size of the sales and marketing force as deemed necessary and such increases or decreases in staff will require additional capital and time expenditures by us and our employees.

Failure to expand our international sales as we intend would reduce our ability to become profitable.

We expect that a portion of our sales will be made outside the United States. A successful international effort will require us to develop relationships with international customers and partners. We may not be able to identify, attract or retain suitable international customers and distribution partners. As a result, we may be unsuccessful in our international expansion efforts. Furthermore, expansion into international markets will require us to continue to establish and expand foreign sales and marketing efforts, hire additional sales and marketing personnel and maintain good relations with our foreign customers and distribution partners.

International operations involve a number of risks not typically present in domestic operations, including:

Our international sales and marketing efforts will also be subject to the risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether tariffs or restrictions upon the importation or exportation of our products will be implemented by the United States or other countries.

We may lose money when we exchange foreign currency received from international sales into U.S. dollars. A portion of our business is expected to be conducted in currencies other than the U.S. dollar. We recognize foreign currency gains or losses arising from our operations in the period incurred. As a result, currency fluctuations between the U.S. dollar and the currencies in which we do business will cause foreign currency transaction gains and losses. We cannot predict the effects of exchange rate fluctuations upon our future operating results because of the number of currencies involved, the variability of currency exposure and the potential volatility of currency exchange rates. We currently do not engage in foreign exchange hedging transactions to manage our foreign currency exposure.

We may have significant product liability exposure.

We face an inherent business risk of exposure to product liability and other claims in the event that our technologies or products are alleged to have caused harm. These risks are inherent in the testing, manufacturing

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and marketing of our products. Any product liability claim brought against us could be expensive to defend and could result in a diversion of management’s attention from our core business. A successful product liability claim or series of claims could have an adverse effect on our business, financial condition and results of operations.

If we lose our key personnel or are unable to attract and retain additional personnel, we may not be able to pursue collaborations or develop our own products.

We are highly dependent on the principal members of our scientific, manufacturing, marketing, administrative, management and executive personnel, the loss of whose services might significantly delay or prevent the achievement of our objectives. We face competition from other companies, academic institutions, government entities and other organizations in attracting and retaining personnel. For the years ended December 31, 2004, 2003 and 2002 we experienced turnover rates of 27%, 25% and 29%, respectively. Turnover at these rates may, and if they continue, will adversely affect us.

The turnover rates above exclude the impact of reductions in workforce. In April 2003, we reduced our workforce by approximately 20% and incurred a severance charge of approximately $500,000 in the second quarter of 2003. Also, in October 2002, we reduced our workforce by approximately 10% and incurred severance charges of approximately $290,000 during the fourth quarter of 2002. Continued layoffs could have an adverse effect on us.

Health care reform and restrictions on reimbursement may limit our returns on potential products.

Our ability to earn sufficient returns on our products will depend in part on the extent to which reimbursement for our products and related treatments will be available from:

If appropriate reimbursement cannot be obtained, we could be prevented from successfully commercializing our potential products.

There are efforts by governmental and third party payors to contain or reduce the costs of health care through various means. We expect that there will continue to be a number of legislative proposals to implement government controls. The announcement of proposals or reforms could impair our ability to raise capital. The adoption of proposals or reforms could impair our business.

Additionally, third party payors are increasingly challenging the price of medical products and services. If purchasers or users of our products are not able to obtain adequate reimbursement for the cost of using our products, they may forego or reduce their use. Significant uncertainty exists as to the reimbursement status of newly approved health care products, and whether adequate third party coverage will be available.

If ethical and other concerns surrounding the use of genetic information become widespread, we may have less demand for our products.

Genetic testing has raised ethical issues regarding confidentiality and the appropriate uses of the resulting information. For these reasons, governmental authorities may call for limits on or regulation of the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Any of these scenarios could reduce the potential markets for our products, which could seriously harm our business, financial condition and results of operations.

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We use hazardous materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our research and development processes involve the controlled storage, use and disposal of hazardous materials including, but not limited to, biological hazardous materials and radioactive compounds. We are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be completely eliminated. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, or at all. We could be required to incur significant costs to comply with current or future environmental laws and regulations.

Our stock price could continue to be highly volatile and our stockholders may not be able to resell their shares at or above the price they paid for them.

The market price of our common stock, like that of many other life sciences companies, has been highly volatile and is likely to continue to be highly volatile. The following factors, among others, could have a significant impact on the market price of our common stock:

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Investor confidence and share value may be adversely impacted if our independent auditors are unable to provide us with the attestation of the adequacy of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act of 2002.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report of management on our internal controls over financial reporting in our annual reports on Form 10-K that contains an assessment by management of the effectiveness of our internal controls over financial reporting. In addition, our independent auditors must attest to and report on management’s assessment of the effectiveness of our internal controls over financial reporting. This requirement first applies to this Annual Report on Form 10-K. How companies are implementing these new requirements including internal control reforms, if any, to comply with Section 404’s requirements, and how independent auditors are applying these new requirements and testing companies’ internal controls, remain subject to uncertainty. The requirements of Section 404 of the Sarbanes-Oxley Act of 2002 are ongoing and also apply to future years. We expect that our internal controls will continue to evolve as our business activities change. Although we will continue to diligently and vigorously review our internal controls over financial reporting in order to ensure compliance with the Section 404 requirements, any control system, regardless of how well designed, operated and evaluated, can provide only reasonable, not absolute, assurance that its objectives will be met. If, during any year, our independent auditors are not satisfied with our internal controls over financial reporting or the level at which these controls are documented, designed, operated, tested or assessed, or if the independent auditors interpret the requirements, rules or regulations differently than we do, then they may decline to attest to management’s assessment or may issue a report that is qualified. This could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact the market price of our shares.

Our anti-takeover provisions could discourage potential takeover attempts and make attempts by stockholders to change management more difficult.

The approval of two-thirds of our voting stock is required to approve some transactions and to take some stockholder actions, including the calling of a special meeting of stockholders and the amendment of any of the anti-takeover provisions contained in our certificate of incorporation.

Further, pursuant to the terms of our stockholder rights plan adopted in November 1998, as amended, we have distributed a dividend of one right for each outstanding share of common stock. These rights will cause substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved in advance by our board of directors and may have the effect of deterring unsolicited takeover attempts.

Our business is subject to changing regulation of corporate governance and public disclosure that has increased both our costs and the risk of noncompliance.

Because our common stock is publicly traded, we are subject to certain rules and regulations of federal, state and financial market exchange entities charged with the protection of investors and the oversight of companies whose securities are publicly traded. These entities, including the Public Company Accounting Oversight Board, the SEC and Nasdaq, have recently issued new requirements and regulations and continue to develop additional regulations and requirements in response to recent laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002 (“SOX”). Our efforts to comply with these new regulations have resulted in, and are likely to

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continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities.

Moreover, because these laws, regulations and standards are subject to varying interpretations, their application in practice may evolve over time as new guidance becomes available. This evolution may result in continuing uncertainty regarding compliance matters and additional costs necessitated by ongoing revisions to our disclosure and governance practices.

We will be dependent upon our agreement with Applied Biosystems for a significant portion of our revenues for 2005 and future periods, and a reduction of sales under or early termination of this agreement would seriously harm our revenues and operating results and would likely cause our stock price to decline

In January 1999, Epoch and Applied Biosystems entered into a License and Supply Agreement pursuant to which we licensed some of our technology to Applied Biosystems for use in its TaqMan^® 5’- nuclease real-time PCR assays, (TaqMan^® is a registered trademark of Roche Molecular Systems, Inc.). In July 1999, Epoch licensed its proprietary software, which speeds the design of oligonucleotide probes used in the study of genes, to Applied Biosystems. In August 2000, the agreement was amended to, among other things, provide for Epoch manufacturing product for Applied Biosystems. In July 2002 this agreement was further amended to remove the manufacturing rights from the contract effective October 2002, redefine product categories, increase the minimum royalties and royalty rates, and establish that minimum royalties are measured and paid quarterly. We will depend upon product sales and royalties from Applied Biosystems’ sales of its TaqMan^® assays under this agreement for a significant portion of our revenues in 2005 and future periods.

The technology licenses and Applied Biosystem’s obligation to pay us royalties on their sale of products that incorporate Epoch’s technologies continue until the expiration of the underlying patents. Since the July 2002 amendment that increased the minimum royalty levels, quarterly royalties earned based on actual sales by Applied Biosystems have been less than the contractual minimum royalty levels. As a result, the royalty payments have been in the amount of the specified quarterly minimum level. The current agreement calls for quarterly royalty minimums through the third quarter 2005. Thereafter, we will receive royalty payments based on actual sales.

Either party may terminate the agreement upon 180 days written notice. In the event that this agreement is terminated, our revenues, financial condition and operating results would be adversely affected and our stock price would likely decline.

Item 2. Properties

At December 31, 2004, we occupied the indicated square footage in the leased facilities described below:

Our leases expire at varying dates through 2012 not including renewals at our option. We believe that our facilities will be suitable and adequate for the present purposes, and that the productive capacity in the San

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Diego, Bothell and Helmond facilities is substantially being utilized. We have excess capacity in our Toronto facility, and have therefore sublet a portion of the facility to help offset the facility cost. In the future, we may need to purchase, build or lease additional facilities to meet the requirements projected in our long-term business plan.

Item 3. Legal Proceedings

In December 2002, Oxford Gene Technologies (“OGT”) filed a complaint against us in the United States District Court for the District of Delaware claiming that we infringe U.S. Patent No. 6,054,270 entitled “Analytical Polynucleotide Sequences.” In April 2003, we filed an answer to the complaint that denied that we infringe this patent. In October 2003, we entered into a settlement agreement with OGT pursuant to which the lawsuit was dismissed by OGT without prejudice. If the litigation were to be reinitiated, significant attorneys’ costs and fees could result. Although it is our position that Oxford Gene’s assertions of infringement have no merit, neither the outcome of any further litigation nor the amount and range of potential fees can be assessed. No assurances can be given that we would prevail in any future lawsuits or that we could successfully defend ourselves against any future claims.

Item 4. Submission of Matters to a vote of Security Holders

Our stockholders voted on the following matters at the Special Meeting of Stockholders on December 15, 2004 (which was postponed from an original date of December 8, 2004):

PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock trades on the Nasdaq National Market under the symbol “NGEN.” The following table sets forth the range of high and low sales prices as reported for our common stock by Nasdaq for the periods indicated:

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As of March 1, 2005 there were approximately 324 stockholders of record of our common stock. We have not paid any cash dividends to date and do not anticipate any being paid in the foreseeable future.

Item 6. Selected Financial Data

The selected financial data set forth below with respect to our consolidated financial statements has been derived from the audited financial statements. The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes thereto appearing elsewhere herein:

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 which provides a “safe harbor” for these types of statements. To the extent statements in this report involve, without limitation, our expectations for growth, estimates of future revenue, expenses, profit, cash flow, balance sheet items or any other guidance on future periods, these statements are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve known and unknown risks, uncertainties and assumptions that may cause actual results, levels of activity, performance or achievements to differ materially from any results, level of activity, performance or achievements expressed or implied by any forward-looking statement. These risks and uncertainties include those included herein under the caption “Factors That May Affect Results” in “Item 1. Business.” We assume no obligation to update any forward-looking statements. The audited financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto for the years ended December 31, 2004, 2003 and 2002 in this Annual Report on Form 10-K.

Overview

Nanogen, Inc. is headquartered in San Diego, California and was founded on the vision of providing higher quality of healthcare by introducing advanced diagnostic medical products that will improve the quality of information in a shorter period of time to our customers in the research, clinical laboratory or point-of-care markets. We intend to turn this vision into reality by continuing to develop new diagnostic products or by acquiring other companies and complementary products that will expand and accelerate our entry into rapidly growing diagnostic markets. We expanded both our product lines and addressable markets during the past year with the acquisition of SynX Pharma in April 2004 and the acquisition of Epoch Biosciences in December 2004. These combinations will accelerate our entry into the point-of-care market and deepen our penetration of the research and clinical laboratory markets, respectively. The combination of internally developed products plus acquired products addressing large markets should provide the stimulus for significant revenue acceleration in 2005 and beyond.

We have historically generated revenues through contract research, grants and licenses and through commercializing molecular diagnostic research tools, such as the Molecular Biology Workstation and related Analyte Specific Reagents (ASRs) for the genetic and clinical research market. In November 2004 we introduced our second generation molecular diagnostic instrument, the NanoChip 400. This platform is expected to ship in 2005 and is designed to serve the clinical laboratory market by offering faster throughput and simpler operating procedures. The new system offers a 400-site cartridge utilizing Nanogen’s unique and patented micro-array technology that will allow customers the flexibility to adjust panels from single-to-multiple arrays to fit their requirements. Since commencing operations in 1993, we have applied substantially all of our resources to our research and development programs on the technology associated with our NanoChip^® System. With the acquisition of SynX, in 2004, we began investing in research and development related to future point-of-care products. We have incurred losses since inception and, as of December 31, 2004, had an accumulated deficit of $215.2 million.

We have focused on the advanced diagnostics market by commercializing products that enhance, bring cost saving and value to our laboratory testing customers. In 2004, we generated $5.4 million in revenues with a net loss of $38.9 million. Of this revenue approximately $2.3 million was associated with product sales that consist of the sale and rental of our NanoChip^® systems and associated consumables to the worldwide molecular diagnostic research market. We sell our products to our customers FOB shipping, and in the case of the NanoChip^® system we offer our products under various commercial arrangements, some of which transfer title of the instrument to the customer and some of which do not transfer title to the customer. An additional $353,000 of product sale revenue was generated from our recent acquisitions, which resulted in sales of various molecular chemistries, reagent products and point-of-care diagnostic tests. The remainder of our revenue was through

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various contractual research agreements such as license fees of our patented technologies, sponsored research through our Hitachi development agreement (terminated in 2004) and contracts and grants revenue with governmental or commercial organizations. Revenues for the years ended December 31, 2004 and 2003 were as follows (dollars in thousands):

Product sales: Developments

We have focused on creating product sales revenue through internally developed products as well as through acquisitions. We initially entered the molecular diagnostics market by selling our first generation NanoChip^® System, the Molecular Biology Workstation, into the research market with a goal of becoming the industry’s preferred platform for molecular testing. We recognized prior to launching our first generation NanoChip^® System in 2000, that sales to the research market alone would not produce sufficient revenue to support our goals. As a result, we have been working to enhance the initial product to enter the clinical laboratory market, and ultimately expect to address the point-of-care market with a micro-array product in the future. During 2003 we launched seven ASRs, that can be used by clinical laboratories to assist them in developing diagnostic tests that can be run on our system. Additionally, in 2005 we expect to launch a second generation system, the NanoChip 400, that should help broaden our reach into the clinical market place. This new system is smaller, is expected to be easier to operate by laboratory personnel and its level of automation does not required continuous monitoring by a technician during production testing. We also plan to expand our ASR products for the NanoChip 400 during 2005.

Through the acquisition of Epoch, we also provide real-time ASR products to clincial laboratories for simpler, lower cost tests than those addressed by our NanoChip^® System, thus expanding the product portfolio available to our customers. We also believe that Epoch will provide additional revenue through providing custom products and services to research customers.

Finally, we have been working on products that will allow us to begin addressing point-of-care customer needs. Specifically, through the acquisition of SynX, we obtained the Nexus D_x^™ Myocardial Infarction (heart failure) product line and are preparing to launch our StatusFirst^™ product for congestive heart failure in 2005.

We also believe that Epoch will provide us additional revenue through the chemistry, design, and synthesis of DNA probes and optimization of real-time PCR assays for our molecular diagnostic customers. In addition to the acquisitions we believe we will generate additional revenue when we launch our second generation of the NanoChip^® System in mid-2005 that is targeted at both the research and diagnostic markets with such products as our infectious disease diagnostics systems.

License fee and royalty income: Developments

While we currently own 111 issued U.S. patents we have strategically limited the licensing of much of this technology to protect our intellectual property position in all areas of our business including the NanoChip^® System, real-time products and point-of-care markers. We are now evaluating our intellectual property position in light of our recent acquisitions. We may choose to license our technology in the future, if we believe the terms and conditions are acceptable given our investment into the research and development and its

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relationship to our future product pipeline. In addition, with our acquisition of Epoch we obtained a royalty agreement with Applied Biosystems, Inc. with contractual minimum royalties through the third quarter of 2005 and thereafter we will receive royalty payments based on actual sales.

Sponsored research: Developments

In July 2000 we executed a ten-year agreement with Hitachi, Ltd., Nissei Sangyo Co. Ltd. and Hitachi Instruments Service Co. Ltd. of Japan (collectively, “Hitachi”) to develop, manufacture and distribute potential products based on the parties’ proprietary technologies. The agreement provides that we work together to jointly determine which projects to prioritize over the term of the agreement. Both Hitachi and we may contribute cash toward our research and development over a ten-year period. At a minimum, we were required to match the Hitachi contribution to our research and development on an annual basis. In addition, we are required to repay to Hitachi 50% of their contributions to research and development over an indefinite period of time. The repayment amount is determined as a percentage of our gross NanoChip^® Cartridge sales until the liability is paid in full.

In August 2003, we received written notice from Hitachi to exercise its right to terminate the collaborative research agreement in accordance with the terms of the agreement. Hitachi’s exercise of its right to terminate this agreement did not accelerate the repayment due Hitachi. From inception of the collaboration agreement with Hitachi through December 31, 2004, we have received a total of $9.8 million in sponsored research funding. Half of this funding has been recorded as revenue or deferred revenue, and the remaining half has been recorded as a long-term liability. We recognized the last $500,000 in revenue from Hitachi in 2004 and do not expect any revenue from this agreement in the future.

Contracts and grants: Developments

We fund some of our research and development efforts through contracts and grants awarded by various federal and state agencies. Revenue is recognized under these contracts and grants as expenses are incurred. We do not believe these grants will be our primary source of on-going revenue but provide us additional revenue while offsetting our research and development costs. We will continue to seek new contracts and grants that are aligned with our internal research and development goals. In 2004, we entered into no new contract and grants; however, we continued to receive revenue from the following on-going grants.

U.S. Army Medical Research Acquisition Activity

In October 2000, we entered into a cooperative agreement with the U.S. Army Medical Research Acquisition Activity (“USAMRAA”) in an amount totaling approximately $1.1 million over a three-year period. The objective of the USAMRAA agreement is to develop an arrayable electronic system for the identification of biological warfare or infectious disease agents. In October 2001, we entered into an additional cooperative agreement with USAMRAA in the amount totaling $1.5 million over a three-year period. The second cooperative agreement is to develop miniaturized electronic devices for isolation and detection of biological warfare and infectious disease agents. In conjunction with the agreements, funding provided by the agency is matched dollar-for-dollar with our funds. We recognized revenue under these agreements of $466,000, $1,093,000, and $688,000 for the years ended December 31, 2004, 2003, and 2002, respectively. These agreements were completed in this year and do not expect any additional funding.

The National Institute of Justice

In April 1997, we entered into an agreement with The National Institute of Justice, U.S. Department of Justice, which provides funding for the development of a chip based genetic detector for rapid DNA-based identification of individuals in an amount totaling approximately $4.4 million over a 9-year period. We recognized revenue under this agreement of $747,000, $979,000, and $232,000, for the years ended December 31, 2004, 2003, and 2002, respectively.

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National Institutes of Health (NIH)

The National Institute of Allergy and Infectious Diseases for the National Institutes of Health (NIH), provides funding for several grants. In July 2002, we were awarded a grant which focused on the development of a compact centrifugal micro fluidics based biological warfare agent (BWA) analyzer. In May and September of 2003, we were awarded a second and third grant. The second grant is for the development of a dieletrophorectic (DEP) separator for cell/pathogen separation. The third grant is aimed at developing an on-chip real-time DNA amplification for BWA detection. The awards under these grants totaled approximately $1.0 million over a 4-year period. We recognized revenue under these agreements of $415,000, $188,000 and $25,000 for the years ended December 31, 2004, 2003 and 2002, respectively.

Acquisitions: Developments

We actively and selectively seek to acquire companies with complementary products and strong intellectual property positions to allow us to penetrate emerging markets. We anticipate using our common stock as the primary currency to purchase future companies or product lines. In 2004, we acquired in all stock transactions, SynX and Epoch to obtain new product lines for the point-of-care and advanced diagnostic markets, respectively. We believe that these acquisitions are important to our long-term strategy and are an example of our ongoing efforts to build a stronger company with products to serve the advanced diagnostic marketplace.

Acquisition of SynX Pharma Inc.

On April 21, 2004, we acquired all the outstanding common stock of SynX Pharma Inc. (“SynX”) in an all-stock transaction by way of a court-approved plan of arrangement. Based in Toronto, Canada, SynX leverages proteomic and biomarker research to develop a line of point-of-care diagnostic tests. As a result of this acquisition, we have entered the point-of-care diagnostic market. We believe that the future markets for advanced diagnostics will include research and clinical reference labs as well as the point-of-care market.

Acquisition of Epoch Biosciences, Inc.

On December 16, 2004, we acquired all the outstanding common stock of Epoch Biosciences, Inc. (“Epoch”). Based in Bothell, Washington, Epoch develops and sells proprietary products with commercial applications in the genomics and molecular diagnostics fields. As a result of the acquisition, we expect to broaden our product offerings to research institutions and clinical reference labs and further leverage our existing sales, marketing infrastructure and expand our customer reach.

Sale of Common Stock: Developments

In March 2004, we sold 4.25 million shares of our common stock to institutional investors at a price of $7.94 per share, for gross proceeds of approximately $33.7 million. In April 2004, we sold an additional 900,000 shares to institutional investors at a price of $8.60 per share for gross proceeds of approximately $7.7 million. After deducting fees and expenses, we received approximately $39.4 million from the sales. We believe that it is beneficial to maintain a significant amount of cash and short-term investments on hand to ensure we have adequate resources to fund future research and development, to create and expand sales distribution channels, to support future acquisitions, to provide working capital and assuage legal risks and challenges to our business model.

Critical Accounting Policies and Estimates

Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and

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judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, valuation of inventory, intangible assets and investments, income taxes, and litigation. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results that differ from our estimates could have a significant adverse effect on our operating results and financial position. We believe that the following significant accounting policies and assumptions may involve a higher degree of judgment and complexity than others.

Revenue Recognition

We have historically derived revenue principally from sales agreements and reagent rental/cost per test agreements of the NanoChip^® Molecular Workstation and related consumables, chemical, reagent products, molecular diagnostic products, from royalties for our intellectual property, sponsored research, contract and grant agreements and from license fees for intellectual property. The timing of revenue recognition and the amount of revenue actually recognized in each case depends upon a variety of factors, including the specific terms of each arrangement and the nature of our deliverables and obligations. Determination of the appropriate amount of revenue recognized involves judgments and estimates that we believe are reasonable, but it is possible that actual results may differ from our estimates.

Valuation of Intangible Assets and Investments

Our business acquisitions typically result in goodwill and other intangible assets, and the recorded values of those assets may become impaired in the future. As of December 31, 2004, our goodwill and intangible assets, net of accumulated amortization was approximately $108 million. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of our acquired businesses, market conditions and other factors. Although there are inherent uncertainties in this assessment process, the estimates and assumptions we use are consistent with our internal planning. If these estimates or their related assumptions change in the future, we may be required to record an impairment charge on all or a portion of our goodwill and intangible assets. Furthermore, we cannot predict the occurrence of future impairment-triggering events nor the impact such events might have on our reported asset values. Future events could cause us to conclude that impairment indicators exist and that goodwill or other intangible assets associated with our acquired businesses is impaired. Any resulting impairment loss could have an adverse impact on our results of operations.

Inventory

We estimate and evaluate obsolescence or non-marketability of our inventory and reduce the carrying value of our inventory to the lower of cost or market by considering future purchase commitments based upon assumptions about future demand and market conditions. In 2004, we took accounting charges of $3.7 million to reduce our inventory to its estimated net realizable value. Theses charges primarily related to our first generation micro-array instrument, the Molecular Biology Workstation. As of December 31, 2004, the net carrying value of our first generation instrument was $210,000, which we expect to be realizable in 2005. If actual future demand or market conditions are less favorable than those projected by us, either generation of our micro-array instrument, or any other component of our inventory, additional inventory write-downs may be required.

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Income Taxes

We regularly review our established valuation allowance against our potential tax assets that is based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and the implementation of tax-planning strategies. As of December 31, 2004, our valuation allowance was $123.5 million.

Results of Operations

Years ended December 31, 2004, 2003 and 2002

Revenues

The following table summarizes our revenues for the years ended December 31, 2004, 2003 and 2002:

Product Sales

The downward trend in product sales revenue relates to the decreased sales of our first generation NanoChip^® System. This is partially due to the limited size of the molecular research market. In 2003, we began to address the much larger clinical diagnostic lab market; however, as the first generation of our product was designed for research applications and not diagnostic use, the clinical diagnostic customer’s acceptance of our initial product has been limited. Our revenue was negatively impacted when we announced in the fourth quarter of 2004 our second-generation molecular diagnostic system, which was designed specifically to meet the needs of the clinical diagnostic user, would be available in 2005. We believe that potential future diagnostic customers may be waiting for the next generation of our NanoChip^® System, the NanoChip^® 400.

The future: We expect to continue to generate revenue from the NanoChip^® System and associated consumables in the research market and are expanding into the molecular diagnostic and point-of-care markets. A core element of this expansion strategy included the mergers with the point-of-care and molecular diagnostic companies, SynX and Epoch, respectively, to provide us revenue growth in 2005. We believe SynX will allow us to penetrate the point-of-care market and provide us with additional revenue in 2005 through a new product for the diagnosis of congestive heart failure which is scheduled to begin shipping in 2005. The SynX congestive heart failure product is expected to provide a 15 minute test result and it will be offered with a point-of-care quantitative reader. We also believe that Epoch will provide additional revenues through the sale of real-time ASRs to clinical laboratories and the sale of custom products and services to research customers. In addition to revenue from acquisitions, we believe we will generate additional revenue when we release in the NanoChip^® 400 in 2005. The NanoChip^® 400 is targeted at both the research and clinical laboratory markets. We also plan to offer ASRs including those for use in detection of respiratory viruses or for detection in the CFTR gene associated with Cystic Fibrosis.

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The future: We are now focusing on evaluating our intellectual property in light of our recent acquisitions and anticipate having additional licensing opportunities of our intellectual property. Through our acquisition of Epoch we obtained a royalty bearing licensing agreement with Applied Biosystems, Inc. for the TaqMan^® 5’-nuclease real-time PCR assays with contractual minimums through the third quarter 2005 and thereafter we will receive royalty payments based on actual sales. We expect license fee revenue to significantly increase as a result of including a full year of revenue under Epoch’s royalty agreement for the TaqMan^® 5’-nuclease real-time PCR assays.

The future: With the termination of our sponsored research agreement with Hitachi completed in the second quarter of 2004 we do not expect any revenue from Hitachi in 2005 or thereafter. We may enter into additional sponsored research projects in the future.

The future: The recognition of revenue under contracts and grants may vary from quarter to quarter and may result in significant fluctuations in operating results from year to year depending on the timing and quantity of agreements and contracts. In the future, we expect contract and grant revenue to become a decreasing portion of our overall revenues. We expect the majority of our revenue growth to be generated through an increase in product revenue.

Cost and expenses

Cost of product sales:

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The future. As we are still in the early stages of commercialization of our product lines, we are still developing our models for accurately predicting the cost of our second generation of the NanoChip^® System, point-of-care testing and the single analytic real time PCR-products. We currently believe that point-of-care testing and the single analytic real time PCR products will positively effect our gross margins. We use outside vendors to manufacture our point-of-care Nexus D_x^™ Myocardial Infarction product line, and our StatusFirst^™ congestive heart failure line. We expect to continue to incur significant costs associated with excess production capacity within our manufacturing facility in 2005 as we transition from the first to second generation NanoChip^® System. Because we are anticipating a significantly lower sale price per unit of our second generation NanoChip^® System our cost of manufacturing will greatly depend on the number of units sold or rented to absorb our excess capacity and therefore lower the overhead and labor costs. Gross margins in future periods may additionally be impaired by minimum product royalties or potential adjustments made to reflect the impairment of inventory or intangible assets related to products sold.

Research and development expenses:

The future. We expect our research and development expenditures to increase modestly from 2004 levels. The increase is primarily the result of including a full year of research and development from our recent acquisitions of Epoch and SynX, partly offset by reduced expenditures from our Nanogen Recognomics subsidiary which ceased operations in 2004. In addition, 2004 included a $3.8 million one-time charge to write-off in-process research and development acquired from SynX.

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Selling, general and administrative expenses:

The future. We expect that our selling, general and administrative expenditures on a percentage basis will trend lower than the increases in our revenue. We expect to incur integration costs, and ongoing operational costs related to the acquisitions of Epoch and SynX for a full year in 2005, rather than only a portion of the year as occurred in 2004. On a consolidated basis, however, we expect to achieve significant synergies and savings by consolidating many of the general and administrative functions. The savings from consolidation of general and administrative activities are expected to be offset by increased sales and marketing expenses required to support the various new product launches expected in 2005. Expenses may also be further impacted by potential future business combinations or corporate development transactions.

Charges for acquired in-process research and development & impairment for acquired technology:

The future. We do not expect to incur any additional charges for acquired in-process research and development related to the SynX or Epoch acquisitions. However, if we acquire other companies in the future, we may incur additional material in-process research and development charges.

The future. As of December 31, 2004, we have approximately $11.8 million in net book value remaining associated with acquired technology rights related to in-licensing of various technologies. We regularly review these assets for impairment and it is possible that additional impairment charges may be necessary in future periods.

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Other income

The following table summarizes our other income for the years ended December 31, 2004, 2003 and 2002 (in thousands):