UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

(Mark One)

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

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

For the transition period from                      to                     

Nanosphere, Inc.

Delaware		36-4339870
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)
4088 Commercial Avenue		Northbrook, Illinois 60062
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (847) 400-9000

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

(Title of Each Class)		(Name of Each Exchange on Which Registered)
Common Stock, par value $0.01		NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No

Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o  (the Registrant is not yet required to submit Interactive Data)

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of June 30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $58,030,023 based on the closing sale price for the registrant’s common stock on the NASDAQ Global Market on that date of $4.91 per share. This number is provided only for the purpose of this report on Form 10-K and does not represent an admission by either the registrant or any such person as to the status of such person.

As of March 4, 2010, there were 28,425,871 outstanding shares of common stock. The common stock is listed on the NASDAQ Global Market (trading symbol “NSPH”).

Portions of the registrant’s definitive proxy statement for fiscal year ended December 31, 2009 to be issued in conjunction with the registrant’s annual meeting of shareholders expected to be held on May 25, 2010 are incorporated by reference in Part III of this Form 10-K.  The definitive proxy statement will be filed by the registrant with the SEC not later than 120 days from the end of the registrant’s fiscal year ended December 31, 2009. Except as specifically incorporated herein by reference, the above mentioned Proxy Statement is not deemed filed as part of this report.

 

 

NANOSPHERE, INC.

INDEX

		Page
Part I.
Item 1. Business			1
Item 1A. Risk Factors			15
Item 1B. Unresolved Staff Comments			26
Item 2. Properties			26
Item 3. Legal Proceedings			26
Item 4. (Removed and Reserved)			26
Part II.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities			27
Item 6. Selected Financial Data			29
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			39
Item 8. Financial Statements and Supplementary Data			40
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			59
Item 9A. Controls and Procedures			59
Item 9B. Other Information			60
Part III.
Item 10. Directors, Executive Officers and Corporate Governance			61
Item 11. Executive Compensation			61
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			61
Item 13. Certain Relationships and Related Transactions and Director Independence			61
Item 14. Principal Accounting Fees and Services			61
Part IV.
Item 15. Exhibits and Financial Statement Schedules			62
Signatures			65
Exhibit 23.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements about us and our industry that involve substantial risks and uncertainties. All statements, other than statements of historical facts, included in this Annual Report on Form 10-K regarding our strategy, future operations, future financial position, future net sales, projected expenses, prospects and plans and objectives of management are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievement to be materially different from those expressed or implied by the forward-looking statements.

In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “predict,” “potential,” “continue,” “objective,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Actual events or results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors.

These forward-looking statements represent our estimates and assumptions only as of the date of this Annual Report on Form 10-K. Unless required by U.S. federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made or to conform these statements to actual results. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this Annual Report on Form 10-K. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 1A — Risk Factors” and elsewhere in this Annual Report on Form 10-K.

PART I.

Item 1.		Business.

References herein to “we,” “us,” “our” or “the Company” refer to Nanosphere, Inc. unless the context specifically requires otherwise.

Overview

We develop, manufacture and market an advanced molecular diagnostics platform, the Verigene System, that enables simple, low cost and highly sensitive genomic and protein testing on a single platform. Our proprietary nanoparticle technology simplifies molecular diagnostic testing, provides the ability to run multiple tests simultaneously on the same sample and has the potential to run a broad menu of tests on a single platform. We have developed or are currently developing diagnostic tests for markers which reveal the existence of a variety of medical conditions including cardiovascular, respiratory, cancer, autoimmune, neurodegenerative and other infectious diseases, as well as for pharmacogenomics.

Pharmacogenomics is an emerging subset of human genetic testing that correlates gene variation with a drug’s efficacy or toxicity. These tests play a key role in the advancement of personalized medicine where drug therapies and dosing are guided by each patient’s genetic makeup. There is a growing demand on laboratories to implement molecular diagnostic testing, but the cost and complexity of existing technologies and the need for specialized personnel and facilities have limited the number of laboratories with these capabilities.

The Verigene System is differentiated by its ease of use, rapid turnaround times and ability to support a broad test menu. It also offers lower cost for laboratories already performing molecular diagnostic testing and allows a broader range of laboratories, including those operated by local hospitals, to perform these tests. Our ability to detect proteins, which can be 100 times more sensitive than current technologies for certain targets, may enable earlier detection of and intervention in diseases associated with known biomarkers as well as the introduction of tests for new biomarkers that exist in concentrations too low to be detected by current technologies. We are focused on the clinical diagnostics market and may seek opportunities either directly or through partnerships to commercialize our technologies in other markets.

We received 510(k) clearance from the United States Food and Drug Administration (“FDA”) for commercial sale of the Verigene System in the second half of 2007. 510(k) clearance is granted by the FDA if the submitted information establishes that the proposed device is “substantially equivalent” to a legally marketed Class I or Class II medical device or a pre-amendment Class III medical device for which the FDA has not sought pre-market approval. We have also received 510(k) clearance to use the Verigene System for four diagnostic tests. The first test is a warfarin metabolism assay, which is a pharmacogenomic test to determine the existence of certain genetic information believed to affect the metabolism of warfarin-based drugs, including Coumadin, the most-prescribed oral anticoagulant in North America and Europe. The second test is a hyper-coagulation assay, one of the highest volume human genetic tests currently performed, to determine an individual’s risk, based upon genetic information, for the development of blood clots, which can lead to stroke, pulmonary embolism and deep vein thrombosis.

The third test is our respiratory panel which detects the presence of influenza A and B as well as respiratory syncitial virus (“RSV”) A and B. Influenza is commonly known as the seasonal flu and RSV is a respiratory virus that infects the lungs and breathing passages. RSV is the most common cause of bronchitis and pneumonia in children under the age of one year and has become a significant concern for older adults. Our respiratory panel provides physicians with a highly accurate, fast determination of which virus is present which helps guide the most appropriate treatment therapy. Most of the respiratory tests currently on the market take days to generate a result, because they depend on culturing, or do not provide a reliable result, because they are rapid tests which lack specificity.

On October 9, 2009, we received 510(k) clearance of our second generation respiratory panel and the Verigene SP System. The Verigene SP instrument automates sample preparation, which should significantly reduce laboratory technician time required to perform this molecular test. We also believe that our respiratory assay on the Verigene SP offers a simple to use molecular test for diagnosing respiratory infections and the flu, while providing improved specificity over currently available rapid tests. On November 24, 2009, we received clearance for a product insert change for this assay confirming that the novel H1N1 virus is detected as a positive Influenza A when using our respiratory assay and the Verigene SP. However, it is uncertain whether the ability to use this assay to detect H1N1 virus will be material to the Company based on the reduction in the number of recently reported H1N1 cases.

The fourth test is our cystic fibrosis test that enables molecular laboratories to perform prenatal screening and diagnostic confirmations through identification of the number of copies of each of the 23 most common gene mutations recognized by the American College of Obstetricians and Gynecologists as markers for cystic fibrosis.

We have elected to delay the launch of our 501(k) cleared cystic fibrosis test until such time as it may receive 510(k) clearance for use on the Verigene SP. In addition, we plan to submit additional FDA applications for each of our previously 510(k) cleared assays to allow their use on the new Verigene SP. We have engaged in dialogue with the FDA to identify any additional clinical studies that we need to receive 510(k) clearance to run these assays on the Verigene SP.

In the first quarter of 2009, we filed a de novo 510(k) submission for a hereditary hemochromatosis (“HFE”) genetic test. We re-submitted an amended 510(k) submission in October 2009 to supply additional data requested by the FDA. Mutations in the HFE gene are associated with hemochromatosis, which is the leading cause of iron overload disease, a systematic iron build up that can eventually adversely affect the heart, liver, pancreas, joints and pituitary gland. Untreated, hemochromatosis can be fatal. Once detected, hemochromatosis is easily treated. Approximately one in every 250 people of European descent has the disease and one in eight is a carrier of at least one of the recessive gene mutations. This is a de novo 510(k) because there are currently no FDA-cleared tests on the market to detect these mutations of the HFE gene. We have received additional feedback from the FDA indicating that further testing would be necessary in order to proceed with this application. This assay was submitted for clearance on the original Verigene System and the FDA requires separate testing and a new application to clear this assay on the Verigene SP. Therefore, we plan to complete all necessary testing on the Verigene SP to submit a 510(k) application for it.

The first ultra-sensitive protein test we plan to commercialize is for cardiac troponin I (“cTnI”), which is the gold standard biomarker for diagnosis of the occurrence of myocardial infarction or heart attack and identification of patients at risk for acute coronary syndromes at risk for subsequent cardiovascular events. We submitted a 510(k) application to the FDA in the fourth quarter of 2009. We have received initial feedback from the FDA regarding our 510(k) submission indicating that significant further studies will be required to obtain clearance for our cTnI assay. We believe that some of the additional requirements suggested by the FDA may be addressed by results from our ongoing FAST-TRAC clinical study, which is designed to support and further demonstrate the clinical utility of ultra-sensitive cTnI measurements as a diagnostic tool for use in the management of both acute and chronic cardiac disease. We plan to complete the FAST-TRAC clinical studies along with any other studies necessary to respond to the FDA’s requests in 2010.

We are currently conducting multi-site trials for our cytochrome P450 2C19 assay that detects genetic mutations associated with deficiencies to metabolize clopidogrel, more commonly known by the trade name Plavix. Clopidogrel inhibits platelet function and is a standard treatment to reduce the risk of thrombolytic events for patients undergoing percutaneous coronary intervention (“PCI”) procedures. Clopidogrel metabolism is affected by the Cytochrome P-450 family of genes. Up to 30-50% of the patient population possess variations in these genes and do not properly metabolize this drug, thus increasing the risk of adverse events. Our 2C19 assay is designed to identify patients possessing these variations so that alternative therapeutic approaches can be prescribed to effectively reduce clotting post-PCI.

In addition, we currently have research and development efforts underway on additional genetic, infectious disease and protein tests. Our test development pipeline includes a blood infection screening assay, an ultra-sensitive prostate-specific antigen (“PSA”) test for early diagnosis of recurrent prostate cancer and a multiplexed protein-based connective-tissue panel for the detection of rheumatoid arthritis, lupus and other related diseases. We are also investigating new biomarkers where our ultra-sensitive protein detection technology may enable earlier detection of a broad range of diseases, such as cancer. We are in the process of assessing the commercial viability of these applications and the various paths to regulatory approval that may be available.

Our technology is broadly applicable beyond the clinical diagnostic market in both research and industrial applications. The Verigene System is presently used in research laboratories supporting collaborations and independent research in areas including cancer, infectious disease and Alzheimer’s disease. We have developed and delivered a biosecurity platform for the detection of various bioterrorism agents to the Technical Support Working Group, an agency affiliated with the U.S. Department of Defense.

As of December 31, 2009, our patent portfolio is comprised, on a worldwide basis, of 132 issued patents and 97 pending patent applications which we own directly or for which we are the exclusive licensee. Some of these patents and patent applications derive from a common parent patent application or are foreign counterpart patent applications and relate to similar or identical technological claims. The issued patents cover approximately 12 different technological claims and the pending patent applications cover approximately 4 additional technological claims.

Many of our issued and pending patents were exclusively licensed from the International Institute for Nanotechnology at Northwestern University (“Northwestern”) in May 2000 and they generally cover our core technology, including nanotechnology based biodiagnostics and biobarcode technology. Our issued patents expire between 2017 and 2025. We believe our patent portfolio provides protection against other companies offering products employing the same technologies and methods as we have patented. While we believe our patent portfolio establishes a proprietary position, there are many competitive products utilizing other technologies that do not infringe on our patents.

In addition, as of December 31, 2009, we have non-exclusive licenses for at least 44 U.S. patents that cover 12 different technological claims from various third parties. Most of these license agreements require us to pay the licensor royalty fees that typically expire upon the patent expiration dates which range from 2010 to 2025. These license agreements are nonexclusive and do not create a proprietary position. The expiration of these non-exclusive licenses will result in the termination of certain royalty payments by us to the licensors.

Our Products

The Verigene System is a bench-top molecular diagnostics workstation that is a universal platform for genomic and protein testing. While many systems currently available on the market provide a diagnostic result for one test or a few tests within a specific market niche, the Verigene System provides for multiple tests to be performed on a single platform including both genomic and protein assays.

The Verigene System is comprised of a microfluidics processor, a touchscreen reader and disposable test cartridges. The microfluidics processor interacts with and manipulates various functional components of the test cartridge, accomplishing a number of necessary steps including target binding to the nucleic acid or protein array, nanoparticle probe hybridization, intermediate washes and signal amplification. The reader houses the optical detection module that illuminates the test slide and automated spot recognition software that analyzes the resulting signal intensities and provides the test results. The reader also serves as the control station for the Verigene System and features a simple and intuitive touchscreen interface that allows users to track samples and test cartridges, initiate and monitor test processing, analyze results and generate reports. The reader is web-enabled to allow remote access to results and reports.

To perform a test, the operator adds a prepared sample to a designated port in the test cartridge, enters sample identification and test cartridge information into the reader using the touchscreen keyboard or via the barcode wand, and inserts the test cartridge into the processor. The processor assimilates information received from the reader and matches it to the inserted test cartridge and initiates the specified test protocol. Once the assay process is complete the test array is introduced into the reader for image analysis and result reporting.

During 2009, we received 510(k) clearance from the FDA for the Verigene SP which handles the same processing steps, including DNA extraction, as the original Verigene system as well as sample preparation. This additional capability further automates and simplifies the testing process by extending the system workflow from sample to result. The Verigene System is also modular so that customers can attach a number of processors to each reader depending upon their laboratory test volume. We are also developing a fully automated instrument with high throughput and sample preparation for larger hospital based laboratories. By basing future generations of our instrument platform on existing design elements, each new generation of development will process assays developed for previous generations.

Our Applications

We are commercializing or have in development several genomic and protein assays including the following:

Assay		Condition Detected		Status
Genomic Tests
Hyper-coagulation		Genetic mutation that could indicate increased risk of blood clots, stroke and pulmonary embolism		Verigene FDA clearance received October 2007
Warfarin Metabolism		Genetic mutation important in proper initial dosing of leading anticoagulant		Verigene FDA clearance received September 2007
Cystic Fibrosis		Cystic fibrosis gene mutation; prenatal carrier screening & diagnosis confirmation		Verigene FDA clearance received July 2009
Respiratory Virus Panel		Respiratory illness		Verigene FDA clearance received May 2009; Verigene SP FDA clearance received October 2009
HFE — hemochromatosis		Hemochromatosis, iron overload disease		Amended 510(k) filed with the FDA in October 2009
CYP450 2C19		Clopidigrel metabolism		In clinical trials
Blood Infection Panel		Blood infection		In development
Protein Tests
Cardiac Troponin I		Cardiovascular disease; risk stratification; diagnosis of heart attack		Filed with the FDA in the fourth quarter of 2009
Connective Tissue Disease		Rheumatoid arthritis, lupus, psoriatic arthritis, spondyloarthropathies, scleroderma and Sjogren’s syndrome		In development
Prostate Specific Antigen		Post-surgical recurrence of prostate cancer		In development

We are also continuing to research the expansion of our test menu in areas including, cancer, autoimmune, allergy, neurodegenerative, cardiovascular, infectious diseases and pharmacogenomics.

Genomic Assays

Hyper-coagulation. Currently available technologies for this test are limited by contamination issues associated with the polymerase chain reaction, or PCR, genomic test as well as its cost resulting from a complex and costly work flow and large number of process steps. Our hyper-coagulation panel consists of a multiplex of three genetic markers. This test enables the direct detection of mutations associated with a pre-disposition to blood clots on a much simpler platform than current alternatives. Our hyper-coagulation assay received 510(k) clearance for use on the original Verigene System in October 2007.

Warfarin Metabolism. Our warfarin metabolism assay received 510(k) clearance for use on the original Verigene System in September 2007. Our assay is the first FDA-cleared genetic diagnostic test to assess warfarin metabolism. Our warfarin metabolism panel detects three genetic markers that play a critical role in metabolizing warfarin and determining an individual’s sensitivity to the drug. Through detection of these genetic markers, doctors are able to determine the appropriate initial warfarin dosage level in a safer and more efficient manner than current methods. Most of the other assays available today require PCR prior to running the assay, which contributes significantly to the cost and complexity of testing.

Cystic Fibrosis. Our cystic fibrosis assay received 510(k) clearance for use on the original Verigene System in July 2009. This assay provides a multiplex panel for the detection of mutations in the CFTR gene that contribute to a higher risk of cystic fibrosis. Currently available technologies for this test typically require up-front PCR and post-PCR multiplexing technologies, which involve complex and costly work flow which require more testing duration and hands-on lab technician time as well as additional process steps. Our direct detection method enables detection of each of the 23 CFTR gene mutations related to cystic fibrosis recognized by the American College of Obstetricians and Gynecologists.

Respiratory Virus Panel. On May 1, 2009, we received 510(k) clearance for the commercial sale of our respiratory panel for use on the original Verigene System which detects the presence of influenza A and B as well as RSV A and B. Influenza is commonly known as the seasonal flu and RSV is a respiratory virus that infects the lungs and breathing passages. RSV is the most common cause of bronchitis and pneumonia in children under 12 months and has become a significant concern for older adults. Our respiratory panel provides physicians with a highly accurate, fast determination of which virus is present which helps guide the most appropriate therapy. On October 9, 2009, we received 510(k) clearance of our second generation respiratory panel for use on the Verigene SP. On November 24, 2009, we received clearance for a label change for this assay confirming that the novel H1N1 virus is detected as a positive Influenza A when using clinical isolates running our respiratory assay on the Verigene SP.

HFE. A de novo 510(k) for our HFE assay for use on the original Verigene System was submitted to the FDA in February 2009 and we submitted an amended 510(k) in October 2009. We have received additional feedback from the FDA indicating that further testing would be necessary in order to proceed with this application. This assay was submitted for clearance on the original Verigene System and the FDA requires separate testing and a new application to clear this assay on the Verigene SP. Therefore, we plan to complete all necessary testing on the Verigene SP to submit a 510(k) application for it. Mutations in the HFE gene are associated with hemochromatosis, which is the leading cause of iron overload disease. Over time, hemochromatosis causes iron build up and eventually can cause diseases in the heart, liver, pancreas, joints and pituitary gland. Untreated, hemochromatosis can be fatal. Once detected, hemochromatosis is easily treated. Approximately one in every 250 people of European descent has the disease and one in eight is a carrier of at least one of the recessive gene mutations. There are currently no FDA cleared tests on the market.

Cytochrome P450 2C19. Our 2C19 assay is for the detection of mutations that lead to deficiency in the metabolism of clopidogrel, more commonly known by the trade name Plavix. Clopidogrel inhibits platelet function and is a standard treatment to reduce the risk of thrombolytic events for patients undergoing percutaneous coronary intervention (“PCI”) procedures. Clopidogrel is metabolized through the Cytochrome P-450 family of genes. Up to 30-50% of the patient population possess variations in these genes and do not properly metabolize this drug, thus increasing the risk of adverse events. Therapeutic approaches can be prescribed to effectively reduce clotting post-PCI.

Blood Stream Infection. We are developing three blood stream infection panels for the earlier determination of specific bacterium present within patients with blood stream infections. Currently under development are gram positive, gram negative and fungal panels. These assays are designed to enable physicians to pinpoint bacterial strains infecting patients and thus prescribe the most appropriate antibiotic regimen within the first 24 hours rather than after several days. We believe that this early detection will allow patients to avoid unnecessary treatments that often include serious side effects.

Protein Assays

Our initial assay development efforts are focused on the earlier detection of disease through application of our ultra-sensitive protein detection technology to existing biomarkers. The following assays are in development:

Cardiac Troponin I. The first ultra-sensitive protein test we plan to commercialize is for cardiac troponin I (“cTnI”), which is the gold standard biomarker for diagnosis of the occurrence of myocardial infarction or heart attack and identification of patients at risk for acute coronary syndrome. We submitted a 510(k) application to the FDA in the fourth quarter of 2009. We have received initial feedback from the FDA regarding our 510(k) submission indicating that significant further studies will be required to obtain clearance for our cTnI assay. We believe that some of the additional requirements suggested by the FDA may be addressed by results from our ongoing FAST-TRAC clinical study, which is designed to support and further demonstrate the clinical utility of ultra-sensitive cTnI measurements as a diagnostic tool for use in the management of both acute and chronic cardiac disease. We plan to complete the FAST-TRAC clinical studies along with any other studies necessary to respond to the FDA’s requests in 2010.

This assay is for the detection of cTnI in patients suspected of having cardiovascular disease. Although there are various diagnostic tests used to detect acute myocardial infarction, both the American College of Cardiology and the American Heart Association issued guidelines asserting that testing for cardiac troponin is the definitive laboratory standard for the diagnosis of myocardial infarction. Troponin assays are not only more sensitive but also more specific than tests for other existing cardiovascular disease biomarkers.

Troponin I is a protein that is found in cardiac muscle and is released when the heart is injured, for instance during a myocardial infarction. Cardiac troponin blood diagnostic tests are used to diagnose a heart attack and evaluate mild to severe heart injury in patients experiencing heart/chest discomfort. However, limitations of current detection levels often result in the failure to accurately diagnose all cases of cardiovascular disease. Each year, millions of patients enter emergency rooms with chest pain, many of whom are discharged from hospital emergency departments after current technologies fail to diagnose acute myocardial infarctions. Tens of thousands of these patients are subsequently readmitted to the hospital or die from cardiac arrest within a few weeks or months after the initial visit.

Initial clinical studies have demonstrated our ability to reliably identify a rise in cardiac troponin significantly below the limits of detection of assays currently on the market, at levels where the assay can diagnose acute myocardial infarctions earlier and detect precursor cardiac events including unstable angina, cardiac necrosis and ischemia. Furthermore, this level of sensitivity could also lead to more accurate risk stratification of people with early stages of cardiovascular disease such as angina. We believe that a new definition of “normal” will be defined at a lower troponin concentration level that currently marketed tests cannot detect. Our FAST-TRAC trial is designed to test new diagnostic attributes of the assay, including its predictive value.

Prostate Specific Antigen — Recurrent Prostate Cancer. This assay is designed to detect a recurrence of prostate cancer following prostate removal, a standard treatment for prostate cancer. Prostate specific antigen, or PSA, is a protein produced by the cells of the prostate gland and may be found in an increased amount in those with prostate cancer. Despite regular post-surgery PSA testing, most cases of recurrence are not detected for several years because the rising PSA levels in these patients does not reach the limit of detection using current technologies. We expect our ultra-sensitive PSA detection assay will diagnose recurrence much more quickly. Our research data suggests that patients without recurrence do not have rising PSA levels within the first six months post prostatectomy. Therefore, we believe our assay will enable more immediate treatment for patients with recurrence and avoidance of unnecessary treatments and life altering side effects for patients without recurrence.

Connective-tissue. We are developing a multiplexed protein test for the detection of rheumatoid arthritis, lupus and other connective tissue diseases. This assay combines the advantage of testing for multiple proteins on a single cartridge with higher sensitivity that enables earlier detection of disease. Additionally, we have novel, proprietary biomarkers in research. We believe these assays will provide rheumatologists an economical and easy to use solution for diagnosing patients with connective tissue diseases.

Biomarker Validation. We are also applying our ultra-sensitive protein detection methods to the development of tests for both established protein biomarkers as well as the validation of novel protein targets that may lead to earlier detection of medical conditions including in the areas of autoimmune diseases, allergies, cancers and neurodegenerative disorders.

Our Technology

We believe our technology will drive greater usage of ultra-sensitive and multiplexed protein and genomic diagnostics in routine clinical laboratories, much as enzyme-linked immunosorbent assay, or ELISA, accelerated the use of protein testing in the 1970s and 1980s and PCR catalyzed the emergence of nucleic acid diagnostics in the 1990s.

Our Gold Nanoparticle Molecular Probes

At the core of our technology are gold nanoparticles which offer a unique set of physical properties that can be exploited in the detection of biological molecules. In 1998, Dr. Mirkin and Dr. Letsinger at Northwestern developed a novel process to prepare stable probes by covalently attaching oligonucleotides to gold nanoparticles. This method, protected by patents, is exclusively assigned to or owned by us. We have refined the synthesis methods to enable highly reproducible production of nanoparticle probes with diameters in the 13-50 nanometer range required for highly sensitive biomedical analysis. Subsequently, we have also developed methods for attaching antibodies to gold nanoparticles, thereby producing highly stable probes for ultra-sensitive detection of proteins.

The properties of nanoparticle probes can be tailored by controlling the size of the particles, the density of recognition-oligomers or antibodies on the nanoparticles, the use of diluent oligonucleotides, the use of spacer oligonucleotides and the salt concentration. Combined, the optimization of these properties enables us to deliver superior analytical performance characteristics versus other methods, for example:

•		High Signal-to-Noise Ratio. Our nanoparticle probes deliver significantly stronger signals than the fluorescent probes, or fluorophores, used in most diagnostic platforms today. Nanoparticles are typically 10-100 nm in diameter and therefore significantly larger than conventional fluorophores. This size difference enables nanoparticles to produce up to 10,000 times more signal via light scattering than a fluorophore. A single nanoparticle can be detected with simple optical instrumentation with very high sensitivity, thus eliminating the need to employ our amplification techniques.
•		Orders of Magnitude Greater Sensitivity and Lower Detection Limits. The sensitivity and limits of detection of our technology are further enhanced by a silver-staining step, which effectively amplifies the signal from each nanoparticle bound to a target molecule. In this process, silver is coated onto the gold nanoparticle surface, producing larger particles with enhanced optical properties. Whereas the leading technologies today can detect molecules at the picomolar range (10-12), our technology is capable of up to a million times higher sensitivity at the attomolar (10-18) range, enabling the unprecedented analysis of rarely expressed genes or low abundance proteins for early disease detection and diagnosis.
•		Unparalleled Specificity. A key property of the oligonucleotide-linked gold nanoparticle is an extremely sharp melting curve. The melting curve is the temperature range during which the capture oligonucleotide dissociates with the complementary target oligonucleotide in the sample.  Our nanoparticles exhibit dissociation transitions of less than one degree in Celsius temperature, whereas most alternative products are based on polymerase chain reaction, or PCR, which exhibits melt transitions typically in the 15-30 degree range. The narrow band of temperature in which binding and dissociation occurs, creates a significantly higher signal to noise ratio resulting in greater specificity. These qualities eliminate errors caused by mismatched nucleotide pairs, thereby allowing genomic targets differing by a single nucleotide (base pair) to be distinguished with unprecedented selectivity.  Sharp melting curves are a proprietary feature of our nanoparticles and our patent portfolio includes issued patents protecting the methods and product performance related to melt transition curves.

•		High Count Multiplexing. Our core technology enables high count multiplexing, or simultaneous multiple target identification in a single sample, using a simple low-density microarray. A sample and probe mixture is introduced simultaneously into a single self-contained reaction chamber pre-printed with multiple reaction spots, each containing capture strand oligonucleotides or proteins that are complementary to a specific target molecule of interest. By utilizing the sharp melt transition of the nanoparticle probes, multiple targets can be discretely identified in a single sample. This methodology eliminates the need for complex and costly means of physically isolating individual target molecules.
•		Detection of Genomic and Protein Molecules Simultaneously. We are able to synthesize our gold nanoparticle probes for the simultaneous multiplexed detection of both protein and genomic targets in the same assay.
•		Superior Reaction Kinetics. The sharp melt transition curves in our gold nanoparticles increase binding affinity thereby leading to improved assay kinetics and efficiency.
•		Long-Term Stability. The high density of oligonucleotides per nanoparticle, serves both as a protective and recognition layer on the nanoparticle surface and ensures the long-term stability of our nanoparticles. We have patented approaches using localized salt and buffer concentrations that deliver long-shelf life for our technology and reagent set.

Assay Format

Our silver-enhanced gold nanoparticles and related optical detection technology are used for diagnostic assays which detect genomic and proteomic targets captured onto microarrays as shown in the “Schematic of Microarray Based Detection Using Nanoparticle Probes” below. The microarray format enables high count multiplexing of assay targets, facilitating the development of a broad menu of tests, including for complex diseases where multiple targets must be evaluated to provide a diagnosis, in a simple, scalable format.

Two probe types can be used in a single assay. Oligonucleotide probes are used for genomic assays and antibodies for protein assays. One probe, complementary to a specific site on the target molecule, is attached to a surface such as a glass slide and the other probe, complementary to a different site on the target molecule, is attached to the surface of gold nanoparticles. In the presence of the target molecule of interest, the probes and target form a three dimensional, cross-linked aggregate. After silver coating the gold nanoparticles, light scatter is measured on the surface of the microarray slide. The silver-enhanced gold nanoparticle probes located on the slide surface scatter light in proportion to the concentration of the target in the sample, which is detected through optical imaging and translated into clinical results via our proprietary software algorithms.

The above graphic depicts a genomic or proteomic assay utilizing a molecule attached to a gold nanoparticle. In the case of a genomic assay, the molecule represents an oligonucleotide. In the case of a proteomic assay, the molecule represents an antibody.

Research and Development

Our research and development efforts are focused on:

•

Expanding and Enhancing the Capabilities of Our Instrument Platform. Design elements and components of our current instrument platform, the Verigene System, will serve as the foundation for future generation development. The Verigene SP incorporates sample preparation into our system. By adding this step, labs can now process a raw sample material, in most cases whole blood, in a single step. This feature is critical for analyzing infectious diseases and will further simplify the processing of clinical samples from swab, cerebrospinal fluid and serum. We are also developing a fully automated instrument with increased high throughput and sample preparation for both infectious disease and human genetic tests for larger hospital based laboratories. By basing future generations of our instrument platform on existing design elements, each new generation of development will process assays developed for previous generations.

•

Developing Additional Genomic and Protein Assays. We are in various phases of developing and commercializing new assays for detecting protein biomarkers, infectious diseases and human genetic markers. Currently, we are researching additional human genetic, infectious disease and ultra-sensitive protein assays.

•

Validating and Commercializing New Biomarkers. We have a dedicated team of protein scientists and assay developers who conduct assay development to support feasibility testing and new protein biomarker validation. This team is collaborating with clinical researchers in academic and private settings to apply our ultra-sensitive protein detection technology to the researchers’ efforts to create diagnostic methods with greater clinical sensitivity and specificity. We are also applying our ultra-sensitivity methods to the development of established protein biomarkers that may lead to earlier detection of medical conditions including cancer, neurodegenerative disorders including Alzheimer’s disease, sepsis and mad cow disease, as well as for blood screening and veterinary applications.

•

Enhancing Performance of Established Product Systems and Developing New Applications. We have entered into a license agreement with Northwestern which provides us with an exclusive license to certain patents and patent applications related to the application of nanotechnology to biodiagnostics and to biobarcode technology. This license covers all discoveries from the International Institute for Nanotechnology at Northwestern in the field of biodiagnostics through January 1, 2013. Nanosphere also has the right of first negotiation for an exclusive license on inventions after such date. Our research team utilizes the research and patents developed at Northwestern to develop diagnostic applications including additional genomic and protein testing assays for use in the Verigene System.

Employees

As of December 31, 2009, we had 105 full-time employees. Of these employees, 46 were in research and development, 31 were in manufacturing (in support of both product sales and the research and development function), 15 were in sales and marketing and 13 were in general and administrative functions. We have never had a work stoppage and none of our employees are covered by collective bargaining agreements or represented by a labor union. We believe our employee relations are good.

Government Grants and Contracts

We have received grants over the last five years that have allowed for the evaluation and development of new technologies and also allowed for development of market specific diagnostic products.

We have benefited from Small Business Innovation Research grants to prove feasibility of gold nanoparticle based detection technology as well as evaluate potential new technologies and medical diagnostic applications.

We have received government contracts for the development of automated biological agent detection systems using nanoparticle probes that are capable of rapidly detecting biological warfare agents and biological toxins. These products have potential applications for both government contractors and civilian first responders. Since inception, we have recorded revenue of approximately $9 million under these grants and contracts.

Manufacturing

We assemble and package all our finished products at our corporate headquarters in Northbrook, Illinois. Our manufacturing facility occupies approximately 12,000 square feet of the 40,945 square feet which we lease at our Northbrook facility. There, we manufacture our proprietary nanoparticle probes, assay reagents, test cartridges and Verigene System instrumentation. We outsource much of the disposable component molding. Reagent manufacturing and cartridge filling is performed under the current Good Manufacturing Practice — Quality System Regulation as required by the FDA for the manufacture of in vitro diagnostic products. These regulations carefully control the manufacture, testing and release of diagnostics products as well as raw material receipt and control.

We have controlled methods for the consistent manufacturing of our proprietary nanoparticles and production oligonucleotides at very high purity (greater than 95%). We also manufacture at our Northbrook facility a proprietary linker to ensure stable bonding of the oligonucleotide to the gold nanoparticle.

All quality control tests are validated to ensure product quality measurements are accurate. Manufacturing of the Verigene System, including test cartridges, is tightly controlled with the use of manufacturing batch records. These records control which product is produced and ensure that each batch of product is manufactured consistently and according to the intended design.

We plan to continue to manufacture components that we determine are highly proprietary or difficult to produce consistently while outsourcing commodity components. As we continue to execute on our sales and market plans, we have ramped-up our manufacturing operations to meet demand. We are likely to establish additional outsourcing partnerships as we manufacture additional products. While we believe our current facilities and expansion rights are adequate to meet our manufacturing needs for at least the next three years, we may need to lease additional space. Our recently revised facilities lease includes a right of first offer on additional available space in our building. While we do not need to expand our facilities to meet anticipated demand for 2010, we will likely require expanded facilities to meet anticipated demand beyond 2010.

Sales and Marketing

As a part of our business strategy, we have a direct sales and marketing organization to support the sales of the Verigene System and its initial menu of tests in the United States. This organization comprises geographically dispersed sales representatives and clinical support specialists as well as a centralized staff of market and product managers. We believe that the primary market for our diagnostic applications will be hospital-based laboratories and academic research institutions in the United States. A customer may purchase the Verigene System, lease it from a third party or enter into a reagent rental agreement. Our reagent rental agreements include customer commitments to purchase a certain minimum volume of cartridges over the term of the agreement. As part of these agreements, a portion of the charge for each cartridge is a rental fee for use of the equipment.

Our sales and marketing organization provides customer service related to order fulfillment, technical service and product support, and distribution logistics.

We believe that the primary international customers for our diagnostic applications will be hospital-based laboratories and academic research institutions. We have obtained CE Mark approval for sale of the Verigene System in European Union countries and will do so for each assay we plan to market in Europe. Outside the United States, we anticipate initiating sales through marketing partners and distributors. A distribution strategy is being developed for each relevant international market. We expect to supplement marketing partnerships with specialists who will train our partners’ sales forces and provide technical support.

Competition

We primarily face competition in the nucleic acid based testing market from companies that provide PCR-based technologies. We believe that, over time, the Verigene System will compete with these companies primarily on the following factors: (1) cost effectiveness; (2) ease of use; (3) multiplex capability; (4) range of tests offered; (5) immediacy of results; and (6) reliability.

We also face competition in the protein detection market from companies that provide mass spectrometry systems. Although mass spectrometry systems offer high sensitivity, they are extremely costly, require significant time and effort by sophisticated staff and cannot detect many complex, disease-causing proteins. Due to these significant limitations we consider mass spectrometry systems to be a lower competitive threat within commercial protein diagnostics laboratories.

The protein detection market also includes companies that provide ELISA-based testing systems. We believe that our technology, which is at least 100 times more sensitive than ELISA-based technologies provides a significant advantage because it can detect proteins at lower concentrations equating to earlier detection of disease. This sensitivity will create new value for existing biomarkers and allow the discovery of novel biomarkers for the treatment and monitoring of disease where none exist today.

Regulation by the United States Food and Drug Administration

In the United States, the FDA regulates the sale and distribution, in interstate commerce, of medical devices, including in vitro diagnostic test kits. Pursuant to the federal Food, Drug, and Cosmetic Act, the FDA regulates the preclinical and clinical design, testing, manufacture, labeling, distribution and promotion of medical devices. We will not be able to commence marketing or commercial sales in the United States of new medical devices under development that fall within the FDA’s jurisdiction until we receive clearance from the FDA.

In the United States, medical devices are 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 their safety and effectiveness. Class I devices are subject to general controls (e.g., establishment registration, medical device listing, labeling regulations, possible premarket notification, possible adherence to current Good Manufacturing Practice). However, most Class I devices are exempt from premarket notification (510(k) clearance) and adherence to current Good Manufacturing Practice. Class II devices are subject to general and special controls (e.g., special labeling requirements, mandatory performance standards, premarket notification (510(k) clearance) often with guidance from an FDA special control guideline, adherence to current Good Manufacturing Practice, possible post-market surveillance). Generally, Class III devices are subject to general and special controls and must receive premarket approval, or PMA, by the FDA to ensure their safety and effectiveness (e.g., new devices for which insufficient information exists to assure safety and effectiveness through general and special controls; often such devices are life-sustaining, life-supporting and implantable). Many devices that have been approved by way of premarket approval are required to perform post-market surveillance.

510(k) Clearance

The FDA will grant 510(k) clearance if the submitted information establishes that the proposed device is “substantially equivalent” to a legally marketed Class I or Class II medical device or a pre-amendment Class III medical device for which the FDA has not sought PMA. The FDA has recently been requiring more rigorous demonstration of substantial equivalence than in the past. In some cases, such as may be the case with our HFE and Cardiac Troponin I 510(k) submissions, the FDA may require additional clinical data than it would have required in the past. The FDA may determine that a proposed device is not substantially equivalent to a legally marketed device or that additional information is needed before a substantial equivalence determination can be made. A “not substantially equivalent” determination, or a request for additional information, could prevent or delay the market introduction of new products that fall into this category. For any devices that are cleared through the 510(k) process, modifications or enhancements that could significantly affect safety or effectiveness, or constitute a major change in the intended use of the device, require new 510(k) submissions and clearances.

Premarket Approval

A PMA application must be filed if a proposed device is a new device not substantially equivalent to a legally marketed Class I or Class II device, or if it is a pre-amendment Class III device for which the FDA has sought PMA. A PMA application must be supported by valid scientific evidence to demonstrate the safety and effectiveness of the device, typically including the results of clinical investigations, bench tests, and laboratory and animal studies. The PMA application must also contain a complete description of the device and its components and a detailed description of the method, facilities and controls used to manufacture the device. In addition, the submission must include the proposed labeling, advertising literature and any training materials. The PMA process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought by other companies have never been approved for marketing.

Upon receipt of a PMA application, the FDA makes a threshold determination as to whether the application is sufficiently complete to permit a substantive review. If the FDA determines that the PMA application is complete, the FDA will accept the application for filing. Once the submission is accepted, the FDA begins an in-depth review of the PMA. The FDA’s review of a PMA application generally takes one to three years from the date the application is accepted, but may take significantly longer. The review time is often extended by the FDA asking for more information or clarification of information already provided in the submission. During the review period, an advisory committee, typically a panel of clinicians, will likely be convened to review and evaluate the application and provide recommendations to the FDA as to whether the device should be approved. The FDA is not bound by the recommendation of the advisory panel. Toward the end of the PMA review process, the FDA generally will conduct an inspection of the manufacturer’s facilities to ensure that the facilities are in compliance with applicable current Good Manufacturing Practices requirements.

If FDA evaluations of both the PMA application and the manufacturing facilities are favorable, the FDA may issue either an approval letter or an approvable letter, which usually contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a premarket approval letter, authorizing commercial marketing of the device for certain indications. If the FDA’s evaluation of the PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA application or issue a non-approvable letter. The FDA may determine that additional clinical investigations are necessary, in which case the PMA may be delayed for one or more years while additional clinical investigations are conducted and submitted in an amendment to the PMA.

Modifications to a device that is the subject of an approved PMA, including its labeling or manufacturing process, may require approval by the FDA of PMA supplements or new PMAs. Supplements to an approved PMA often require the submission of the same type of information required for an initial PMA, except that the supplement is generally limited to that information needed to support the proposed change from the product covered by the original PMA.

Clinical Investigations

Before we can submit a medical device for 510(k) clearance, we may have to perform a short (i.e., months) method comparison study at clinical sites to ensure that end-users can perform the test successfully. This is a study in a clinical environment, but is not usually considered a clinical trial. Alternatively, when we submit a PMA, we generally must conduct a longer (i.e., years) clinical trial of the device which supports the clinical utility of the device and how the device will be used.

Although clinical investigations of most devices are subject to the investigational device exemption, or IDE requirements, clinical investigations of in vitro diagnostic tests, including our products and products under development, are exempt from the IDE requirements. Thus, our tests do not require the FDA’s prior approval, provided the testing is non-invasive, does not require an invasive sampling procedure that presents a significant risk, does not intentionally introduce energy into the subject, and is not used as a diagnostic procedure without confirmation by another medically established test or procedure. In addition, our tests must be labeled “for research use only” or “for investigational use only,” and distribution controls must be established to assure that our tests distributed for research, method comparisons or clinical trials are used only for those purposes.

Obtaining FDA Clearance for Our Products

We received 510(k) clearance from the FDA for commercial sale of the Verigene System in the second half of 2007. We have also received 510(k) clearance to use the Verigene System for four diagnostic tests. The first test is a warfarin metabolism assay, which is a pharmacogenomic test to determine the existence of certain genetic information believed to affect the metabolism of warfarin based drugs, including Coumadin, the most-prescribed oral anticoagulant in North America and Europe. The second test is a hyper-coagulation assay, one of the highest volume human genetic tests currently performed, to determine an individual’s risk, based upon genetic information, for the development of blood clots, which can lead to stroke, pulmonary embolism and deep vein thrombosis.

The third test is our respiratory panel which detects the presence of influenza A and B as well as respiratory syncitial virus (“RSV”) A and B. Influenza is commonly known as the seasonal flu and RSV is a respiratory virus that infects the lungs and breathing passages. RSV is the most common cause of bronchitis and pneumonia in children under the age of one year and has become a significant concern for older adults. Our respiratory panel provides physicians with a highly accurate, fast determination of which virus is present which helps guide the most appropriate treatment therapy. Most of the respiratory tests currently on the market take days to generate a result, because they depend on culturing, or do not provide a reliable result, because they are rapid tests which lack specificity. The fourth test is our cystic fibrosis test that enables molecular laboratories to perform prenatal screening and diagnostic confirmations through identification of the number of copies of each of the 23 most common gene mutations recognized by the American College of Obstetricians and Gynecologists as markers for cystic fibrosis.

Most of our tests have special control guidances for 510(k) clearance. Some of our future tests may be Class III devices. We also plan to conduct method comparison studies or clinical trials of our products currently under development, which we intend to distribute in the United States. Our future developments may not be exempt from IDE requirements and may require us to obtain approval from the FDA through the PMA process rather than 510(k) clearance. In addition, any failure to maintain compliance with the IDE exemption requirements could result in, among other things, the loss of the IDE exemption or the imposition of other restrictions on the distribution of our products.

Regulation After FDA Approval or Clearance

Any devices we manufacture or distribute pursuant to clearance or approval by the FDA are subject to pervasive and continuing regulation by the FDA and certain state agencies. We are required to adhere to applicable regulations setting forth detailed current Good Manufacturing Practices requirements, which include testing, control and documentation requirements. Non-compliance with these standards can result in, among other things, fines, injunctions, civil penalties, recalls or seizures of products, total or partial suspension of production, failure of the government to grant 510(k) clearance PMA for devices, withdrawal of marketing approvals and criminal prosecutions. We have designed and implemented our manufacturing facilities under the current Good Manufacturing Practices requirements. Our manufacturing facility has been inspected by the FDA and will continue to be periodically audited by the FDA.

Because we are a manufacturer of medical devices, we must also comply with medical device reporting requirements by reporting to the FDA any incident in which our product may have caused or contributed to a death or serious injury. We must also report any incident in which our product malfunctioned if that malfunction would likely cause or contribute to a death or serious injury if it were to recur. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses.

We are also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. We have numerous policies and procedures in place to ensure compliance with these laws and to minimize the risk of occupational exposure to hazardous materials. In addition, we do not expect the operations of our products to produce significant quantities of hazardous or toxic waste that would require extraordinary disposal practices. Although the costs to comply with these applicable laws and regulations have not been material, we cannot predict the impact on our business of new or amended laws or regulations, or any changes in the way existing and future laws and regulations are interpreted or enforced. Moreover, as we develop toxin and pathogen detection products for the food and agriculture markets, we may be subject to the regulations of various food safety organizations, including the United States Department of Agriculture.

Export of Our Products

Export of products subject to the 510(k) notification requirements, but not yet cleared to market, are permitted with FDA authorization provided certain requirements are met. Unapproved products subject to the PMA requirements must be approved by the FDA for export. To obtain FDA export approval, we must meet certain requirements, including, with some exceptions, documentation demonstrating that the product is approved for import into the country to which it is to be exported and, in some instances, safety data for the devices.

Clinical Laboratory Improvement Amendments of 1988

The use of our products is also affected by the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and related federal and state regulations, which provide for regulation of laboratory testing. These regulations mandate that clinical laboratories must be certified by the federal government, by a federally-approved accreditation agency or by a state that has been deemed exempt from the regulation’s requirements. Moreover, these laboratories must meet quality assurance, quality control and personnel standards, and they must undergo proficiency testing and inspections. The CLIA standards applicable to clinical laboratories are based on the complexity of the method of testing performed by the laboratory, which range from “waived” to “moderately complex” to “highly complex.” We expect that most of our products will be categorized as either “moderately complex” or “highly complex.”

Foreign Government Regulation

We anticipate that our products will be introduced in foreign markets in the future. We have obtained CE Mark approval for sale of the Verigene System in European Union countries and will do so for any assay we plan to launch in Europe. The regulatory review process varies from country to country, and many countries also impose product standards, packaging requirements, labeling requirements and import restrictions on devices. Each country has its own tariff regulations, duties and tax requirements.

Other Information

Copies of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the investor relations section of the Company’s website (www.nanosphere.us) as soon as reasonably practicable after the Company electronically files the material with, or furnishes it to, the Securities and Exchange Commission.

Item 1A.		Risk Factors.

Our results from operations may be affected by the risk factors set forth below.  All investors should consider the following risk factors before deciding to purchase securities of the Company.  If any of the following events actually occur, our business, operating results, prospects or financial condition could be materially and adversely affected. This could cause the trading price of our common stock to decline and you may lose all or part of your investment. The risks described below are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also significantly impair our business operations and could result in a complete loss of your investment.

Risks Related to Our Business

We have a history of losses and we may never achieve or maintain profitability.

We have a limited operating history and have incurred significant losses in each fiscal year since our inception, including net losses attributable to common stock of $33.9 million, $37.0 million and $59.3 million in the years ended December 31, 2009, 2008 and 2007, respectively. As of December 31, 2009, we had an accumulated deficit of approximately $239.3 million. Our losses resulted principally from costs incurred in our research and development programs and from our general and administrative expenses. In recent years, we have incurred significant costs in connection with the development of the Verigene System and its test menu. We expect our research and development expense levels to remain high for the foreseeable future as we seek to enhance our existing product and develop new products. These losses, among other things, have had and will continue to have an adverse effect on our working capital, total assets and stockholders’ equity. Because of the numerous risks and uncertainties associated with our product development and commercialization efforts, we are unable to predict when we will become profitable, and we may never become profitable. If we fail to achieve profitability in the future, the market price of our common stock could decline.

Our financial results depend on commercial acceptance of the Verigene System, its array of tests, and the development of additional tests.

Our future depends on the success of the Verigene System, which depends primarily on its acceptance by hospitals, research institutions, and independent diagnostic laboratories as a reliable, accurate and cost-effective replacement for traditional molecular diagnostic measurement methods. Many hospitals and laboratories already use expensive molecular diagnostic testing instruments in their laboratories and may be reluctant to change their current procedures for performing such analyses.

The Verigene System currently does not process a sufficiently broad menu of tests for some hospitals and laboratories to consider adopting it. Although we continue to develop additional tests to respond to hospitals’ and laboratories’ needs, we cannot guarantee that we will be able to develop enough additional tests quickly enough or in a manner that is cost-effective or at all. The development of new or enhanced products is a complex and uncertain process requiring the accurate anticipation of technological and market trends, as well as precise technological execution. We are currently not able to estimate when or if we will be able to develop, commercialize or sell additional tests or enhance existing products. If we are unable to increase sales of the Verigene System and its tests or to successfully develop and commercialize other products or tests, our revenues and our ability to achieve profitability would be impaired.

The regulatory approval process is expensive, time consuming and uncertain and the failure to obtain such approvals will prevent us from commercializing our future products.

Our products are subject to approval or clearance by the FDA or foreign governmental entities prior to their marketing for commercial use. The 510(k) clearance and premarket approval processes as well as the foreign approvals required to initiate sales outside the United States can be expensive, time consuming and uncertain. It may take as long as eighteen months or longer from submission to obtain 510(k) clearance, and from one to three years from submission to obtain premarket approval; however, it may take longer, and 510(k) clearance or premarket approval may never be obtained. Delays in receipt of, or failure to obtain, clearances or approvals for future products, including tests that are currently in development, would result in delayed, or no, realization of revenues from such products and in substantial additional costs which could decrease our profitability. We have limited experience in filing FDA applications for 510(k) clearance and premarket approval. There are no assurances that we will obtain any required clearance or approval. Any such failure, or any material delay in obtaining the clearance or approval, could harm our business, financial condition and results of operations.

We and our customers are subject to various governmental regulations, and we may incur significant expenses to comply with, and experience delays in our product commercialization as a result of, these regulations.

The products we develop, manufacture and market are subject to regulation by the FDA and numerous other federal, state and foreign governmental authorities. We generally are prohibited from marketing our products in the United States unless we obtain either 510(k) clearance or premarket approval from the FDA.

In addition, we are required to continue to comply with applicable FDA and other regulatory requirements once we have obtained clearance or approval for a product. These requirements include the Quality System Regulation, labeling requirements, the FDA’s general prohibition against promoting products for unapproved or “off-label” uses and adverse event reporting regulations. Failure to comply with applicable FDA product regulatory requirements could result in warning letters, fines, injunctions, civil penalties, repairs, replacements, refunds, recalls or seizures of products, total or partial suspension of production, the FDA’s refusal to grant future pre-market clearances or approvals, withdrawals or suspensions of current product applications and criminal prosecution. Any of these actions, in combination or alone, could prevent us from selling our products and would likely harm our business.

Our manufacturing facilities are subject to periodic regulatory inspections by the FDA and other federal and state regulatory agencies. The use of our diagnostic products by our customers is also affected by the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and related federal and state regulations that provide for regulation of laboratory testing. CLIA is intended to ensure the quality and reliability of clinical laboratories in the United States by mandating specific standards in the areas of personnel qualifications, administration, participation in proficiency testing, patient test management, quality and inspections. Current or future CLIA requirements or the promulgation of additional regulations affecting laboratory testing may prevent some laboratories from using some or all of our diagnostic products.

The FDA and foreign governmental regulators have made, and may continue to make, changes in approval requirements and processes. We cannot predict what these changes will be, how or when they will occur or what effect they will have on the regulation of our products. Any new regulations, including regulations specifically related to nanotechnology, may impose additional costs or lengthen review times of our products. Delays in receipt of or failure to receive regulatory approvals or clearances for our new products would have a material adverse effect on our business, financial condition and results of operations.

If third-party payors do not reimburse our customers for the use of our clinical diagnostic products or if they reduce reimbursement levels, our ability to sell our products will be harmed.

We intend to sell our products primarily to hospital-based laboratories and academic research institutions, substantially all of which receive reimbursement for the health care services they provide to their patients from third-party payors, such as Medicare, Medicaid and other domestic and international government programs, private insurance plans and managed care programs. Most of these third-party payors may deny reimbursement if they determine that a medical product was not used in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Third-party payors also may refuse to reimburse for procedures and devices deemed to be experimental.

In the United States, the American Medical Association assigns specific Current Procedural Terminology, or CPT, codes, which are necessary for reimbursement of diagnostic tests. Once the CPT code is established, the Centers for Medicare and Medicaid Services establish reimbursement payment levels and coverage rules under Medicaid and Medicare, and private payors establish rates and coverage rules independently. Although the tests performed by our assays in development have previously assigned CPT Codes, we cannot guarantee that our assays are covered by such CPT codes and are therefore approved for reimbursement by Medicare and Medicaid as well as most third-party payors. Additionally, certain of our future products may not be approved for reimbursement. Third-party payors may choose to reimburse our customers on a per test basis, rather than on the basis of the number of results given by the test. This may result in reference laboratories, public health institutions and hospitals electing to use separate tests to screen for each disease so that they can receive reimbursement for each test they conduct. In that event, these entities likely would purchase separate tests for each disease, rather than products that multiplex.

Third-party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement for medical products and services. Increasingly, Medicare, Medicaid and other third-party payors are challenging the prices charged for medical services, including clinical diagnostic tests. Levels of reimbursement may decrease in the future, and future legislation, regulation or reimbursement policies of third-party payors may adversely affect the demand for and price levels of our products. If our customers are not reimbursed for our products, they may reduce or discontinue purchases of our products, which would cause our revenues to decline.

We may fail to receive positive clinical results from the diagnostic tests currently in development that require clinical trials, and even if we receive positive clinical results, we may still fail to receive the necessary clearances or approvals to market our products.

We are investing in the research and development of new products to expand the menu of testing options for the Verigene System. In order to commercialize our products, we are required to undertake time consuming and costly development activities, sometimes including clinical trials for which the outcome is uncertain. Products that appear promising during early development and preclinical studies may, nonetheless, fail to demonstrate the results needed to support regulatory approval. Even if we receive positive clinical results, we may still fail to obtain the necessary FDA clearance and approvals.

Our operating results may be variable and unpredictable.

The sales cycles for our products may be lengthy, which will make it difficult for us to accurately forecast revenues in a given period, and may cause revenues and operating results to vary significantly from period to period. In addition to its length, the sales cycle associated with our products is subject to a number of significant risks, including the budgetary constraints of our customers, their inventory management practices and possibly internal acceptance reviews, all of which are beyond our control. Sales of our products will also involve the purchasing decisions of large, medium and small hospitals and laboratories which can require many levels of pre-approvals, further lengthening sales time. As a result, we may expend considerable resources on unsuccessful sales efforts or we may not be able to complete transactions on the scheduled anticipated.

If we do not achieve significant product revenue, we may not be able to meet our cash requirements without obtaining additional capital from external sources, and if we are unable to do so, we may have to curtail or cease operations.

We expect capital outlays and operating expenditures to increase over the next few years as we expand our infrastructure, commercialization, manufacturing, and research and development activities. We anticipate that our current cash and cash equivalents, which include the net proceeds of our initial and secondary public offerings, will be sufficient to meet our estimated needs for approximately two years. However, we operate in a market that makes our prospects difficult to evaluate, and we may need additional financing to execute on our current or future business strategies. The amount of additional capital we may need to raise depends on many factors, including:

	•		the level of research and development investment required to maintain and improve our technology;
	•		the amount and growth rate, if any, of our revenues;
	•		changes in product development plans needed to address any difficulties in manufacturing or commercializing the Verigene System and enhancements to our system;
	•		the costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;
	•		competing technological and market developments;
	•		our need or decision to acquire or license complementary technologies or acquire complementary businesses;
	•		the expansion of our sales force; and
	•		changes in regulatory policies, practices or laws that affect our operations, including clearance to market our products.

We cannot be certain that additional capital will be available when and as needed or that our actual cash requirements will not be greater than anticipated. If we require additional capital at a time when investment in diagnostics companies or in the marketplace in general is limited due to the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter. In addition, if we raise additional funds through the issuance of common stock or convertible securities, the percentage ownership of our stockholders could be significantly diluted, and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we obtain additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technologies or products, or grant licenses on terms that are not favorable to us.

The adverse capital and credit market conditions could affect our liquidity.

Adverse capital and credit market conditions could affect our ability to meet liquidity needs, as well as our access to capital and cost of capital. The capital and credit markets have been experiencing extreme volatility and disruption for more than 12 months. In recent months, the volatility and disruption have reached unprecedented levels and the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers. For example, recently credit spreads have widened considerably. Our results of operations, financial condition, cash flows and capital position could be materially adversely affected by continued disruptions in the capital and credit markets.

If our products do not perform as expected or the reliability of the technology on which our products are based is questioned, we could experience lost revenue, delayed or reduced market acceptance of our products, increased costs and damage to our reputation.

Our success depends on the market’s confidence that we can provide reliable, high-quality diagnostics systems. We believe that customers in our target markets are likely to be particularly sensitive to product defects and errors.

Our reputation and the public image of our products or technologies may be impaired if our products fail to perform as expected or our products are perceived as difficult to use. Our products are complex and may develop or contain undetected defects or errors. Any defects or errors could lead to the filing of product liability claims, which could be costly and time-consuming to defend and result in substantial damages. If we experience a sustained material defect or error, this could result in loss or delay of revenues, delayed market acceptance, damaged reputation, diversion of development resources, legal claims, increased insurance costs or increased service and warranty costs, any of which could materially harm our business. We cannot assure you that our product liability insurance would protect our assets from the financial impact of defending a product liability claim. A product liability claim could have a serious adverse effect on our business, financial condition and results of operations.

We rely on third-party license agreements for patents and other technology related to our products, and the termination of these agreements could delay or prevent us from being able to commercialize our products.

As of December 31, 2009, our patent portfolio is comprised, on a worldwide basis, of 132 issued patents and 97 pending patent applications which we own directly or for which we are the exclusive licensee. Some of these patents and patent applications derive from a common parent patent application or are foreign counterpart patent applications and relate to similar or identical technological claims. The issued patents cover approximately 12 different technological claims and the pending patent applications cover approximately 4 additional technological claims.

Many of our issued and pending patents were exclusively licensed from the International Institute for Nanotechnology at Northwestern University (“Northwestern”) in May 2000 and they generally cover our core technology, including nanotechnology based biodiagnostics and biobarcode technology. Our issued patents expire between 2017 and 2025. Our patent portfolio provides protection against other companies offering products employing the same technologies and methods as we have patented. While we believe our patent portfolio establishes a proprietary position, there are many competitive products utilizing other technologies that do not infringe on our patents.

In addition, we have non-exclusive licenses for 44 patents that cover 12 different technological claims from various third parties. Most of these license agreements require us to pay the licensor royalty fees that typically expire upon the patent expiration dates which range from 2009 to 2025. These license agreements are nonexclusive and do not create a proprietary position. The expiration of these non-exclusive licenses will result in the termination of certain royalty payments by us to the licensors.

If we are unable to obtain, maintain and enforce intellectual property protection covering our products, others may be able to make, use, or sell our products, which could adversely affect our ability to compete in the market.

Our success is dependent in part on obtaining, maintaining and enforcing intellectual property rights, including patents. If we are unable to obtain, maintain and enforce intellectual property legal protection covering our products, others may be able to make, use or sell products that are substantially identical to ours without incurring the sizeable discovery, development and licensing costs that we have incurred, which would adversely affect our ability to compete in the market.

We seek to obtain and maintain patents and other intellectual property rights to restrict the ability of others to market products that compete with our products. Currently, our patent portfolio is comprised, on a worldwide basis, of 132 issued patents and 97 pending patent applications which, in either case, we own directly or for which we are the exclusive licensee. However, patents may not be issued from any pending or future patent applications owned by or licensed to us, and moreover, issued patents owned or licensed to us now or in the future may be found by a court to be invalid or otherwise unenforceable. Also, even if our patents are determined by a court to be valid and enforceable, they may not be sufficiently broad to prevent others from marketing products similar to ours or designing around our patents, despite our patent rights, nor provide us with freedom to operate unimpeded by the patent rights of others.

Furthermore, we cannot be certain that we were the first to make the invention claimed in our United States issued patents or pending patent applications, or that we were the first to file for protection of the inventions claimed in our foreign issued patents or pending patent applications. We may become subject to interference proceedings conducted in the patent and trademark offices of various countries to determine our entitlement to patents, and these proceedings may conclude that other patents or patent applications have priority over our patents or patent applications. It is also possible that a competitor may successfully challenge our patents through various proceedings and those challenges may result in the elimination or narrowing of our patents, and therefore reduce our patent protection. Accordingly, rights under any of our issued patents, patent applications or future patents may not provide us with commercially meaningful protection for our products or afford us a commercial advantage against our competitors or their competitive products or processes.

We have a number of foreign patents and applications. However, the laws of some foreign jurisdictions do not protect intellectual property rights to the same extent as laws in the United States, and many companies have encountered significant difficulties in protecting and defending such rights in foreign jurisdictions. If we encounter such difficulties or we are otherwise precluded from effectively protecting our intellectual property rights in foreign jurisdictions, our business prospects could be substantially harmed.

We may initiate litigation to enforce our patent rights, which may prompt our adversaries in such litigation to challenge the validity, scope or enforceability of our patents. Patent litigation is complex and often difficult and expensive, and would consume the time of our management and other significant resources. In addition, the outcome of patent litigation is uncertain. If a court decides that our patents are not valid, not enforceable or of a limited scope, we may not have the right to stop others from using the subject matter covered by those patents.

We also rely on trade secret protection to protect our interests in proprietary know-how and for processes for which patents are difficult to obtain or enforce. We may not be able to protect our trade secrets adequately. In addition, we rely on non-disclosure and confidentiality agreements with our employees, consultants and other parties to protect, in part, our trade secrets and other proprietary technology. These agreements may be breached and we may not have adequate remedies for any breach. Moreover, others may independently develop equivalent proprietary information, and third parties may otherwise gain access to our trade secrets and proprietary knowledge. Any disclosure of confidential data into the public domain or to third parties could allow our competitors to learn our trade secrets and use the information in competition against us.

Our products could infringe patent rights of others, which may require costly litigation and, if we are not successful, could cause us to pay substantial damages or limit our ability to commercialize our products.

Our commercial success depends on our ability to operate without infringing the patents and other proprietary rights of third parties. We are aware of third party patents that may relate to our products and technology. There may also be other patents that relate to our products and technology of which we are not aware. We may unintentionally infringe upon valid patent rights of third parties. Although we are currently not involved in any material litigation involving patents, a third party patent holder could assert a claim of patent infringement against us in the future. Alternatively, we may initiate litigation against the third party patent holder to request that a court declare that we are not infringing the third party’s patent and/or that the third party’s patent is invalid or unenforceable. If a claim of infringement is asserted against us and is successful, and therefore we are found to infringe, we could be required to pay damages for infringement, including treble damages if it is determined that we knew or became aware of such a patent and we failed to exercise due care in determining whether or not we infringed the patent. If we have supplied infringing products to third parties or have licensed third parties to manufacture, use or market infringing products, we may be obligated to indemnify these third parties for damages they may be required to pay to the patent holder and for any losses they may sustain. We can also be prevented from selling or commercializing any of our products that use the infringing technology in the future, unless we obtain a license from such third party. A license may not be available from such third party on commercially reasonable terms, or may not be available at all. Any modification to include a non-infringing technology may not be possible or if possible may be difficult or time-consuming to develop, and require revalidation, which could delay our ability to commercialize our products.

Any infringement action asserted against us, even if we are ultimately successful in defending against such action, would likely delay the regulatory approval process of our products, harm our competitive position, be expensive and require the time and attention of our key management and technical personnel.

We have limited experience in sales and marketing and may be unable to successfully commercialize our Verigene System, or it may be difficult to build brand loyalty.

We have limited marketing, sales and distribution experience and capabilities. Our ability to achieve profitability depends on attracting customers for the Verigene System and building brand loyalty. To successfully perform sales, marketing, distribution and customer support functions ourselves, we will face a number of risks, including:

	•		our ability to attract and retain the skilled support team, marketing staff and sales force necessary to commercialize and gain market acceptance for our technology and our products;
	•		the ability of our sales and marketing team to identify and penetrate the potential customer base including hospitals, research institutions, and independent diagnostic laboratories;
	•		the time and cost of establishing a support team, marketing staff and sales force; and
	•		the difficulty of establishing brand recognition and loyalty for our products.

In addition, we may seek to enlist one or more third parties to assist with sales, distribution and customer support globally or in certain regions of the world. If we do seek to enter into such arrangements, we may not be successful in attracting desirable sales and distribution partners, or we may not be able to enter into such arrangements on favorable terms. If our sales and marketing efforts, or those of any third-party sales and distribution partners, are not successful, our technologies and products may not gain market acceptance, which would materially impact our business operations.

We may be unsuccessful in our long-term goal of expanding our product offerings outside the United States.

To the extent we begin to offer our products broadly outside the United States, we expect that we will be dependent on third-party distribution relationships. Distributors may not commit the necessary resources to market and sell our products to the level of our expectations. If distributors do not perform adequately, or we are unable to locate distributors in particular geographic areas, our ability to realize long-term international revenue growth would be materially adversely affected.

Additionally, our products may require regulatory clearances and approvals from jurisdictions outside the United States. These products may not be sold in these jurisdictions until the required clearances and approvals are obtained. We cannot assure you that we will be able to obtain these clearances or approvals on a timely basis, or at all.

Manufacturing risks and inefficiencies may adversely affect our ability to produce products.

We must manufacture or engage third parties to manufacture components of our products in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs and complying with regulatory requirements. In determining the required quantities of our products and the manufacturing schedule, we must make significant judgments and estimates based on historical experience, inventory levels, current market trends and other related factors. Because of the inherent nature of estimates, there could be significant differences between our estimates and the actual amounts of products we require. Additionally, some of the components of the Verigene System are custom-made by only a few outside vendors, and we do not have long-term supply contracts for the materials or components supplied by any of our vendors. If we are unable to obtain from one or more of these vendors the needed materials or components that meet our specifications on commercially reasonable terms, or at all, we may not be able to meet the demand for our products. We have not arranged for alternate suppliers, and it may be difficult to find alternate suppliers in a timely manner and on terms acceptable to us.

We manufacture in one facility. If there were to be a significant disruption in our ability to use this facility, it would take significant time to setup and validate an alternative manufacturing facility. Disruptions due to lack of power, flooding, fire and environmental controls could adversely impact our ability to manufacture. In addition, we have been steadily increasing manufacturing capacity to meet demand for our products. A disruption of our manufacturing operations resulting from scale-up related challenges such as obtaining sufficient raw materials, hiring of qualified factory personnel, installation and efficient operation of new equipment, and management of our quality controls could cause us to cease, delay, or limit our manufacturing operations and consequently adversely impact our business, our results of operations and our financial condition.

We may experience unforeseen technical complications in the processes we use to develop, manufacture, customize or receive orders for our products. These complications could materially delay or limit the use of products we attempt to commercialize, substantially increase the anticipated cost of our products or prevent us from implementing our processes at appropriate quality and scale levels, thereby causing our business to suffer. In addition, our manufacturing operations use highly technical processes involving unique, proprietary techniques that our manufacturing personnel must continuously monitor and update, especially as we develop more products. In order to be profitable, we must manufacture greater quantities of products than we have to date and we must do this more efficiently than we have in the past. We may not be able to do so.

We will need to develop manufacturing capacity by ourselves or with third parties.

We will need to either continue to build internal manufacturing capacity or contract with one or more manufacturing partners, or both. We currently use a combination of outsourced and internal manufacturing activities. We may encounter difficulties in manufacturing our products and, due to the complexity of our technology and our manufacturing process, we cannot be sure we fully understand all of the factors that affect our manufacturing processes or product performance. We may not be able to build manufacturing capacity internally or find one or more suitable manufacturing partners, or both, to meet the volume and quality requirements necessary to be successful in the market. If our products do not consistently meet our customers’ performance expectations, we may be unable to generate sufficient revenues to become profitable. Significant additional resources, implementation of additional manufacturing equipment and changes in our manufacturing processes and organization may be required for the scale-up of each new product prior to commercialization or to meet increasing customer demand once commercialization begins, and this work may not be successfully or efficiently completed. Any delay in establishing or inability to expand our manufacturing capacity could delay our ability to develop or sell our products, which would result in lost revenue and seriously harm our business, financial condition and results of operations.

Our business and future operating results may be adversely affected by events outside of our control.

We develop and manufacture the Verigene System and assays in our facility located in Northbrook, Illinois. This facility and the manufacturing equipment we use would be costly to replace and could require substantial lead time to repair or replace. Our business and operating results may be harmed due to interruption of our manufacturing by events outside of our control, including earthquakes, tornadoes and fires. Other possible disruptions may include power loss and telecommunications failures. In the event of a disruption, we may lose customers and we may be unable to regain those customers thereafter. Our insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.

We face intense competition from established and new companies in the molecular diagnostics field.

We compete with companies that design, manufacture and market already existing and new molecular diagnostics systems, and single target or low count multiplexing systems and assays are abundant. We anticipate that we will face increased competition in the future as new companies enter the market with new technologies and our competitors improve their current products. One or more of our competitors may offer technology superior to ours and render our technology obsolete or uneconomical. If a competitor were able to deliver a testing application that offers simplicity and ease of use, high count multiplexing and high throughput and fast turnaround, our ability to successfully market our products would be materially adversely affected. Most of our current competitors, as well as many of our potential competitors, have greater name recognition, more substantial intellectual property portfolios, longer operating histories, significantly greater resources to invest in new technologies and more substantial experience in new product development, regulatory expertise, manufacturing capabilities and the distribution channels to deliver products to customers. If we are not able to compete successfully, we may not generate sufficient revenue to become profitable.

Our success may depend upon how we and our competitors anticipate and adapt to market conditions.

The markets for our products are characterized by rapidly changing technology, evolving industry standards, changes in customer needs, emerging competition and new product introductions. The success of our products will depend on our ability to continue to increase their performance and decrease their price. New technologies, techniques or products could emerge with similar or better price-performance than our system and could exert pricing pressures on our products. It is critical to our success for us to anticipate changes in technology and customer requirements and to successfully introduce enhanced and competitive technology to meet our customers’ and prospective customers’ needs on a timely basis. We may not be able to maintain our technological advantages over emerging technologies in the future and we will need to respond to technological innovation in a rapidly changing industry. If we fail to keep pace with emerging technologies our system will become uncompetitive, our market share will decline and our business, revenue, financial condition and operating results could suffer materially.

We may not be able to manage our anticipated growth, and we may experience constraints or inefficiencies caused by unanticipated acceleration and deceleration of customer demand.

Demand for our respiratory products is directly proportionate to the size and duration of influenza and other respiratory illnesses. Unanticipated acceleration and deceleration of customer demand for our products may result in constraints or inefficiencies related to our manufacturing, sales force, implementation resources and administrative infrastructure. Such constraints or inefficiencies may adversely affect us as a result of delays, lost potential product sales or loss of current or potential customers due to their dissatisfaction. Similarly, over-expansion or investments in anticipation of growth that does not materialize, or develops more slowly than we expect, could harm our financial results and result in overcapacity.

To manage our anticipated future growth effectively, we must enhance our manufacturing capabilities and operations, information technology infrastructure, and financial and accounting systems and controls. Organizational growth and scale-up of operations could strain our existing managerial, operational, financial and other resources. Our growth could require significant capital expenditures and may divert financial resources from other projects, such as the development of new products or enhancements of existing products. If our management is unable to effectively manage our growth, our expenses may increase more than expected, our revenue could grow more slowly than expected and we may not be able to achieve our research and development and commercialization goals. Our failure to manage our anticipated growth effectively could have a material adverse effect on our business, operating results or financial condition.

We use hazardous chemicals, biological materials, and infectious diseases 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 and manufacturing processes involve the controlled use of hazardous materials, including chemicals, biological materials and infectious diseases. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our insurance coverage and our total assets. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these hazardous materials and specified waste products, as well as the discharge of pollutants into the environment and human health and safety matters. Compliance with environmental laws and regulations may be expensive, and may impair our research, development and production efforts. If we fail to comply with these requirements, we could incur substantial costs, including civil or criminal fines and penalties, clean-up costs, or capital expenditures for control equipment or operational changes necessary to achieve and maintain compliance. In addition, we cannot predict the impact on our business of new or amended environmental laws or regulations, or any changes in the way existing and future laws and regulations are interpreted and enforced.

If we are unable to recruit and retain key executives and scientists, we may be unable to achieve our goals.

Our performance is substantially dependent on the performance of our senior management and key scientific and technical personnel. The loss of the services of any member of our senior management or our scientific or technical staff could divert management’s attention to transition matters and identification of suitable replacements, if any, and have a material adverse effect on our business, operating results and financial condition. Each of our executive officers and other key employees could terminate his or her relationship with us at any time. We do not maintain key man life insurance on any of our employees.

In addition, our product development and marketing efforts could be delayed or curtailed if we are unable to attract, train and retain highly skilled employees and scientific advisors, particularly our management team, senior scientists and engineers and sales and marketing personnel. To expand our research, product development and sales efforts we need additional people skilled in areas such as protein science, information services, manufacturing, sales, marketing and technical support. Because of the complex and technical nature of our system and the dynamic market in which we compete, any failure to attract and retain a sufficient number of qualified employees could materially harm our ability to develop and commercialize our technology. We may not be successful in hiring or retaining qualified personnel and our failure to do so could have a material adverse effect on our business, financial condition and results of operations.

Healthcare reform and restrictions on reimbursement may adversely affect our profitability.

In the United States, healthcare providers that purchase our products and other diagnostic products generally rely on third-party payors to reimburse all or part of the cost of the procedure. In international markets, reimbursement and healthcare payment systems vary significantly by country, and include both government-sponsored healthcare and private insurance. Third-party payors can affect the pricing or the relative attractiveness of our products by regulating the maximum amount of reimbursement provided by such payors for laboratory testing services. Lower-than-expected or decreases in reimbursement amounts for tests performed using our products may decrease amounts physicians and other practitioners are able to charge patients, which in turn may adversely affect the willingness of physicians and other practitioners to purchase our products at prices we target, or at all. If we were not able to sell our products at target prices, then we will suffer a decrease in expected profitability that would likely adversely affect our business, financial condition and results of operations.

Risks Related to Our Common Stock

The market price of our common stock may be volatile and fluctuate significantly, which could result in substantial losses for investors and subject us to securities class action litigation.

Market prices of diagnostics companies have been volatile. Among the factors that may cause the market price of our common stock to fluctuate are the risks described in this “Risk Factors” section and other factors, including:

•		fluctuations in our quarterly operating results or the operating results of our competitors;
•		changes in estimates of our financial results or recommendations by securities analysts;
•		variance in our financial performance from the expectations of securities analysts;
•		changes in the estimation of the future size and growth rate of our markets;
•		changes in accounting principles or changes in interpretations of existing principles, which could affect our financial results;
•		failure of our products to achieve or maintain market acceptance or commercial success;
•		conditions and trends in the markets we serve;
•		changes in general economic, industry and market conditions;
•		success of competitive products and services;
•		changes in market valuations or earnings of our competitors;
•		changes in our pricing policies or the pricing policies of our competitors;
•		announcements of significant new products, contracts, acquisitions or strategic alliances by us or our competitors;
•		changes in legislation or regulatory policies, practices, or actions;
•		the commencement or outcome of litigation involving our company, our general industry or both;
•		recruitment or departure of key personnel;
•		changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;
•		actual or expected sales of our common stock by our stockholders; and
•		the trading volume of our common stock.

In addition, the stock market in general, the NASDAQ Global Market and the market for diagnostics companies in particular, may experience a loss of investor confidence. Such loss of investor confidence may result in extreme price and volume fluctuations in our common stock that are unrelated or disproportionate to the operating performance of our business, financial condition or results of operations. These broad market and industry factors may materially harm the market price of our common stock and expose us to securities class action litigation. Such litigation, even if unsuccessful, could be costly to defend and divert management’s attention and resources, which could further materially harm our financial condition and results of operations.

If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

The liquidity of the trading market for our common stock may be affected in part by the research and reports that equity research analysts publish about us and our business. We do not control the opinions of these analysts. The price of our stock could decline if one or more equity analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business.

Certain provisions of our corporate governing documents could make an acquisition of our company more difficult.

Certain provisions of our organizational documents could discourage potential acquisition proposals, delay or prevent a change in control of us or limit the price that investors may be willing to pay in the future for shares of our common stock. For example, our amended and restated certificate of incorporation and amended and restated by-laws:

•		authorize the issuance of preferred stock that can be created and issued by our board of directors without prior stockholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock;
•		limit the persons who can call special stockholder meetings;
•		provide that a majority vote of our stockholders is required to amend our amended and restated certificate of incorporation and amended and restated by-laws;
•		establish advance notice requirements to nominate persons for election to our board of directors or to propose matters that can be acted on by stockholders at stockholder meetings;
•		not provide for cumulative voting in the election of directors; and
•		provide for the filling of vacancies on our board of directors by action of a majority of the directors and not by the stockholders.

These and other provisions in our organizational documents could allow our board of directors to affect your rights as a stockholder in a number of ways, including making it more difficult for stockholders to replace members of the board of directors. Because our board of directors is responsible for approving the appointment of members of our management team, these provisions could in turn affect any attempt to replace the current management team. These provisions could also limit the price that investors would be willing to pay in the future for shares of our common stock.

Our amended and restated articles of incorporation provide that Section 203 of the Delaware General Corporation Law, an anti-takeover law, will not apply to us. Section 203 generally prohibits an interested stockholder from engaging in certain types of business combinations with a Delaware corporation for three years after becoming an interested stockholder. An “interested stockholder” is a person who, together with affiliates and associates, owns 15% or more of the corporation.

Our 2007 Long-Term Incentive Plan includes an automatic share replenishment, or “evergreen,” provision that, unless our board of directors takes action to the contrary, will automatically increase the number of shares of our common stock reserved for issuance under this plan each year. Issuances of awards under this Plan would cause further dilution to existing stockholders.

In March 2007 our board of directors adopted and our shareholders approved our 2007 Long-Term Incentive Plan (the “2007 Plan”). The 2007 Plan authorizes the grant of stock options, share appreciation rights, restricted shares, restricted share units, unrestricted shares, incentive stock options, deferred share units and performance awards. The total awards originally authorized under the 2007 Plan was 4,106,009 shares, plus up to an additional 773,591 shares of common stock that will become available in the event that awards made under our 2000 Equity Incentive Plan expire, are forfeited or cancelled, plus an annual increase in the number of shares pursuant to the evergreen provision equal to the least of: 900,000 shares of common stock; 4.0% of our outstanding shares of common stock as of fiscal year end; and an amount determined by the board of directors.

At December 31, 2009, there were 28,422,461 outstanding shares of our common stock. In addition, there were outstanding options to purchase 4,338,695 shares of our common stock (including 620,732 shares authorized pursuant to the evergreen provision of the Plan), of which 3,843,095 were in-the-money based on our December 31, 2009 closing stock price. Pursuant to the evergreen provision, an additional 900,000 shares of our common stock were authorized for issuance under the 2007 Plan as of January 1, 2010. Collectively, the outstanding shares as of December 31, 2009, the in-the-money options and warrants as of December 31, 2009 and the additional shares authorized on January 1, 2010 pursuant to the evergreen provision were 33,165,556 (the “Adjusted Outstanding Shares”).

On January 1, 2011 and January 1, 2012, a maximum of 900,000 additional shares per year may be authorized under our 2007 Plan as a result of this evergreen provision. If the maximum number of shares under the evergreen provision were to be authorized and issued, the future shares issued under the evergreen provision would result in an approximate 5% increase in the Adjusted Outstanding Shares as of December 31, 2009.

The evergreen provision of the 2007 Plan will increase the likelihood that we will not request existing stockholders to authorize additional shares for issuance under the 2007 Plan or a new plan. However, other factors, such as a material increase in the number of our award-eligible employees, or competitive conditions to attract or keep valuable employees, may affect the likelihood of our requesting stockholders to authorize additional shares under this plan or a new plan. The issuance, perception that issuance may occur, or exercise of these options may have a dilutive impact on other stockholders and could have a material negative effect on the market price of our common stock.

We do not currently intend to pay dividends on our capital stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We have never declared or paid any cash dividends on our common stock, and we currently intend to invest our future earnings, if any, to fund the development and growth of our business. Therefore, we do not anticipate declaring or paying cash dividends on our common stock in the foreseeable future. The payment of dividends will be at the discretion of our board of directors and will depend on our results of operations, capital requirements, financial condition, future prospects, contractual arrangements, restrictions imposed by applicable law, any limitations on payments of dividends present in our current and future debt agreements, and other factors our board of directors may deem relevant. If we do not pay dividends, your ability to achieve a return on your investment in our company will depend on any future appreciation in the market price of our common stock. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.

We will continue to incur costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which may adversely affect our operating results and failure to achieve and maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could cause investors to lose confidence in our operating results and in the accuracy of our financial reports and could have a material adverse effect on our business and on the price of our common stock.

As a public company, we are required, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting for our 2009 fiscal year. Management is responsible for implementing controls and other procedures designed to ensure that information required to be disclosed by us in the reports that we file with the SEC is disclosed accurately and is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. While we have implemented the internal controls that we feel are necessary to comply with Section 404 of the Sarbanes Oxley Act, these controls may become inadequate because of changes in conditions or the degree of compliance with these policies or procedures may deteriorate.

Furthermore, as a public company, changing laws, regulations and standards relating to corporate governance and public disclosure, including regulations implemented by the Securities and Exchange Commission and the NASDAQ may increase legal and financial compliance costs and make some activities more time consuming. These laws, regulations and standards are subject to varying interpretations and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. We intend to invest resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If notwithstanding our efforts to comply with new laws, regulations and standards, we fail to comply, regulatory authorities may initiate legal proceedings against us and our business may be harmed.

Failure to comply with these rules might also make it more difficult for us to obtain certain types of insurance, including director and officer liability insurance, and we might be forced to accept reduced policy limits and coverage and/or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on committees of our board of directors, or as executive officers.

Concentration of ownership among some of our stockholders, including directors and management may limit your ability to influence corporate matters.

As of March 4, 2010, approximately 64% of our common stock including the exercise of all outstanding warrants and exercisable options to purchase our common stock will be beneficially held by our directors, our executive officers, and greater than five percent stockholders and their respective affiliates. Lurie Investment Fund, L.L.C., Lurie Investments, Inc., AOQ Trust, Alfa-Tech, L.L.C., and their respective affiliates, own 29% of our common stock, and Bain Capital Venture Fund 2005, L.P. and their respective affiliates own 7% of our common stock. Consequently, a small number of our stockholders may be able to substantially influence our management and affairs. If they choose to act together, they would be able to influence most matters requiring approval by our stockholders, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets and any other transaction. The concentration of ownership may also delay or prevent a change in control of us even if such changes might otherwise be beneficial to our stockholders. In addition the significant concentration of share ownership may adversely affect the trading price of our common stock because investors often perceive disadvantages in owning shares in companies with controlling stockholders.

Item 1B.		Unresolved Staff Comments.

None.

Item 2.		Properties.

Our executive, research and development and manufacturing functions are all located at a 40,945 square foot leased facility in Northbrook, Illinois. The lease for our Northbrook facility expires in May 2014. Our recently revised facilities lease includes the right of first offer on additional available space in our building. While we do not need to expand our facilities to meet anticipated demand for 2010, we will likely require expanded facilities to meet anticipated demand beyond 2010.

We do not own any real property.

Item 3.		Legal Proceedings.

We are from time to time subject to various claims and legal actions during the ordinary course of our business. We believe that there are currently no claims or legal actions that would, in management’s judgment based on information currently available, have a material adverse effect on our results of operations or financial condition.

In July 2009, the Company was named as a defendant in a lawsuit filed by Eppendorf AG alleging patent infringement. The Company intends to vigorously defend this case as it believes that the claims lack merit. The Company believes that the resolution to these proceedings will not have a material adverse effect on the Company’s financial position, liquidity or future operations. The Company has not recorded any reserves related to this case.

Item 4.		(Removed and Reserved).

PART II

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

Market Information

Our common stock has been traded on the NASDAQ Global Market since November 1, 2007 under the symbol “NSPH”. The following table sets forth the high and low sale prices for our common stock for each quarter of our two most recent fiscal years, as reported on the NASDAQ Global Market for the period indicated.

		High				Low
Fiscal year ended December 31, 2009
First Quarter		$	6.26			$	2.71
Second Quarter			5.58				2.95
Third Quarter			8.61				3.94
Fourth Quarter			7.85				5.60
Fiscal year ended December 31, 2008
First Quarter		$	14.61			$	6.78
Second Quarter			10.32				6.62
Third Quarter			12.00				7.10
Fourth Quarter			8.50				3.03

Stockholders

The last reported sale price of common stock on March 4, 2010 as reported on the NASDAQ Global Market was $3.20. As of March 4, 2010, there were 185 holders of record of our common stock.

Dividend Policy

We have never declared or paid any cash dividends on our common stock and do not expect to pay any dividends for the foreseeable future. We currently intend to retain any future earnings to fund the operation, development and expansion of our business. Any future determination to pay dividends will be at the sole discretion of our board of directors and will depend upon a number of factors, including our results of operations, capital requirements, financial condition, future prospects, contractual arrangements, restrictions imposed by applicable law, any limitations on payments of dividends present in our current and future debt arrangements, and other factors our board of directors may deem relevant.

Stock Performance Graph

The following graph shows a comparison of cumulative total stockholder returns for our common stock, the NASDAQ Composite Index and the NASDAQ Biotechnology Index. The graph assumes the investment of $100 on November 1, 2007, and the reinvestment of all dividends. The performance shown is not necessarily indicative of future performance.

Investment Return Analysis		Nov 07				Dec 07				Mar 08				Jun 08				Sep 08				Dec 08				Mar 09				Jun 09				Sep 09				Dec 09
Nanosphere		$	100.00			$	99.93			$	61.86			$	56.14			$	60.93			$	34.00			$	35.50			$	35.07			$	51.14			$	46.00
NASDAQ Composite		$	100.00			$	93.55			$	80.39			$	80.88			$	73.79			$	55.63			$	53.92			$	64.73			$	74.86			$	80.04
NASDAQ Biotechnology		$	100.00			$	94.07			$	87.98			$	89.39			$	94.20			$	82.19			$	76.93			$	84.45			$	94.59			$	95.04

The information contained in the graph above shall not be deemed to be “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, or subject to Regulation 14A or 14C promulgated under the Exchange Act, other than as provided in Item 402 of the SEC’s Regulation S-K, or to the liabilities of Section 18 of the Exchange Act, except to the extent that Nanosphere specifically requests that the information be treated as soliciting material or specifically incorporates it by reference in such filing.

Equity Compensation Plan Information

The following table provides information as of December 31, 2009 with respect to shares of the Company’s common stock that may be issued under the 2007 Plan, which is the Company’s only existing equity compensation plan under which grants can be made. Stockholders approved the Company’s 2007 Plan on March 27, 2007.

Equity Compensation Plan Information

Number of securities

remaining available for

future issuance under

Number of securities to be

equity compensation plans

issued upon exercise of

Weighted Average exercise

(excluding securities

outstanding awards

price of outstanding awards

reflected in column(a))

Plan Category

(a)

(b)

(c)

Equity compensation plans approved by stockholders

4,338,695

$

5.75

268,416

Equity compensation plans not approved by stockholders

—

—

—

Total

4,338,695

$

5.75

268,416

Item 6.		Selected Financial Data.

The following selected financial data should be read in conjunction with, and is qualified by reference to, our financial statements and related notes and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report.

		As of December 31,
Statements of Operations Data:		2009				2008				2007				2006				2005
Total revenue		$	2,214,103			$	1,366,732			$	1,167,364			$	1,138,011			$	1,914,517
Research and development expense			18,607,921				23,675,138				21,445,994				18,185,564				13,717,654
Sales, general and administrative expense			14,471,973				13,615,322				13,443,304				5,415,525				4,502,970
Net loss			(33,948,653	)			(37,041,996	)			(53,199,184	)			(24,269,918	)			(16,408,082	)
Net loss attributable to common stock			(33,948,653	)			(37,041,996	)			(59,284,411	)			(46,421,053	)			(19,306,869	)
Net loss per common share:
basic and diluted			(1.46	)			(1.67	)			(14.18	)			(53.63	)			(31.57	)
Weighted average number of common shares:
basic and diluted (1)(2)			23,301,764				22,213,164				4,180,979				865,559				611,496

		As of December 31,
Balance Sheet Data:		2009				2008				2007				2006				2005
Cash and cash equivalents (1)(2)		$	76,689,279			$	75,356,960			$	114,312,573			$	29,112,429			$	3,641,338
Working capital (1)(2)			71,152,601				69,027,249				107,684,875				27,332,463				(2,642,582	)
Total assets (1)(2)			88,668,954				86,895,910				125,963,862				37,968,243				9,015,260
Long-term debt			—				3,352,137				7,462,237				58,802				—
Convertible preferred stock (2)			—				—				—				108,868,040				51,143,984
Stockholders’ equity (deficit) (1)(2)			79,081,998				74,541,108				109,199,722				(108,307,662	)			(62,292,544	)

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

The following discussion and analysis is based primarily on the financial statements of Nanosphere, Inc. for the years presented and should be read together with the notes thereto contained in this annual report on Form 10-K. Terms employed herein as defined terms, but without definition, have the meanings set forth in the notes to the financial statements (see “Item 8. Financial Statements and Supplementary Data”).

Business Overview

We develop, manufacture and market an advanced molecular diagnostics platform, the Verigene System, that enables simple, low cost and highly sensitive genomic and protein testing on a single platform. Our proprietary nanoparticle technology simplifies molecular diagnostic testing, provides the ability to run multiple tests simultaneously on the same sample and has the potential to run a broad menu of tests on a single platform. We have developed or are currently developing diagnostic tests for markers which reveal the existence of a variety of medical conditions including cardiovascular, respiratory, cancer, autoimmune, neurodegenerative and other infectious diseases, as well as for pharmacogenomics.

Pharmacogenomics is an emerging subset of human genetic testing that correlates gene variation with a drug’s efficacy or toxicity. These tests play a key role in the advancement of personalized medicine where drug therapies and dosing are guided by each patient’s genetic makeup. There is a growing demand on laboratories to implement molecular diagnostic testing, but the cost and complexity of existing technologies and the need for specialized personnel and facilities have limited the number of laboratories with these capabilities.

The Verigene System is differentiated by its ease of use, rapid turnaround times and ability to support a broad test menu. It also offers lower cost for laboratories already performing molecular diagnostic testing and allows a broader range of laboratories, including those operated by local hospitals, to perform these tests. Our ability to detect proteins, which can be 100 times more sensitive than current technologies for certain targets, may enable earlier detection of and intervention in diseases associated with known biomarkers as well as the introduction of tests for new biomarkers that exist in concentrations too low to be detected by current technologies. We are focused on the clinical diagnostics market and may seek opportunities either directly or through partnerships to commercialize our technologies in other markets.

We received 510(k) clearance from the United States Food and Drug Administration (“FDA”) for commercial sale of the Verigene System in the second half of 2007. 510(k) clearance is granted by the FDA if the submitted information establishes that the proposed device is “substantially equivalent” to a legally marketed Class I or Class II medical device or a pre-amendment Class III medical device for which the FDA has not sought pre-market approval. We have also received 510(k) clearance to use the Verigene System for four diagnostic tests. The first test is a warfarin metabolism assay, which is a pharmacogenomic test to determine the existence of certain genetic information believed to affect the metabolism of warfarin-based drugs, including Coumadin, the most-prescribed oral anticoagulant in North America and Europe. The second test is a hyper-coagulation assay, one of the highest volume human genetic tests currently performed, to determine an individual’s risk, based upon genetic information, for the development of blood clots, which can lead to stroke, pulmonary embolism and deep vein thrombosis.

The third test is our respiratory panel which detects the presence of influenza A and B as well as respiratory syncitial virus (“RSV”) A and B. Influenza is commonly known as the seasonal flu and RSV is a respiratory virus that infects the lungs and breathing passages. RSV is the most common cause of bronchitis and pneumonia in children under the age of one year and has become a significant concern for older adults. Our respiratory panel provides physicians with a highly accurate, fast determination of which virus is present which helps guide the most appropriate treatment therapy. Most of the respiratory tests currently on the market take days to generate a result, because they depend on culturing, or do not provide a reliable result, because they are rapid tests which lack specificity.

On October 9, 2009, we received 510(k) clearance of our second generation respiratory panel and the Verigene SP System. The Verigene SP instrument automates sample preparation, which should significantly reduce laboratory technician time required to perform this molecular test. We also believe that our respiratory assay on the Verigene SP offers a simple to use molecular test for diagnosing respiratory infections and the flu, while providing improved specificity over currently available rapid tests. On November 24, 2009, we received clearance for a label change for this assay confirming that the novel H1N1 virus is detected as a positive Influenza A when using our respiratory assay and the Verigene SP. However, it is uncertain whether the ability to use this assay to detect H1N1 virus will be material to the Company based on the reduction in the number of recently reported H1N1 cases.

The fourth test is our cystic fibrosis test that enables molecular laboratories to perform prenatal screening and diagnostic confirmations through identification of the number of copies of each of the 23 most common gene mutations recognized by the American College of Obstetricians and Gynecologists as markers for cystic fibrosis.

We have elected to delay the launch of our 501(k) cleared cystic fibrosis test until such time as it may receive 510(k) clearance for use on the Verigene SP. In addition, we plan to submit additional FDA applications for each of our previously 510(k) cleared assays to allow their use on the new Verigene SP. We have engaged in dialogue with the FDA to identify the tests that we need to receive 510(k) clearance to run these assays on the Verigene SP.

In the first quarter of 2009, we filed a de novo 510(k) submission for a hereditary hemochromatosis (“HFE”) genetic test. We re-submitted an amended 510(k) submission in October 2009 to supply additional data requested by the FDA. Mutations in the HFE gene are associated with hemochromatosis, which is the leading cause of iron overload disease, a systematic iron build up that can eventually adversely affect the heart, liver, pancreas, joints and pituitary gland. Untreated, hemochromatosis can be fatal. Once detected, hemochromatosis is easily treated. Approximately one in every 250 people of European descent has the disease and one in eight is a carrier of at least one of the recessive gene mutations. This is a de novo 510(k) because there are currently no FDA-cleared tests on the market to detect these mutations of the HFE gene. We have received additional feedback from the FDA indicating that further testing would be necessary in order to proceed with this application. This assay was submitted for clearance on the original Verigene System and the FDA requires separate testing and a new application to clear this assay on the Verigene SP. Therefore, we plan to complete all necessary testing on the Verigene SP and submit a new application for clearance of this assay on the Verigene SP.

The first ultra-sensitive protein test we plan to commercialize is for cardiac troponin I (“cTnI”), which is the gold standard biomarker for diagnosis of the occurrence of myocardial infarction or heart attack and identification of patients at risk for acute coronary syndrome. We submitted a 510(k) application to the FDA in the fourth quarter of 2009. We have received initial feedback from the FDA regarding our 510(k) submission indicating that significant further studies will be required to obtain clearance for our cTnI assay. We believe that some of the additional requirements suggested by the FDA may be addressed by results from our ongoing FAST-TRAC clinical study, which is designed to support and further demonstrate the clinical utility of ultra-sensitive cTnI measurements as a diagnostic tool for use in the management of both acute and chronic cardiac disease. We plan to complete the FAST-TRAC clinical studies along with any other studies necessary to respond to the FDA’s requests in 2010.

We are currently conducting multi-site trials for our cytochrome P450 2C19 assay that detects genetic mutations associated with deficiencies to metabolize clopidogrel, more commonly known by the trade name Plavix. Clopidogrel inhibits platelet function and is a standard treatment to reduce the risk of thrombolytic events for patients undergoing percutaneous coronary intervention (“PCI”) procedures. Clopidogrel metabolism is affected by the Cytochrome P-450 family of genes. Up to 30-50% of the patient population possess variations in these genes and do not properly metabolize this drug, thus increasing the risk of adverse events. Our 2C19 assay is designed to identify patients possessing these variations so that alternative therapies can be prescribed to effectively reduce clotting post-PCI.

In addition, we currently have research and development efforts underway on additional genetic, infectious disease and protein tests. Our test development pipeline includes a blood infection screening assay, a human papillomavirus (“HPV”) assay for cervical cancer screening, an ultra-sensitive prostate-specific antigen (“PSA”) test for early diagnosis of recurrent prostate cancer and a multiplexed protein-based connective-tissue panel for the detection of rheumatoid arthritis, lupus and other related diseases. We are also investigating new biomarkers where our ultra-sensitive protein detection technology may enable earlier detection of a broad range of diseases. We are in the process of assessing the commercial viability of these applications and the various paths to regulatory approval that may be available.

Our technology is broadly applicable beyond the clinical diagnostic market in both research and industrial applications. The Verigene System is presently used in research laboratories supporting collaborations and independent research in areas including ovarian cancer, mad cow disease and HIV. We are currently working with the FDA on a joint research program to develop an H5N1 avian flu assay. We have developed and delivered a biosecurity platform for the detection of various bioterrorism agents to the Technical Support Working Group, an agency affiliated with the U.S. Department of Defense.

As of December 31, 2009, our patent portfolio is comprised, on a worldwide basis, of 132 issued patents and 97 pending patent applications which we own directly or for which we are the exclusive licensee. Some of these patents and patent applications derive from a common parent patent application or are foreign counterpart patent applications and relate to similar or identical technological claims. The issued patents cover approximately 12 different technological claims and the pending patent applications cover approximately 4 additional technological claims.

Many of our issued and pending patents were exclusively licensed from the International Institute for Nanotechnology at Northwestern University (“Northwestern”) in May 2000 and they generally cover our core technology, including nanotechnology based biodiagnostics and biobarcode technology. Our issued patents expire between 2017 and 2025. We believe our patent portfolio provides protection against other companies offering products employing the same technologies and methods as we have patented. While we believe our patent portfolio establishes a proprietary position, there are many competitive products utilizing other technologies that do not infringe on our patents.

In addition, as of December 31, 2009, we have non-exclusive licenses for at least 44 U.S. patents that cover 12 different technological claims from various third parties. Most of these license agreements require us to pay the licensor royalty fees that typically expire upon the patent expiration dates which range from 2010 to 2025. These license agreements are nonexclusive and do not create a proprietary position. The expiration of these non-exclusive licenses will result in the termination of certain royalty payments by us to the licensors.

Since inception we have incurred net losses each year, and we expect to continue to incur losses for the foreseeable future. Our net losses attributable to common stock were approximately $34 million for fiscal 2009. As of December 31, 2009, we had an accumulated deficit of approximately $239 million. Our operations to date have been funded principally through capital contributions from investors in two underwritten direct public offerings of common stock, and prior thereto in our convertible preferred stock, which was converted to common stock in 2007, and our debt borrowings.

In November 2007, we completed our initial public offering of 8,050,000 shares of common stock at $14.00 per share. We received approximately $102 million of net proceeds from our initial public offering. In October 2009, we completed a public offering of 5,405,000 shares of our common stock at $7.00 per share. We received approximately $35.4 million of net proceeds from this offering.

Financial Operations Overview

Revenue

Product sales revenue is derived from the sale or lease of the Verigene System, including cartridges and related products sold to research laboratories and hospitals. Grant and contract revenue consists of funds received under contracts and government grants, including funds for the reimbursement of certain research and development expenses. Our market efforts are primarily focused on driving product sales rather than grants and contracts. However, the Company recently completed development of certain custom pharmacogenetic assays to be used in conjunction with the clinical trials associated with new therapeutic drugs for a major pharmaceutical company. We will continue to be opportunistic with regard to future contract and grant opportunities.

Cost of Sales

Cost of sales represents the cost of materials, direct labor and other manufacturing overhead costs incurred to produce Verigene cartridges and instruments, as well as royalties on product sales, amortization of purchased intellectual property relevant to products available for sale and depreciation of instrument leases and rentals. Costs associated with custom assay development contracts also include labor associated with assay development, validation and testing.

Research and Development Expenses

Research and development expenses primarily include all costs incurred during the development of the Verigene System and assays, and the expenses associated with fulfilling our development obligations related to the United States government contracts and grants. Such expenses include salaries and benefits for research and development personnel, consulting services, materials, patent-related costs and other expenses. We expense all research and development costs in the periods in which they are incurred. We expect research and development expenses to grow modestly as we continue to develop future generations of the Verigene System, and additional genomic and protein tests.

Sales, General and Administrative Expenses

Sales, general and administrative expenses principally include compensation for employees in our sales, customer service, marketing, management and administrative functions. We also include professional services, facilities, technology, communications and administrative expenses in sales, general and administrative. The professional services costs primarily consist of legal and accounting costs. We expect sales and marketing expenses will increase as additional sales and customer support are needed to drive and support customer growth.

Interest Income

Interest income principally includes interest earned on our excess cash balances. Such balances are primarily invested in money market and bank checking accounts at major financial institutions. We anticipate that interest income will continue to decline as capital reserves are consumed by operating losses and working capital. Recent declines in interest rates will also contribute to reduced interest income for the foreseeable future.

Interest Expense

Interest expense includes the interest charges related to our debt borrowings, including non-cash amortization of debt discount and issuance costs.

Fiscal 2009 Compared to 2008

Revenues

Revenues were $2.2 million for fiscal 2009 as compared to $1.4 million for fiscal 2008. Product sales increased slightly to $1.1 million for fiscal 2009 as compared to $1.0 million for fiscal 2008. The change in product sales was driven by a 47% increase in consumables revenue and a 50% reduction in system sales. Fiscal 2009 revenues also included $1.0 million of service revenue related primarily to the assay development contracts with a major pharmaceutical company described earlier. Revenues from government grants were $0.3 million for fiscal 2008.

Cost of Sales

For fiscal 2009, cost of sales was $2.2 million, as compared to $1.5 million for fiscal 2008. The $0.7 million increase in cost of sales for fiscal 2009 resulted from the costs associated with assay development revenue from our commercial contracts, the increase in product sales and the fixed amortization of license fees. We have initiated several product cost reduction programs, which include initiatives to reduce the cost of materials and labor. We expect per unit material costs to decline as a result of process automation, additional multi-cavity molds and volume absorption of overhead. Per unit labor costs will be reduced through additional cartridge assembly automation, increased production lot sizes and higher overall volume. We expect to reduce cost per unit substantially as we implement these programs and as volume increases.

Research and Development Expenses

Research and development expenses decreased from $23.7 million in fiscal 2008 to $18.6 million in fiscal 2009. The $5.1 million decrease in research and development expenses for fiscal 2009 consists primarily of $2.0 million in staffing, $1.5 million of materials spending and $1.0 million in reduced facilities and depreciation expense. The staffing reduction was driven by a more narrow focus on core research and development projects. The materials reduction was primarily related to the completion of the up-front investment in Verigene SP development activities.

Sales, General and Administrative Expenses

Sales, general and administrative expenses increased from $13.6 million for fiscal 2008 to $14.5 million for fiscal 2009. The increase in sales, general and administrative expenses for fiscal 2009 consists primarily of a $1.4 million increase in clinical trial expenses associated with the FAST-TRAC Troponin I study intended to create market differentiation for this assay, partially offset by a decrease in spending due to the completion of the initial implementation of our Sarbanes-Oxley compliance program.

Interest Expense

Interest expense was $1.3 million for fiscal 2009 as compared to $2.1 million for fiscal 2008. The decrease in interest expense for fiscal 2009 resulted from increased principal payments and lower interest, in accordance with our loan and security agreements.

Interest Income

Interest income was $0.4 million and $2.5 million for fiscal 2009 and 2008, respectively. The decrease in interest income during fiscal 2009 resulted from a lower average cash balance during this period as compared to fiscal 2008. In addition, interest rates declined significantly for fiscal 2009 as compared to fiscal 2008.

Fiscal 2008 Compared to 2007

Revenues

Revenues were $1.4 million for fiscal 2008, as compared to $1.2 million for fiscal 2007. Product revenues increased to $1.0 million for fiscal 2008 from $0.1 million for fiscal 2007 due to sales and rentals of the Verigene System following clearance from the FDA during 2007. Revenues from contracts and government grants were $0.3 million for fiscal 2008 and $1.1 million for fiscal 2007.

Cost of Sales

For fiscal 2008, cost of sales was $1.5 million, as compared to $0.1 million for fiscal 2007. Cost of sales increased during 2008 due to the increase in Verigene System sales as well as a $0.3 million increase in amortization expense related to upfront license fees. Approximately 63% of the 2008 license fee amortization expense was associated with the license of a patent which expired in May 2009.

Research and Development Expenses

Research and development expenses increased to $23.7 million in fiscal 2008, from $21.4 million in fiscal 2007. The $2.3 million increase in research and development expenses for 2008 versus 2007 consisted primarily of $1.7 million in increased staffing and non-cash stock compensation expenses and $0.6 million in increased depreciation expense. Research and development staffing increases were primarily focused on development of our respiratory virus panel and Troponin I assays as well as Verigene SP. Depreciation expense increased primarily due to investments in leasehold improvements for lab space.

Sales, General and Administrative Expenses

Sales, general and administrative expenses remained relatively flat at $13.6 million for fiscal 2008 versus $13.4 million for fiscal 2007. Sales and marketing spending increased by $0.8 million due to personnel and marketing expenses associated with our initial product launches. General and administrative expenses increased by approximately $1.5 million for public company expenses such as insurance, legal and accounting expenses. These increases were offset by a $1.5 million decrease in payroll expense due primarily to a bonus paid to our chief executive officer in 2007. Additional expense reductions totaling $0.6 million related to franchise taxes, which were higher in 2007 due to our initial public offering, stock compensation expense, which was higher in 2007 due to shorter than normal vesting periods of certain stock options granted in 2007 and facilities maintenance expenses.

Change in Fair Value of Convertible Derivative Liability

Our Series C-2 and Series D Convertible Preferred Stock contained conversion features which were embedded derivatives and therefore required bifurcation and accounting at fair value separate and distinct from the convertible preferred stock. Changes in the fair value of the conversion liability were recognized in earnings. For fiscal 2007, the fair value of the conversion liability increased, resulting in a $14.9 million non-cash charge to earnings. The increase in fair value that resulted in the non-cash charge to earnings was due to the increased valuation of the Company. Upon the closing of our initial public offering, our preferred stock was converted into common stock and accordingly, we stopped incurring charges for this embedded derivative and the liability converted into additional paid-in capital.

Interest Expense

Interest expense remained relatively flat at $2.1 million for fiscal 2008 as compared to $2.0 million for fiscal 2007. In February 2007, the Company borrowed $12.5 million under two loan and security agreements with Venture Lending & Leasing IV, Inc., and Venture Lending & Leasing V, Inc.

Interest Income

Interest income was $2.5 million and $1.9 million for fiscal 2008 and 2007, respectively. The increase in interest income in 2008 resulted from the increase in cash from the initial public offering, which was significantly offset by the reduction in interest rates.

Liquidity and Capital Resources

From our inception in December 1999 through December 31, 2009, we have received net proceeds of $103.9 million from the sale of convertible preferred stock and issuance of notes payable that were exchanged for convertible preferred stock, $102.2 million from our November 2007 initial public offering, $35.4 million from our October 2009 underwritten public offering, $12.5 million from our debt borrowings, and $9.2 million from government grant revenue. We have devoted substantially all of these funds to research and development and sales, general and administrative expenses. Since our inception, we have generated minimal revenues from the sale of the Verigene System, including cartridges and related products, to our initial clinical customers, research laboratories and government agencies. We also incurred significant losses and, as of December 31, 2009, we had an accumulated deficit of approximately $239.3 million. While we are currently in the commercialization stage of operations, we have not yet achieved profitability and anticipate that we will continue to incur net losses for the foreseeable future.

Because we recently began to commercialize our products, we do not anticipate achieving positive operating cash flow before 2013. During this period we expect to increase spending on additional manufacturing scale-up, research and development costs to expand our assay menu and to develop a fully automated instrument with increased throughput, and continue to grow sales and marketing personnel. Achievement of positive cash flow from operations will depend upon revenue resulting from adoption of our initial products and expansion of the number of our FDA-cleared tests. Demand for our respiratory products is directly proportional to the size and duration of influenza and other respiratory illnesses. Any unanticipated acceleration or deceleration of customer demand for our products relative to projections will have a material effect on our cash flows. We anticipate that our current cash and cash equivalents will be sufficient to cover our operating and investing activities as well as our debt interest and principal obligations for approximately two years.

A customer may purchase the Verigene System, lease it from a third party or enter into a reagent rental agreement. Our reagent rental agreements include customer commitments to purchase a certain minimum volume of cartridges over the term of the agreement. As part of these agreements, a portion of the charge for each cartridge is a rental fee for use of the equipment. To date, our aggregate investment in systems rented to customers has not been material. However, we may need to increase investment in such systems to support future product placements under reagent rental agreements. We have established a relationship with a third party financing company to provide our customers with lease financing for their Verigene equipment. This arrangement will help mitigate the demand on our capital resources by allowing us to recover the cost of such systems immediately, instead of over three to five years.

As of December 31, 2009, we had $76.7 million in cash and cash equivalents, compared to $75.4 million at December 31, 2008. Cash used in operations decreased to $27.9 million for 2009 as compared to $32.0 million in 2008 due to a decrease in research and development expenses during 2009.

Net cash used in investing activities decreased to $1.8 million for the year ended December 31, 2009 from $2.7 million for the year ended December 31, 2008. Investments in property and equipment decreased $1.0 million during 2009 due to the significant spending in 2008 to scale-up manufacturing for the commencement of product commercialization activities.

Net cash provided by financing activities was $31.1 million for the year ended December 31, 2009, compared to cash used by financing activities of $4.2 million for the year ended December 31, 2008. In October 2009, we completed our public offering of 5,405,000 shares of common stock at $7.00 per share. We received approximately $35.4 million of net proceeds from this offering. In 2008 cash was used to repay our long-term debt, whereas in 2007, we received net proceeds of approximately $102 million from our initial public offering of 8,050,000 shares of common stock and we borrowed $12.5 million. In February 2007, we entered into two loan and security agreements with Venture Lending & Leasing IV, Inc. and Venture Lending & Leasing V, Inc. Pursuant to these loan agreements, we are required to pay interest and a minimal amount of principal, for the initial twelve month period, which ended in February 2008, followed by a thirty month period within which the note principal will be amortized. Interest was paid during the initial twelve month period at a fixed annual interest rate of 12.5% and will be paid during the following thirty month period at a fixed annual interest rate of 10.0%.

While we anticipate that our capital resources will be sufficient to meet our estimated needs for approximately two years, we may need to increase our capital outlays and operating expenditures over the next several years as we expand our product offering, drive product adoption, further scale-up manufacturing and implement product cost savings. The amount of additional capital we may need to raise depends on many factors, including:

•

the level of research and development investment required to maintain and improve our technology;

•

the amount and growth rate of our revenues;

•

changes in product development plans needed to address any difficulties in manufacturing or commercializing the Verigene System and enhancements to our system;

•

the costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

•

competing technological and market developments;

•

our need or decision to acquire or license complementary technologies or acquire complementary businesses; and

•

changes in regulatory policies or laws that affect our operations.

We cannot be certain that additional capital will be available when and as needed or that our actual cash requirements will not be greater than anticipated. If we require additional capital at a time when investment in diagnostics companies or in the marketplace in general is limited due to the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter. In addition, if we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we obtain additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technologies or products, or grant licenses on terms that are not favorable to us.

Income Taxes

Since inception, we have incurred operating losses and, accordingly, have not recorded a provision for income taxes for any of the periods presented. As of December 31, 2009, we had net operating loss carryforwards for federal and state income tax purposes of $157 million. The Company also has federal research and development tax credit carryforwards of $8 million which will begin to expire in 2020. Section 382 of the Internal Revenue Code subjects the utilization of net operating loss and credit carryforwards to an annual limitation that is applicable if the Company experiences an ownership change. The Company believes its public offerings and/or prior equity investments may have triggered an ownership change as defined by the Internal Revenue Code. However, the Company has yet to perform the computations under Section 382 which would determine the amount of annual limitation on its utilization of its net operating loss and tax credit carryforwards. The annual limitation may result in the expiration of the Company’s net operating loss and tax credit carryforwards before they can be used.

Contractual Obligations and Commitments

As of December 31, 2009, the annual amounts of future minimum payments under certain of our contractual obligations were:

		Payments Due by Period
Contractual Obligations		Total				Less than 1 Year				1-3 Years				3-5 Years				More than 5 Years
Long-term debt obligations		$	3,917,293			$	3,917,293			$	—			$	—			$	—
Interest on long-term debt obligations			195,107				195,107				—				—				—
Operating lease			1,972,488				465,595				865,564				641,329				—
Obligations under license agreements			1,783,750				173,750				365,000				425,000				820,000
Total		$	7,868,638			$	4,751,745			$	1,230,564			$	1,066,329			$	820,000

On August 28, 2009, the Company executed a lease renewal which commences on June 1, 2010 and ends on May 31, 2014. Base rent on the lease renewal will range from $34,957 per month for the first twelve months of the lease to $38,026 per month for the final twelve months of the lease renewal. The Company will also pay as additional rent its proportionate share of real estate taxes and operating expenses, which include all costs of operating, maintaining, replacing and repairing the leased facility.

License Agreements

We have entered into several nonexclusive license agreements with various companies covering certain technologies which are embedded in the Company’s diagnostic instruments and diagnostic test products. Since inception, we have paid aggregate initial license fees of $2.4 million for these licenses, and have agreed to pay a percentage of net sales as royalties, in percentage amounts ranging from less than 1% to 12%. Certain of the license agreements have minimum annual royalty payments, and such minimum payments are as shown above. These licenses expire at various times, corresponding to the subject patents expirations, which currently range from 2010 to 2025.

We have entered into a license agreement with Northwestern which provides us with an exclusive license to certain patents and patent applications related to the application of nanotechnology to biodiagnostics and to biobarcode technology. This license covers all discoveries from the International Institute for Nanotechnology at Northwestern in the field of biodiagnostics through January 1, 2013. Nanosphere also has the right of first negotiation for an exclusive license on inventions after such date. Our research team utilizes the research and patents developed at Northwestern to develop diagnostic applications including additional genomic and protein testing assays for use in the Verigene System.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing or unconsolidated special-purpose entities.

Critical Accounting Policies and Significant Judgments and Estimates

This discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differ materially from those estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our financial statements.

Revenue Recognition

We recognize revenue under grants and contracts and for reimbursement of related research and development expenses at the time the relevant expenses are incurred. For product sales, revenue is recognized when persuasive evidence of an arrangement exists, title and risk of loss is transferred to customers, the price to the buyer is fixed or determinable, and collectability is reasonably assured.

Verigene System instrument units are sold outright to customers or leased to customers pursuant to operating leases. We recognize revenue from sales of the Verigene System, including cartridges and related products, when the risks and rewards of ownership are transferred to the customer. Revenue for Verigene System instrument units leased under operating lease arrangements is recognized on an installment basis over the life of the lease while the cost of the leased equipment is carried on the Company’s balance sheet and fully amortized over the life of lease arrangements.

Stock-Based Compensation Expense

We have granted share-based compensation consisting of restricted stock and common stock options issued to employees, consultants and founders. Compensation expense is recognized based on the fair value of the stock-based awards granted utilizing various assumptions regarding the underlying attributes of the options and our common stock. The estimated fair value of options granted, net of forfeitures expected to occur during the vesting period, is determined using the Black-Scholes option-pricing model and then amortized as compensation expense on a straight-line basis over the vesting period of the options. All of the stock options granted prior to November 2007 have exercise prices at or above the estimated fair value of the common stock on the date of grant, as determined by our board of directors prior to our initial public offering in November 2007, who used their knowledge of us and our affairs along with third-party valuation assessments, to determine the fair value of our common stock. For option grants after our initial public offering, we use the fair value of our common stock as determined by the closing price of our common stock on NASDAQ on the date of grant. In addition to the grant date fair value of our common stock, the Black-Scholes model requires inputs for risk-free interest rate, dividend yield, volatility and expected lives of the options. Due to the Company’s limited period of trading activity as a public company from 2007 through the third quarter of 2009, the expected volatility of option grants prior to the fourth quarter of 2009 was based on historical data from various peer public companies with similar product portfolios. The expected volatility for option awards granted in the fourth quarter of 2009 was based on the Company’s actual historical volatility. The expected life of options that vest ratably over four years of service is derived from the average of the vesting period and the term of the option following the guidance in SEC Staff Accounting Bulletins No. 107 and 110. The Company estimates the expected life of options with accelerated vesting terms giving consideration to the dates that the Company expects to achieve key milestones under the option agreements and the term of the option. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

Recent Accounting Pronouncements

Effective January 1, 2008, the Company adopted new accounting guidance on fair value measurements. The new guidance clarifies the definition of fair value, prescribes methods for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and expands disclosures about the use of fair value measurements. It was effective for certain financial assets and liabilities beginning January 1, 2008. The Company adopted the provisions of the new accounting guidance related to nonfinancial assets and nonfinancial liabilities effective January 1, 2009, and such adoption had no material impact on the Company’s financial statements.

In April 2008, the FASB issued new accounting guidance on the determination of the useful life of intangible assets. The new guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The Company adopted this new guidance on January 1, 2009 which resulted in no financial impact.

In May 2009, the FASB issued new accounting and disclosure guidance for events that occur subsequent to the balance sheet date but before the date that financial statements are issued or are available to be issued. The Company’s management has evaluated its subsequent events for disclosure in this annual report on Form 10-K through the date on which the financial statements were issued.

In June 2009, the FASB issued authoritative guidance which replaced the previous hierarchy of generally accepted accounting principles (“GAAP”) and establishes the FASB Codification as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities. SEC rules and interpretive releases are also sources of authoritative GAAP for SEC registrants. This guidance modifies the GAAP hierarchy to include only two levels of GAAP: authoritative and nonauthoritative. This guidance was effective for the Company as of September 30, 2009. The adoption of this guidance did not impact the Company’s financial statements since the FASB Codification is not intended to change or alter existing GAAP.

In October 2009, the FASB issued authoritative guidance that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenue based on those separate deliverables. The guidance is expected to result in more multiple-deliverable arrangements being separable than under current guidance. This guidance is effective for the Company beginning on January 1, 2011 and is required to be applied prospectively to new or significantly modified revenue arrangements. The Company is currently assessing the impact this guidance may have on its financial statements.

Item 7A.		Quantitative and Qualitative Disclosures About Market Risk.

Our exposure to market risk is currently confined to our cash and cash equivalents. We have not used derivative financial instruments for speculation or trading purposes. The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term investments through a variety of securities, including commercial paper, money market funds and corporate debt securities. Our cash and cash equivalents through December 31, 2009 included amounts in bank checking and liquid money market accounts. As a result, we believe we have minimal interest rate risk; however, a one percentage point decrease (or increase) in the average interest rate on our portfolio, if such a decrease were possible, would have reduced (or increased) interest income for the year ended December 31, 2009 by $655,930.

Item 8.		Financial Statements and Supplementary Data.

The following financial statements and the related notes thereto, of Nanosphere, Inc. and the Report of Independent Registered Public Accounting Firm, Deloitte & Touche LLP, are filed as a part of this Form 10-K.

		Page
Reports of Independent Registered Public Accounting Firm			41
Balance Sheets as of December 31, 2009 and 2008			43
Statements of Operations for the years ended December 31, 2009, 2008 and 2007			44
Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2009, 2008 and 2007			45
Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007			46
Notes to Financial Statements			47-58

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Nanosphere, Inc.
Northbrook, Illinois

We have audited the accompanying balance sheets of Nanosphere, Inc. (the “Company”) as of December 31, 2009 and 2008, and the related statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2010, expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Chicago, Illinois
March 11, 2010

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Nanosphere, Inc.
Northbrook, Illinois

We have audited the internal control over financial reporting of Nanosphere, Inc. (the “Company”) as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the financial statements as of and for the year ended December 31, 2009, of the Company and our report dated March 11, 2010 expressed an unqualified opinion on those financial statements.

/s/ DELOITTE & TOUCHE LLP

Chicago, Illinois
March 11, 2010

Nanosphere, Inc.

		As of December 31,
		2009				2008
CURRENT ASSETS:
Cash and cash equivalents		$	76,689,279			$	75,356,960
Accounts receivable			735,047				385,908
Inventories			2,940,574				1,727,518
Other current assets			374,657				559,528
Total current assets			80,739,557				78,029,914
PROPERTY AND EQUIPMENT — Net			6,144,555				7,294,224
INTANGIBLE ASSETS — Net of accumulated amortization			1,709,842				1,443,582
OTHER ASSETS			75,000				128,190
TOTAL		$	88,668,954			$	86,895,910
CURRENT LIABILITIES:
Accounts payable		$	2,509,405			$	1,813,777
Accrued compensation			955,130				829,292
Other current liabilities			2,303,631				1,541,385
Long-term debt — current portion			3,818,790				4,818,211
Total current liabilities			9,586,956				9,002,665
LONG-TERM LIABILITIES:
Long-term debt — noncurrent portion			—				3,352,137
Total liabilities			9,586,956				12,354,802
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Common stock, $0.01 par value; 100,000,000 shares authorized; 28,422,461 shares and 22,228,696 shares issued and outstanding as of December 31, 2009 and 2008, respectively			284,225				222,287
Preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued			—				—
Additional paid-in capital			312,660,430				274,232,825
Warrants to acquire common stock			5,423,771				5,423,771
Accumulated deficit			(239,286,428	)			(205,337,775	)
Total stockholders’ equity			79,081,998				74,541,108
TOTAL		$	88,668,954			$	86,895,910

See notes to financial statements.

Nanosphere, Inc.

		Years Ended December 31,
		2009				2008				2007
REVENUE:
Grant and contract revenue		$	1,089,890			$	346,070			$	1,056,874
Product sales			1,124,213				1,020,662				110,490
Total revenue			2,214,103				1,366,732				1,167,364
COSTS AND EXPENSES:
Cost of sales			2,175,281				1,464,066				86,349
Research and development			18,607,921				23,675,138				21,445,994
Sales, general, and administrative			14,471,973				13,615,322				13,443,304
Total costs and expenses			35,255,175				38,754,526				34,975,647
Loss from operations			(33,041,072	)			(37,387,794	)			(33,808,283	)
OTHER INCOME (EXPENSE):
Change in fair value of convertible derivative liability			—				—				(14,860,901	)
Change in fair value of preferred stock warrants			—				—				(4,414,207	)
Foreign exchange loss			(4,207	)			(23,691	)			(52,362	)
Interest expense			(1,257,445	)			(2,080,629	)			(1,977,619	)
Interest income			354,071				2,450,118				1,914,188
Total other income (expense)			(907,581	)			345,798				(19,390,901	)
NET LOSS			(33,948,653	)			(37,041,996	)			(53,199,184	)
Accumulated convertible preferred stock dividends			—				—				(5,476,287	)
Convertible preferred stock redemption value adjustment			—				—				(608,940	)
NET LOSS ATTRIBUTABLE TO COMMON STOCK		$	(33,948,653	)		$	(37,041,996	)		$	(59,284,411	)
Net loss per common share — basic and diluted		$	(1.46	)		$	(1.67	)		$	(14.18	)
Weighted average number of common shares outstanding — basic and diluted			23,301,764				22,213,164				4,180,979

See notes to financial statements.

Nanosphere, Inc.

																		Note
														Warrants				Receivable
										Additional				To Acquire				From Chief
		Common Stock								Paid-In				Common				Executive				Accumulated
		Shares				Par Value				Capital				Stock				Officer				Deficit				Total
BALANCE — January 1, 2007			932,646			$	92,580			$	2,051,126			$	—			$	(1,440,000	)		$	(109,011,368	)		$	(108,307,662	)
Share-based compensation related to stock options											1,669,006																1,669,006
Exercise of stock options on common stock			16,150				162				119,863																120,025
Issuance of common stock from initial public offering, net of offering expenses			8,050,000				80,500				102,092,417																102,172,917
Conversion of preferred stock to common stock			13,048,119				130,481				116,151,384																116,281,865
Conversion of convertible derivative liability to additional paid-in capital											47,554,882																47,554,882
Conversion of warrant liability to equity															5,424,551												5,424,551
Exercise of warrants			145,090				1,451				2,036,358																2,037,809
Interest received on note receivable from chief executive officer											90,740																90,740
Proceeds from note receivable from chief executive officer																			1,440,000								1,440,000
6% dividends, earned on Series C-2 and Series D Convertible Preferred Stock																							(5,476,287	)			(5,476,287	)
Convertible preferred stock redemption value adjustment																							(608,940	)			(608,940	)
Net loss																							(53,199,184	)			(53,199,184	)
BALANCE — December 31, 2007			22,192,005				305,174				271,765,776				5,424,551				—				(168,295,779	)			109,199,722
Share-based compensation related to stock options											2,217,858																2,217,858
Exercise of stock options on common stock			36,491				365				163,845																164,210
Exercise of warrants			200				2				2,966				(780	)											2,188
Other							(83,254	)			82,380																(874	)
Net loss																							(37,041,996	)			(37,041,996	)
BALANCE — December 31, 2008			22,228,696				222,287				274,232,825				5,423,771				—				(205,337,775	)			74,541,108
Share-based compensation			672,500				6,725				2,527,352																2,534,077
Exercise of stock options on common stock			116,265				1,163				520,969																522,132
Issuance of common stock from public offering, net of offering expenses			5,405,000				54,050				35,379,284																35,433,334
Net loss																							(33,948,653	)			(33,948,653	)
BALANCE — December 31, 2009			28,422,461			$	284,225			$	312,660,430			$	5,423,771			$	—			$	(239,286,428	)		$	79,081,998

See notes to financial statements.

Nanosphere, Inc.

		Years Ended December 31,
		2009				2008				2007
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(33,948,653	)		$	(37,041,996	)		$	(53,199,184	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			3,067,063				3,170,265				1,785,972
Amortization of financing costs and accretion of debt discount			499,386				762,277				671,480
Loss from write-off of intangible assets			—				245,134				—
Loss from disposal of fixed assets			2,758				326,291				—
Share-based compensation			2,534,077				2,217,858				1,669,006
Change in fair value of preferred stock warrants			—				—				4,414,207
Change in fair value of convertible derivative liability			—				—				14,860,901
Changes in operating assets and liabilities:
Accounts receivable			(349,139	)			(285,109	)			(55,983	)
Inventories			(1,334,763	)			(1,078,965	)			(1,018,155	)
Other current assets			205,328				110,874				(207,544	)
Other assets			—				2,630				10,830
Accounts payable			518,640				(208,760	)			712,225
Accrued and other current liabilities			856,137				(195,047	)			1,038,759
Net cash used in operating activities			(27,949,166	)			(31,974,548	)			(29,317,486	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment			(1,326,542	)			(2,332,267	)			(3,157,478	)
Investments in intangible assets			(507,794	)			(400,732	)			(399,911	)
Net cash used in investing activities			(1,834,336	)			(2,732,999	)			(3,557,389	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt			—				—				12,500,000
Repayment of long-term debt			(4,818,211	)			(3,597,823	)			(166,673	)
Payments on capital lease obligation			(21,434	)			(37,036	)			(32,776	)
Deferred financing fees			—				—				(114,565	)
Proceeds from principal and interest on CEO note receivable			—				—				1,530,740
Proceeds from the issuance of common stock, net of offering expenses			35,433,334				(778,731	)			102,951,648
Proceeds from warrant redemptions			—				2,188				1,286,620
Proceeds from stock option exercises			522,132				164,210				120,025
Other			—				(874	)			—
Net cash (used in) provided by financing activities			31,115,821				(4,248,066	)			118,075,019
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			1,332,319				(38,955,613	)			85,200,144
CASH AND CASH EQUIVALENTS — Beginning of year			75,356,960				114,312,573				29,112,429
CASH AND CASH EQUIVALENTS — End of year		$	76,689,279			$	75,356,960			$	114,312,573
NONCASH INVESTING AND FINANCING ACTIVITIES:
Capital expenditures included in accounts payable		$	205,677			$	—			$	201,441
License costs capitalized and included in accounts payable			—				—				26,233
License costs capitalized and included in other current liabilities			278,381				225,000				347,500
6% dividends earned on Series C-2 and Series D Convertible Preferred Stock			—				—				5,476,287
Conversion of Preferred Stock, including accumulated dividends on Series C-2 and Series D Convertible Preferred Stock into common stock			—				—				116,281,865
Conversion of convertible derivative liability to additional paid-in capital			—				—				47,554,882
Conversion of preferred stock warrant liability to warrants to acquire common stock			—				—				5,424,551
Equity offering transaction costs included in accrued financing costs			—				—				778,731
Reclassification of inventory to equipment at customers			251,727				1,254,451				—

See notes to financial statements.

Nanosphere, Inc.

Notes to Financial Statements
As of December 31, 2009 and 2008, and
For the years ended December 31, 2009, 2008 and 2007

1. Description of Business

Nanosphere, Inc. (the “Company”) develops, manufactures and markets an advanced molecular diagnostics platform, the Verigene System, that enables simple, low cost, and highly sensitive genomic and protein testing on a single platform.

Basis of Presentation — The accompanying financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred net losses attributable to common stock of $239.3 million since inception, and has funded those losses primarily through the sale and issuance of equity securities and secondarily through the issuance of debt. While the Company is no longer in the development stage and the focus of the Company’s business activities has turned towards commercialization of its products, because of the numerous risks and uncertainties associated with its product development and commercialization efforts, the Company is unable to predict when it will become profitable, and the Company may never become profitable. Capital outlays and operating expenditures may increase over the next few years as the Company expands its infrastructure, commercialization, manufacturing, and research and development activities. The Company operates in a market that makes its prospects difficult to evaluate, and the Company may need additional financing in the future to execute on its current or future business strategies.

2. Summary of Significant Accounting Policies

Cash and Cash Equivalents — The Company considers all highly liquid investments with a maturity of three months or less, at date of purchase, to be cash equivalents. The majority of these funds are held in interest-bearing money market and bank checking accounts. Interest income is recorded on the accrual basis as earned.

Receivables — Accounts receivable consists of amounts due to the Company for sales of the Verigene system as well as amounts due under various contracts and government grants. An allowance for doubtful accounts is not recorded because the Company has no history of uncollectible receivables and there are no specifically identified uncollectible accounts.

Inventories — Inventories are carried at the lower of cost or market, using the first-in, first-out method. Certain finished goods inventory is ultimately leased rather than sold, and upon the lease date is transferred to Property and equipment and subsequently depreciated to Cost of sales over the period indicated below.

Property and Equipment — Property and equipment are recorded at cost and depreciated using the straight-line method over the assets’ estimated useful lives, which are:

Equipment with customers		3-5 years
Computers and office equipment		3 years
Engineering and laboratory equipment, including tooling		3-5 years
Furniture and fixtures		7 years
Manufacturing equipment		5-7 years

The economic life of the Company’s equipment with customers is based on the original term of the lease, which is typically three years. The Company believes that this is representative of the period during which the instrument is expected to be economically usable.

Assets classified as leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term using the straight-line method. Maintenance and repair costs are expensed as incurred.

Intangible Assets — Intangible assets are stated at cost less accumulated amortization and consist of purchased intellectual property. Purchased intellectual property represents licenses and is associated with patents owned by third-parties for technologies which are embedded in the Company’s diagnostic instruments and diagnostic test products that the Company licensed in anticipation of sales of such products. Amortization of purchased intellectual property begins upon the Company obtaining FDA clearance to sell products containing the licensed technology and is calculated using the straight-line method over the remaining expected lives of the licensed technology, which range from 0.75 to 14.75 years. Such amortization of upfront license fees is classified in Cost of sales on the statement of operations.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)

Deferred Financing Costs — Deferred financing costs of $114,565 incurred in connection with the Company’s issuance of debt are amortized over the life of the debt using the effective interest rate method with amortization of such costs being charged to interest expense. Such costs, net of accumulated amortization, are classified in Other Assets on the balance sheet.

Impairment of Long-Lived Assets — The Company assesses the recoverability of long-lived assets, including intangible assets, by periodically evaluating the carrying value of such assets whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If impairment is indicated, the Company will value the asset at its estimated fair value.

Use of Estimates — The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the notes thereto. The Company’s significant estimates included in the preparation of the financial statements are related to inventories, property and equipment, intangible assets and share-based compensation. Actual results could differ from those estimates.

Revenue Recognition — The Company recognizes revenue from product sales and contract arrangements. The Company recognizes revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable and collectability is reasonably assured. Verigene System instrument units are sold outright to customers or leased to customers pursuant to operating leases. The Company recognizes revenue from sales of the Verigene System, including cartridges and related products, when the risks and rewards of ownership are transferred to the customer. Revenue for Verigene System instrument units sold under operating lease arrangements is recognized on an installment basis over the life of the lease while the cost of the leased equipment is carried on the Company’s balance sheet in Property and equipment and depreciated over its estimated useful life to Cost of sales.

Shipping and handling costs are expensed as incurred and included in Cost of sales. In those cases where the Company bills shipping and handling costs to customers, the amounts billed are classified as revenue.

Grant and government sponsored research revenue and contract revenue related to research and development services are recognized as the related services are performed based on the performance requirements of the relevant contract. Under such agreements, the Company is required to perform specific research and development activities and is compensated either based on the costs or costs plus a mark-up associated with each specific contract over the term of the agreement or when certain milestones are achieved.

Research and Development Costs — Research and development costs are expensed as incurred.

Income Taxes — The Company accounts for income taxes, including uncertain tax positions, under the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 740 “Accounting for Income Taxes”. This Topic requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. An allowance is provided to reduce net deferred tax assets to the amount management believes will, more likely than not, be recovered.

Share-Based Compensation — The Company recognizes share-based compensation expense related to restricted stock and common stock options issued to employees, consultants and directors. ASC Topic 718 “Stock Compensation” provides for recognition of compensation expense based on the fair value of the stock-based compensation utilizing various assumptions regarding the underlying attributes of the options and stock. The estimated fair value of options granted, net of forfeitures expected to occur during the vesting period, is amortized as compensation expense on a straight-line basis over the service period of the options.

Preferred Stock — Prior to the Company’s initial public offering in November 2007, the Company had outstanding shares of preferred stock. The Company recognized changes in the redemption value of its preferred stock immediately as they occurred and adjusted the carrying value of the preferred stock to be equal to the redemption value of the preferred stock at the end of each reporting period. Upon the closing of the initial public offering on November 6, 2007, all preferred stock was converted to common stock.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)

Fair Value of Financial Instruments — The carrying amount of the Company’s financial instruments, including cash and cash equivalents, accounts receivable and accounts payable approximate their fair values. See Note 10 for information on the fair value of the Company’s long-term debt.

Effective January 1, 2008, the Company adopted ASC Topic 820 “Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements,” which clarifies the definition of fair value, prescribes methods for measuring fair value, establishes a fair value hierarchy based on the inputs used to measure fair value and expands disclosures about the use of fair value measurements. ASC Topic 820 and its applicable subtopics were effective for certain financial assets and liabilities beginning January 1, 2008. The Company adopted the provisions of ASC Topic 820 related to nonfinancial assets and nonfinancial liabilities effective January 1, 2009, and such adoption had no material impact on the Company’s financial statements.

New Accounting Standards — In May 2009, the FASB issued new accounting and disclosure guidance for events that occur subsequent to the balance sheet date but before the date that financial statements are issued or are available to be issued. The Company’s management has evaluated its subsequent events for disclosure in this Form 10-K through the date on which the financial statements were issued.

In October 2009, the FASB issued authoritative guidance that amends existing guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenue based on those separate deliverables. The guidance is expected to result in more multiple-deliverable arrangements being separable than under current guidance. This guidance is effective for the Company beginning on January 1, 2011 and is required to be applied prospectively to new or significantly modified revenue arrangements. The Company is currently assessing the impact this guidance may have on its financial statements.

Net Loss Per Common Share — Basic and diluted net loss per common share have been calculated in accordance with ASC Topic 260, “Earnings Per Share”, for the years ended December 31, 2009, 2008 and 2007. As the Company had a net loss in each of the periods presented, basic and diluted net loss per common share are the same.

The computation of basic net loss per common share for the year ended December 31, 2009 excluded 672,500 shares of restricted stock issued during 2009 (see Note 5). While these restricted shares of stock are included in outstanding shares on the balance sheet at December 31, 2009, these restricted shares are excluded from basic net loss per common share in accordance with ASC Topic 260 due to the forfeiture provisions associated with these shares.

The computations of diluted net loss per common share for the years ended December 31, 2009, 2008 and 2007 did not include the outstanding shares of restricted stock as well as the effects of the following options to acquire common stock and common stock warrants as the inclusion of these securities would have been antidilutive:

		Year ended December 31,
		2009				2008				2007
Restricted stock			672,500				—				—
Stock options			4,338,695				3,362,721				3,141,530
Common stock warrants			1,300,119				1,300,119				1,300,319
			6,311,314				4,662,840				4,441,849

3. Intangible Assets

Intangible assets, consisting of purchased intellectual property, as of December 31, 2009 and 2008 comprise the following:

		December 31, 2009												December 31, 2008
						Accumulated												Accumulated
		Cost				Amortization				Net				Cost				Amortization				Net
Intellectual property — licenses		$	2,438,218			$	(728,376	)		$	1,709,842			$	1,877,043			$	(433,461	)		$	1,443,582

Nanosphere, Inc.

Notes to Financial Statements — (Continued)

Amortization expense for intangible assets amounted to $294,915, $343,217, and $90,244 for the years ended December 31, 2009, 2008, and 2007, respectively. Estimated future amortization expense is as follows:

Years Ending December 31
2010		$	447,744
2011			150,719
2012			139,810
2013			136,174
2014			136,174
Thereafter			447,221

Licenses are amortized from the date of the U.S. Food and Drug Administration (the “FDA”) clearance of products associated with the licensed technology and such amortization continues over the remaining life of the license. The future amortization expense reflected above is based on licenses related to products cleared by the FDA as of December 31, 2009. The amortization period related to $0.3 million of licenses is not known as the diagnostic test products associated with the licensed technology have not been cleared by the FDA and, accordingly, amortization has not begun and no expense associated with the licenses is included in the table above. During the year ended December 31, 2008, the Company wrote off capitalized license fees of $245,134 associated with licenses which the Company did not plan to utilize in the Verigene System. There were no license costs written off in the years ended December 31, 2009 or 2007.

4. Related Party Transactions

Robert Letsinger and Chad Mirkin, co-founders of the Company, provide contracted research and development services to the Company, which are reimbursed based upon negotiated contract rates. Such contracts automatically renew on an annual basis. The Company incurred expenses of $150,000 for these services in each of the years ended December 31, 2009, 2008 and 2007.

In March 2006, the Company issued to William Moffitt, the Company’s chief executive officer and a director, 320,000 shares of restricted common stock at a price of $4.50 per share, for an aggregate price of $1,440,000. The restrictions on the common stock lapsed in July 2007. In connection with this sale of common stock, the Company received a full recourse, long-term promissory note from William Moffitt for a total of $1,440,000, which note was secured by the shares of common stock purchased. Interest on the promissory note accrued and was paid annually in cash at an interest rate of 4.51%. Interest income on this note was $39,326 for the year ended December 31, 2007. In 2007, $90,740 of interest was paid to the Company on the note and was recorded as additional paid in capital. The note receivable due from the Company’s chief executive officer was repaid in August 2007.

In August 2007, in accordance with terms of the Amended Bonus Agreement between the Company and the chief executive officer, the Company paid a $2.3 million bonus payment to the chief executive officer. $1.9 million of the expense for this bonus was recorded in 2007.

Brookside Capital Partners Fund, L.P., a 5% stockholder of the Company, purchased 892,857 shares of the Company’s common stock at $13.53 per share in the Company’s initial public offering in November 2007.

AOQ Trust, a 5% stockholder of the Company, and LFT Partnership, an affiliate of AOQ Trust, purchased 337,849 shares and 162,151 shares of the Company’s common stock, respectively, at $7.00 per share in the Company’s October 2009 underwritten public offering. Mark Slezak, a director of the Company, is a trustee of AOQ Trust and the investment manager of LFT Partnership.

5. Equity Incentive Plans

The Company’s 2000 Equity Incentive Plan, as amended (the “2000 Plan”), permitted the grant of options to employees, founders, and consultants for up to 1,600,000 shares of common stock. Option awards are generally granted with an exercise price equal to the fair value of the Company’s common stock at the date of grant; those option awards have various vesting structures and have 10 year contractual terms. In connection with the approval of the 2007 Plan as defined below, the Company terminated the 2000 Plan and therefore, the Company may not make any further awards of options, share appreciations rights or restricted shares under the 2000 Plan.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)

In March 2007, the Company’s board of directors adopted and its shareholders approved the Nanosphere 2007 Long-Term Incentive Plan (the “2007 Plan”). The 2007 Plan authorizes the grant of stock options, share appreciation rights, restricted shares, restricted share units, unrestricted shares, incentive stock options, deferred share units and performance awards. The total awards originally authorized under the 2007 Plan was 4,106,009 shares, plus up to an additional 773,591 shares of common stock that will become available in the event that awards made under the 2000 Plan expire, are forfeited or cancelled, plus an annual increase in the number of shares pursuant to the evergreen provision equal to the least of: 900,000 shares of common stock; 4.0% of the Company’s outstanding shares of common stock as of fiscal year end; and an amount determined by the board of directors. Pursuant to the evergreen provision, an additional 900,000 shares of common stock were authorized for issuance under the 2007 Plan as of January 1, 2010.

Certain options vest ratably over four years of service, while other options vest after seven years of service but provide for accelerated vesting contingent upon the achievement of various company-wide performance goals, such as decreasing time to market for new products and entering into corporate collaborations (as defined in the option grant agreements). For these “accelerated vesting” options, 20-25% of the granted option shares will vest upon the achievement of each of four or five milestones as defined in the option grant agreements, with any remaining unvested options vesting on the seven year anniversary of the option grant dates. Approximately 46% of the options granted and outstanding contain “accelerated vesting” provisions.

The fair values of the Company’s option awards were estimated at the dates of grant using the Black-Scholes option pricing model with the following assumptions:

		2009				2008				2007
Expected dividend yield			0	%			0	%			0	%
Expected volatility			97	%			68	%			77	%
Risk free interest rate			2.42	%			3.02	%			4.65	%
Weighted-average expected option life		6.1 years				6.4 years				7.0 years
Estimated weighted-average fair value on the date of grant based on the above assumptions		$	4.59			$	6.97			$	3.38
Estimated forfeiture rate for unvested options			4.4	%			4.6	%			4.6	%

Due to the Company’s limited period of trading activity as a public company from 2007 through the third quarter of 2009, the expected volatility was based on historical data from various peer public companies with similar product portfolios. The expected volatility for option awards granted in the fourth quarter of 2009 was based on the Company’s actual historical volatility. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of the grants for periods consistent with the expected life of the option. The expected life of options that vest ratably over four years of service is derived from the average of the vesting period and the term of the option as defined in the Plans, following the guidance in Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin Nos. 107 and 110. The Company estimates the expected life of options with accelerated vesting terms giving consideration to the dates that the Company expects to achieve key milestones under the option agreements and the term of the option. Total compensation cost associated with the option awards was $2,381,251, $2,217,858, and $1,669,006 in 2009, 2008, and 2007, respectively.

As of December 31, 2009, the total compensation cost not yet recognized related to the nonvested awards is approximately $9.8 million, which amount is expected to be recognized over the next four years, which is a weighted average term. Certain milestone events are deemed probable of achievement prior to their seven year vesting term, and the acceleration of vesting resulting from the achievement of such milestone events has been factored into the weighted average vesting term. While the Company does not have a formally established policy, as a practice the Company has delivered newly issued shares of its common stock upon the exercise of stock options.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)

A summary of option activity under the Plan as of December 31, 2009, and for the year then ended is presented below:

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
		Number of				Exercise				Contractual				Intrinsic
Options		Shares				Price				Term				Value of Options
Outstanding — January 1, 2009			3,362,721			$	5.68
Granted			1,398,399			$	5.92
Exercised			(116,265	)		$	4.49
Expired			(6,750	)		$	6.43
Forfeited			(299,410	)		$	6.22
Outstanding — December 31, 2009			4,338,695			$	5.75				7.86			$	5,650,628
Exercisable — December 31, 2009			1,499,585			$	5.82				6.69			$	2,466,252
Vested and Expected to Vest — December 31, 2009			4,208,096			$	5.75				7.84			$	5,504,147

The intrinsic value of options exercised in 2009, 2008 and 2007 was $234,305, $205,385 and $110,687, respectively.

Included in the number of options outstanding at December 31, 2009, are 1,982,056 options with a weighted average exercise price of $5.30 per share and accelerated vesting provisions based on the criteria mentioned above. During 2009, two of the five milestones as defined in the 2000 Plan were achieved, and one of the four milestones as defined in the 2007 Plan was achieved. As a result, 40% of the outstanding options under the 2000 Plan with accelerated vesting provisions were vested as of December 31, 2009 and 25% of the outstanding options under the 2007 Plan with accelerated vesting provisions were vested as of December 31, 2009. The total fair value of shares vested during 2009, 2008, and 2007 was $3,068,055, $1,255,800, and $548,226, respectively.

On November 25, 2009, the Company granted 672,500 shares of restricted stock under the 2007 Plan, of which 50% vest in two, equal installments commencing on the first anniversary of the grant date and are subject to forfeiture until vested, and 50% vest in four, equal annual installments commencing on the first anniversary of the grant date and are subject to forfeiture until vested. No shares were forfeited as of December 31, 2009. The weighted average grant-date fair value was $6.06 per share. In 2009, the Company recognized $152,826 in compensation expense associated with the restricted stock. As of December 31, 2009, the total compensation cost not yet recognized related to the nonvested restricted stock awards is approximately $3.9 million, which amount is expected to be recognized over the next two years, which is a weighted average term.

6. Income Taxes

Deferred tax assets consist primarily of net operating loss (“NOL”) carryforwards related to U.S. federal and state taxes and research and development tax credits. Realization of future tax benefits related to deferred tax assets is dependent on many factors, including the Company’s ability to generate future taxable income. Due to the Company’s history of operating losses, the Company has recorded a full valuation allowance against these assets.

NOL carryforwards of approximately $157 million for income tax purposes are available to offset future taxable income. If not used, these carryforwards will expire in varying amounts from 2020 through 2029. The Company also has federal research and development tax credit carryforwards of $8 million which will expire from 2020 through 2029. Section 382 of the Internal Revenue Code subjects the utilization of net operating loss and credit carryforwards to an annual limitation that is applicable if the Company experiences an ownership change. The Company believes its public offerings and/or prior equity investments may have triggered an ownership change as defined by the Internal Revenue Code. However, the Company has yet to perform the computations under Section 382 which would determine the amount of annual limitation on its utilization of its net operating loss and tax credit carryforwards. The annual limitation may result in the expiration of the Company’s net operating loss and tax credit carryforwards before they can be used.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)

The following is a summary of the components of the Company’s deferred tax assets and liabilities as of December 31, 2009 and 2008:

		2009				2008
Deferred tax assets:
Net operating losses		$	60,851,659			$	49,363,621
Research and development credits			8,130,439				6,974,400
Stock option compensation			777,116				554,748
Amortization of intangible assets			1,202,101				1,233,349
Other			566,289				308,095
			71,527,604				58,434,213
Valuation allowance			(70,976,214	)			(57,995,579	)
Net deferred tax assets after valuation allowance			551,390				438,634
Deferred tax liabilities:
Depreciation on property and equipment			(551,390	)			(438,634	)
Deferred tax assets — net		$	—			$	—

The reconciliation of the federal statutory rate to the Company’s effective tax rate of zero percent for the years ended December 31, 2009, 2008 and 2007 is as follows:

		Years Ended December 31,
		2009				2008				2007
Tax provision at the statutory federal rate			34.0	%			34.0	%			34.0	%
State income taxes, net of federal income tax benefit			4.8	%			4.8	%			4.8	%
Fair value adjustments to convertible derivative liability and preferred stock warrants			—				—				(14.1)	%
Other			(5.5	)%			(5.8	)%			0.5	%
Valuation allowance			(33.3	)%			(33.0	)%			(25.2	)%
			0.0	%			0.0	%			0.0	%