Nanosphere 10-Q 2010 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2010

OR

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

For the transition period from                     to                     

Commission File Number 001-33775

Nanosphere, Inc.

(Exact name of registrant as specified in its charter)

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

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

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. Yesþ Noo

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).o Yeso No [This requirement is currently not applicable to the registrant.]

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 filero Accelerated filero Non-accelerated filerþ Smaller reporting companyo

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

The number of outstanding shares of the registrant’s common stock, par value $0.01 per share, as of May 3, 2010 was 28,428,526.

NANOSPHERE, INC.

INDEX

Part I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Balance Sheets	1
Statements of Operations	2
Statements of Cash Flows	3
Notes to Financial Statements	4-8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	9-14
Item 3. Quantitative and Qualitative Disclosures About Market Risk	14
Item 4. Controls and Procedures	15
Part II. OTHER INFORMATION
Item 1. Legal Proceedings	16
Item 1A. Risk Factors	16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	16
Item 6. Exhibits	16
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I.
FINANCIAL INFORMATION

Item 1. Financial Statements

Nanosphere, Inc.

Balance Sheets

(Unaudited)

	March 31,			December 31,
	2010			2009
CURRENT ASSETS:
Cash and cash equivalents	$	67,304,962		$	76,689,279
Accounts receivable		474,983			735,047
Inventories		3,380,736			2,940,574
Other current assets		790,163			374,657
Total current assets		71,950,844			80,739,557
PROPERTY AND EQUIPMENT— Net		6,082,410			6,144,555
INTANGIBLE ASSETS — Net of accumulated amortization		1,533,056			1,709,842
OTHER ASSETS		75,000			75,000
TOTAL	$	79,641,310		$	88,668,954
CURRENT LIABILITIES:
Accounts payable	$	2,242,621		$	2,509,405
Accrued compensation		632,112			955,130
Other current liabilities		2,095,197			2,303,631
Long-term debt — current portion		2,581,658			3,818,790
Total current liabilities		7,551,588			9,586,956
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Common stock, $0.01 par value; 100,000,000 shares authorized; 28,425,871 and 28,422,461 shares issued and outstanding as of March 31, 2010 and December 31, 2009, respectively		284,259			284,225
Preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued		—			—
Additional paid-in capital		314,219,149			312,660,430
Warrants to acquire common stock		5,423,771			5,423,771
Accumulated deficit		(247,837,457	)		(239,286,428	)
Total stockholders’ equity		72,089,722			79,081,998
TOTAL	$	79,641,310		$	88,668,954

See notes to financial statements.

1

Nanosphere, Inc.

Statements of Operations

(Unaudited)

	Three Month Periods Ended March 31,
	2010			2009
REVENUE:
Grant and contract revenue	$	380,285		$	—
Product sales		445,542			255,225
Total revenue		825,827			255,225
COSTS AND EXPENSES:
Cost of sales		725,198			310,171
Research and development		4,412,949			4,800,252
Sales, general, and administrative		4,104,004			3,126,865
Total costs and expenses		9,242,151			8,237,288
Loss from operations		(8,416,324	)		(7,982,063	)
OTHER INCOME (EXPENSE):
Foreign exchange gain (loss)		10,628			(274	)
Interest expense		(163,982	)		(398,922	)
Interest income		18,649			187,786
Total other expense		(134,705	)		(211,410	)
NET LOSS	$	(8,551,029	)	$	(8,193,473	)
Net loss per common share — basic and diluted	$	(0.31	)	$	(0.37	)
Weighted average number of common shares outstanding — basic and diluted		27,752,979			22,228,696

See notes to financial statements.

2

Nanosphere, Inc.

Statements of Cash Flows

(Unaudited)

	Three Month Periods Ended March 31,
	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(8,551,029	)	$	(8,193,473	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		951,099			744,155
Amortization of financing costs and accretion of debt discount		70,324			153,789
Share-based compensation		1,544,469			604,571
Changes in operating assets and liabilities:
Accounts receivable		260,064			20,832
Inventories		(1,090,688	)		(175,201	)
Other current assets		(423,689	)		(343,453	)
Accounts payable		(61,107	)		(429,982	)
Accrued and other current liabilities		(441,602	)		23,575
Net cash used in operating activities		(7,742,159	)		(7,595,187	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(267,319	)		(127,832	)
Investments in intangible assets		(89,850	)		(100,000	)
Net cash used in investing activities		(357,169	)		(227,832	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long term debt		(1,299,273	)		(1,149,998	)
Payments on capital lease obligation		—			(21,434	)
Proceeds from stock option exercises		14,284			—
Other		—			(35	)
Net cash used in financing activities		(1,284,989	)		(1,171,467	)
NET DECREASE IN CASH AND CASH EQUIVALENTS		(9,384,317	)		(8,994,486	)
CASH AND CASH EQUIVALENTS — Beginning of period		76,689,279			75,356,960
CASH AND CASH EQUIVALENTS — End of period	$	67,304,962		$	66,362,474
NONCASH INVESTING AND FINANCING ACTIVITIES:
License costs capitalized and included in accrued liabilities	$	168,163		$	275,000
Reclassification of inventory to property and equipment		650,526			—

See notes to financial statements.

3

Nanosphere, Inc.

Notes to Financial Statements

As of March 31, 2010 and

For the Three Month Periods Ended March 31, 2010 and 2009

(Unaudited)

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 unaudited condensed financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America and in conformity with Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. However, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, unless otherwise noted herein, necessary to present fairly the results of operations, financial position and cash flows have been made. Therefore, these financial statements should be read in conjunction with the Company’s most recent audited financial statements for the year ended December 31, 2009 and notes thereto included in the Company’s Annual Report on Form 10-K. The results of operations for any interim period are not necessarily indicative of the results of operations expected for the full year.

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 $247.8 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.

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.

2. Net Loss Per Common Share

Basic and diluted net loss per common share have been calculated in accordance with Accounting Standards Codification (“ASC”) Topic 260, “Earnings Per Share”, for the three month periods ended March 31, 2010 and 2009. 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 three month period ended March 31, 2010 excluded 672,500 shares of restricted stock issued during November 2009. While these restricted shares of stock are included in outstanding shares on the balance sheet, 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 three month periods ended March 31, 2010 and 2009 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:

	Three Month Periods Ended March 31,
	2010		2009
Restricted stock		672,500		—
Stock options		4,264,130		3,508,438
Common stock warrants		1,300,119		1,300,119
		6,236,749		4,808,557

4

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

3. Intangible Assets

Intangible assets, consisting of purchased intellectual property, as of March 31, 2010 and December 31, 2009 comprise the following:

	March 31, 2010							December 31, 2009
			Accumulated							Accumulated
	Cost		Amortization			Net		Cost		Amortization			Net
Intellectual property — licenses	$	2,438,218	$	(905,162	)	$	1,533,056	$	2,438,218	$	(728,376	)	$	1,709,842

Amortization expense for intangible assets amounted to $176,786 and $82,889 for the three month periods ended March 31, 2010 and 2009, respectively. Estimated future amortization expense is as follows:

Years Ending December 31
2010 (Period from April 1 to December 31)	$	295,136
2011		165,226
2012		154,317
2013		150,681
2014		146,135
Thereafter		369,561

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 March 31, 2010. 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.

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. The Company incurred expenses of $37,500 for these services in each of the three month periods ended March 31, 2010 and 2009.

5. Equity Incentive Plan

The Company’s board of directors has adopted and the shareholders have approved the Nanosphere 2000 Equity Incentive Plan (the “2000 Plan”) and the Nanosphere 2007 Long-Term Incentive Plan. The plans authorize the compensation committee to grant stock options, share appreciation rights, restricted shares, restricted share units, unrestricted shares, incentive stock options, deferred share units and performance awards. Option awards are generally granted with an exercise price equal to or above the fair value of the Company’s common stock at the date of grant with ten year contractual terms. Certain options vest ratably over four years of service, while other options cliff 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 granted during the three month period ended March 31, 2010 were estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions:

Expected dividend yield		0	%
Expected volatility		102	%
Risk free interest rate		2.78	%
Weighted-average expected option life	6.1 years
Estimated weighted-average fair value on the date of grant based on the above assumptions	$	3.49
Estimated forfeiture rate for unvested options		10.5	%

5

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

The expected volatility for option awards granted in 2010 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 recognized was $1,162,405 and $604,571 in the three month periods ended March 31, 2010 and 2009, respectively.

As of March 31, 2010, the total compensation cost not yet recognized related to the nonvested awards is approximately $8.8 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.

A summary of option activity under the plans as of March 31, 2010, and for three month period 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, 2010		4,338,695		$	5.75
Granted		33,000		$	4.50
Exercised		(3,410	)	$	4.19
Expired		(74,130	)	$	10.71
Forfeited		(30,025	)	$	5.38
Outstanding — March 31, 2010		4,264,130		$	5.66		7.68	$	780,300
Exercisable — March 31, 2010		1,518,566		$	5.76		6.67	$	386,666
Vested and Expected to Vest — March 31, 2010		4,137,834		$	5.66		7.67	$	762,193

The intrinsic value of options exercised during the three month period ended March 31, 2010 was insignificant. There were no options exercised in the three month period ended March 31, 2009.

Included in the number of options outstanding at March 31, 2010, are 1,976,321 options with a weighted average exercise price of $5.30 per share and accelerated vesting provisions based on the criteria mentioned above. The total fair value of shares vested during the three month periods ended March 31, 2010 and 2009 was $506,971 and $581,622, respectively.

In November 2009, the Company granted 672,500 shares of restricted stock under the 2007 Plan, of which 50% vest on the two-year anniversary of the grant date and are subject to forfeiture until vested, and 50% vest on the four-year anniversary of the grant date and are subject to forfeiture until vested. No shares were forfeited as of March 31, 2010. During the three month period ended March 31, 2010, the Company recognized $382,064 in compensation expense associated with the restricted stock. As of March 31, 2010, the total compensation cost not yet recognized related to the nonvested restricted stock awards was approximately $3.5 million, which amount is expected to be recognized over the next two years, which is a weighted average term.

6. License Agreements

The Company has 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. As of March 31, 2010, the Company has paid aggregate initial license fees of $2.5 million for these licenses, and has agreed to pay a percentage of net sales as royalties, in percentage amounts ranging from 1.0% to 12.0%. Certain of the license agreements have minimum annual royalty payments, and the sums of such minimum payments are expected to be $173,750 in 2010, $178,750 in 2011, $186,250 in 2012, $210,000 in 2013, $215,000 in 2014 and are $30,000 to $220,000 annually thereafter through the dates the respective licenses terminate. These licenses expire at various times, corresponding to the subject patents expirations, which currently range from 2010 to 2025.

6

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

7. Stockholders’ Equity

As of March 31, 2010 and December 31, 2009, there were outstanding warrants to acquire 1,300,119 shares of common stock. The expiration dates of the warrants outstanding at March 31, 2010 are as follows:

Class of Stock for	Number of		Expiration
which the Warrant is Exercisable	Warrants		Date
Common — exercise price of $15.32 per share		1,135,194	April 2011
Common — exercise price of $8.75 per share		164,925	April 2013

The exercise price on the common stock warrants with an exercise price of $15.32 per share at March 31, 2010 will increase to $17.50 per share in April 2010.

8. Commitments and Contingencies

The Company’s existing operating lease for its office and laboratory space expires in May 2010. On August 28, 2009, the Company executed a lease renewal which commences in June 2010 and ends in May 2014. Under the terms of the lease renewal, the Company has two successive three year options to renew the lease, and the Company has the right of first refusal to lease additional space within the facility.

Rent and operating expenses associated with the office and laboratory space were $117,870 and $70,819 for the three month periods ended March 31, 2010 and 2009, respectively.

Annual future minimum obligations for the operating leases as of March 31, 2010, are as follows:

	Operating
Years Ending December 31	Lease
2010 (Period from April 1 to December 31)	$	333,927
2011		426,643
2012		438,921
2013		451,198
2014		190,131
Total minimum lease payments	$	1,840,820

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.

9. Long-Term Debt

In February 2007, the Company entered into two loan and security agreements, with commitments for debt financing with Venture Lending & Leasing IV, Inc., and Venture Lending & Leasing V, Inc. The Company borrowed $12.5 million under these agreements in February 2007. Interest rates under the agreements are 12.5% for the initial twelve month period and 10.0% during the following thirty month period. Notes issued pursuant to this commitment are secured by a first security lien on all of the Company’s assets including intellectual property.

The $12.5 million of proceeds received were allocated to debt and the Series D Convertible Preferred Stock based on their fair values at the borrowing date with $1.9 million allocated to Series D Convertible Preferred Stock and the remaining $10.6 million allocated to debt. The discount on the debt of $1.9 million resulted in an effective interest rate on the debt of 21% and the discount will be amortized to interest expense over the term of the debt following the interest method. Interest expense on this debt was $155,799 and $390,066 for the three month periods ended March 31, 2010 and 2009, respectively, which includes $62,141 and $145,606 of discount amortization, respectively. Cash interest paid on this debt was $106,940 and $256,215 for the three month periods ended March 31, 2010 and 2009, respectively. The fair value of the debt at March 31, 2010 is $2.7 million, which was derived by applying an income approach to determine the present value of forecasted debt payments as required under the debt agreements. To determine the appropriate yield by which to discount the future cash payments, the Company relied upon observable inputs of yields for securities with comparable risk and return profiles, which are Level 2 measurements under Accounting Standards Codification Topic 820, “Fair Value Measurements and Disclosures”.

This debt will mature in August 2010. Aggregate future principal payments on this debt will be $2.7 million.

7

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

10. Supplemental Financial Information

Inventories:	March 31, 2010		December 31, 2009
Work-in-process component parts	$	1,611,191	$	1,061,982
Finished goods		1,769,545		1,878,592
Total	$	3,380,736	$	2,940,574

Property and Equipment — Net:	March 31, 2010			December 31, 2009
Total property and equipment — at cost	$	16,658,033		$	16,029,532
Less accumulated depreciation		(10,575,623	)		(9,884,977	)
Property and equipment — net	$	6,082,410		$	6,144,555

Other Current Liabilities:	March 31, 2010		December 31, 2009
Accrued clinical trial expenses	$	879,893	$	939,509
All other		1,215,304		1,364,122
Total	$	2,095,197	$	2,303,631

8

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

This Quarterly Report onForm 10-Q contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, about us and our industry that involve substantial risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical facts, included in this Quarterly Report onForm 10-Q 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 Quarterly Report onForm 10-Q. 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 any 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 Quarterly Report onForm 10-Q. 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” in our Annual Report on Form 10-K for the year ended December 31, 2009 and elsewhere in this Quarterly Report onForm 10-Q.

Business Overview

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. 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 that 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.

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 costs 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 for certain targets can be greater than 100 times more sensitive than current technologies, 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 that affects 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.

9

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.

On October 9, 2009, we received 510(k) clearance of our second generation respiratory panel and the VerigeneSPSystem. The VerigeneSPinstrument automates sample preparation, which significantly reduces laboratory technician time required to perform this molecular test. We believe that our respiratory assay on the VerigeneSPoffers 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 VerigeneSP. 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 cystic fibrosis test until such time as it may receive 510(k) clearance for use on the VerigeneSP. 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 VerigeneSP. We have engaged in dialogue with the FDA to identify additional clinical studies that we need to receive 510(k) clearance to run these assays on the VerigeneSP.

In the first quarter of 2009, we filed ade novo510(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 theHFEgene 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 ade novo510(k) because there are currently no FDA-cleared tests to detect these mutations of theHFEgene. 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 VerigeneSP. Therefore, we plan to complete all necessary testing on the VerigeneSPto 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 with 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 re-submit to the FDA in 2010.

We are currently conducting multi-site trials for our cytochrome P450 2C19 assay that detects genetic mutations associated with deficient 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 interventions. Clopidogrel metabolism is affected by the cytochrome P-450 family of genes. Up to 30-50% of the 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 reduce clotting that can result in heart attack or stroke.

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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.

Since inception we have incurred net losses each year, and we expect to continue to incur losses for the foreseeable future. Our net loss was $8.6 million for the three month period ended March 31, 2010. As of March 31, 2010, we had an accumulated deficit of approximately $247.8 million. Our operations to date have been funded principally through capital contributions from investors in two underwritten public offerings of common stock, and prior thereto in private placements of 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 consumables 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. Labor, validation and testing associated with our custom assay development contracts is also included in cost of sales.

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.

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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, including non-cash interest expense relating to the amortization of debt discount and issue costs.

Three month Period Ended March 31, 2010 Compared to the Three month Period Ended March 31, 2009

Revenues

Revenues were $0.8 million for the three month period ended March 31, 2010, as compared to $0.3 million for the three month period ended March 31, 2009. Product sales were $0.4 million for the three month period ended March 31, 2010 as compared to $0.3 million for the same period in 2009. The three month period ended March 31, 2010 also included $0.4 million of service revenue related primarily to the assay development contract with a major pharmaceutical company described earlier.

Cost of Sales

Cost of sales was $0.7 million for the three month period ended March 31, 2010 and $0.3 million for the three month period ended March 31, 2009. The $0.4 million increase in cost of sales for the three month period ended March 31, 2010 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.

Research and Development Expenses

Research and development expenses decreased to $4.4 million for the three month period ended March 31, 2010, from $4.8 million for the three month period ended March 31, 2009 due to a decrease in VerigeneSPprototype materials spending. During 2009, the Company completed most of its investment in VerigeneSPdevelopment activities.

Sales, General and Administrative Expenses

Sales, general and administrative expenses increased from $3.1 million for the three month period ended March 31, 2009 to $4.1 million for the three month period ended March 31, 2010. The $1.0 million increase in sales, general and administrative expenses for the three months ended March 31, 2010 resulted from a $0.7 million increase in non-cash share-based compensation associated with options and restricted stock granted in the fourth quarter of 2009 and $0.3 million in bonus-related compensation expenses.

Interest Expense

Interest expense was $0.2 million for the three month period ended March 31, 2010, as compared to $0.4 million for the three months ended March 31, 2009. The decrease in interest expense for the three months ended March 31, 2010 resulted from a decrease in the scheduled amortization, which includes increased principal and lower interest, in accordance with the loan and security agreements.

Interest Income

Interest income decreased by $0.2 million for the three month period ended March 31, 2010 as compared to the same period in 2009. The decrease in interest income during the three months ended March 31, 2010 resulted from a significant decline in interest rates for the three-month period ended March 31, 2010 as compared to the same period in 2009.

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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 consumables and related products, to our initial clinical customers, research laboratories and government agencies. We also incurred significant losses and, as of March 31, 2010, we had an accumulated deficit of approximately $247.8 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 investment in additional manufacturing scale-up, research and development costs to expand our assay menu and to develop a fully automated instrument with increased throughput, and to add to sales and marketing personnel. Achievement of positive cash flow from operations will depend upon revenue resulting from adoption of both our initial products and added products resulting from expansion of the number of our FDA-cleared tests. Demand for our respiratory products is directly proportional to the size and duration of the annual season for 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 our 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 may help mitigate the demand on our capital resources as it allows us to recover the cost of such systems immediately, instead of over three to five years.

As of March 31, 2010, we had $67.3 million in cash and cash equivalents as compared to $76.7 million at December 31, 2009. The decrease in cash and cash equivalents was principally due to the use of cash in operating activities.

Net cash used in operating activities remained relatively flat at $7.7 million for the three months ended March 31, 2010 as compared to $7.6 million for the three months ended March 31, 2009.

Net cash used in investing activities increased slightly to $0.4 million for the three months ended March 31, 2010 as compared to $0.2 million for the three months ended March 31, 2009. Our increase in capital spending related to product cost reduction programs.

Net cash used in financing activities increased slightly from $1.2 million for the three months ended March 31, 2009 to $1.3 million for the three months ended March 31, 2010 due to the scheduled payments under the loan and security agreements, which will be fully repaid in the third quarter of 2010.

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 reductions. 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;

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• 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.

Contractual Obligations and Commitments

The Company’s contractual obligations and commitments have not changed materially from the disclosures included in the Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 11, 2010.

Off-Balance Sheet Arrangements

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

Recent Accounting Pronouncements

See Note 1 to the Financial Statements for a discussion of recent accounting pronouncements.

Item 3. 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 March 31, 2010 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 in the average interest rate on our portfolio, if such a decrease were possible, would have reduced interest income for the three month period ended March 31, 2010 by $176,105.

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Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Management of the Company, with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of March 31, 2010. The Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported on a timely basis and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding disclosure. Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2010.

(b) Changes in Internal Control over Financial Reporting

There have been no material changes to the Company’s internal control over financial reporting during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II.
OTHER INFORMATION

Item 1. 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 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K.

Item 2. Unregistered Sales of Securities and Use of Proceeds

During the three month period ended March 31, 2010, there were no sales of unregistered securities.

Item 6. Exhibits, Financial Statement Schedules

Exhibit Number		Exhibit Description
	31.1	Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
	31.2	Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *
	32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
	32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *

* Filed herewith.

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SIGNATURES

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

NANOSPHERE, INC.
By:	/s/ William P. Moffitt
	William P. Moffitt
	President and Chief Executive Officer

Date: May 6, 2010

By:	/s/ Roger Moody
	Roger Moody
	Chief Financial Officer and Treasurer

Date: May 6, 2010