Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

OR

For the transition period from              to             

Commission File Number 000-23541

NANOGEN, INC.

(Exact name of Registrant as specified in its charter)

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

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

NONE

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

Common Stock $0.001 par value

Preferred Stock Purchase Rights

(Title of Class)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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

Table of Contents

NANOGEN, INC.

TABLE OF CONTENTS

FORM 10-K

For the Year Ended December 31, 2004

INDEX

Table of Contents

PART I

Trademarks and trade names

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

Forward Looking Statement

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

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

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

Item 1. Business

Overview

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

1

Table of Contents

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

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

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

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

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

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

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

Technology

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

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

2

Table of Contents

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

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

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

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

Customers

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

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

Products

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

3

Table of Contents

1) Real-time ASRs

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

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

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

2) Microarray Instrument Platforms and related ASRs

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

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

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

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

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

4

Table of Contents

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

3) Point-of-care market

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

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

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

5

Table of Contents

Our Growth Strategy

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

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

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

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

6

Table of Contents

Products and Applications in Research and Development

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

Array-based ASRs:

The Next Generation of NanoChip^® System

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

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

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

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

Point-of-care

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

7

Table of Contents

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

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

Biodefense

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

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

Nanotechnology

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

8

Table of Contents

Forensics

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

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

Pharmacogenomics

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

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

9

Table of Contents

Research and Development

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

Sales and Marketing

Molecular diagnostic products

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

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

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

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

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

Point-of-care

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

10

Table of Contents

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

Collaborations and Strategic Arrangements

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

We are currently involved in the following corporate collaborations:

Prodesse

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

Hitachi—Manufacturing Agreement

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

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

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

Hitachi—Research Collaboration Agreement

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

11

Table of Contents

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

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

Princeton Biomeditech (PBM)

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

Government Grants

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

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

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

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

12

Table of Contents

Patents and Proprietary Technology Rights

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

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

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

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

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

Competition

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

13

Table of Contents

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

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

Government Regulation

Currently our NanoChip^® System is marketed for the detection of known sequences in the U.S. and primarily distributed for research use in Europe. The ASRs under development and commercially available are manufac