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

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

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. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). o Yes o 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 filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o

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

The number of outstanding shares of the registrant’s common stock, par value $0.01 per share, as of April 22, 2011 was 28,437,506.

 

 

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			9-15
Item 3. Quantitative and Qualitative Disclosures About Market Risk			15
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
(dollars in thousands)
(Unaudited)

		March 31,				December 31,
		2011				2010
CURRENT ASSETS:
Cash and cash equivalents		$	30,001			$	39,628
Accounts receivable			322				198
Inventories			2,570				2,428
Other current assets			893				673
Total current assets			33,786				42,927
PROPERTY AND EQUIPMENT— Net			4,850				5,142
INTANGIBLE ASSETS — Net of accumulated amortization			3,202				3,231
OTHER ASSETS			75				75
TOTAL		$	41,913			$	51,375
CURRENT LIABILITIES:
Accounts payable		$	1,787			$	3,352
Accrued compensation			677				794
Other current liabilities			1,344				1,355
Total current liabilities			3,808				5,501
LONG-TERM LIABILITIES:
Other noncurrent liabilities			1,350				1,350
Total liabilities			5,158				6,851
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Common stock, $0.01 par value; 100,000,000 shares authorized; 28,437,506 and 28,408,506 shares issued and outstanding as of March 31, 2011 and December 31, 2010, respectively			284				284
Preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares issued			—				—
Additional paid-in capital			319,834				318,714
Warrants to acquire common stock			5,424				5,424
Accumulated deficit			(288,787	)			(279,898	)
Total stockholders’ equity			36,755				44,524
TOTAL		$	41,913			$	51,375

See notes to financial statements.

Nanosphere, Inc.

Statements of Operations
(dollars and shares in thousands except per share data)
(Unaudited)

		Three Month Periods Ended March 31,
		2011				2010
REVENUE:
Grant and contract revenue		$	54			$	380
Product sales			586				446
Total revenue			640				826
COSTS AND EXPENSES:
Cost of sales			491				725
Research and development			4,695				4,413
Sales, general, and administrative			4,350				4,104
Total costs and expenses			9,536				9,242
Loss from operations			(8,896	)			(8,416	)
OTHER INCOME (EXPENSE):
Foreign exchange gain (loss)			(4	)			10
Interest expense			—				(164	)
Interest income			11				19
Total other income (expense)			7				(135	)
NET LOSS		$	(8,889	)		$	(8,551	)
Net loss per common share — basic and diluted		$	(0.32	)		$	(0.31	)
Weighted average number of common shares outstanding — basic and diluted			27,759				27,753

See notes to financial statements.

Nanosphere, Inc.

(dollars in thousands)
(Unaudited)

		Three Month Periods Ended
		March 31,
		2011				2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(8,889	)		$	(8,551	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			653				951
Amortization of financing costs and accretion of debt discount			—				70
Share-based compensation			1,120				1,545
Changes in operating assets and liabilities:
Accounts receivable			(124	)			260
Inventories			(380	)			(1,091	)
Other current assets			(220	)			(424	)
Accounts payable			(1,554	)			(61	)
Accrued and other current liabilities			(128	)			(441	)
Net cash used in operating activities			(9,522	)			(7,742	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment			(105	)			(267	)
Investments in intangible assets			—				(90	)
Net cash used in investing activities			(105	)			(357	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long term debt			—				(1,299	)
Proceeds from stock option exercises			—				14
Net cash used in financing activities			—				(1,285	)
NET DECREASE IN CASH AND CASH EQUIVALENTS			(9,627	)			(9,384	)
CASH AND CASH EQUIVALENTS — Beginning of period			39,628				76,689
CASH AND CASH EQUIVALENTS — End of period		$	30,001			$	67,305
NONCASH INVESTING AND FINANCING ACTIVITIES:
License costs capitalized and included in other current liabilities		$	350			$	168
License costs capitalized and included in other noncurrent liabilities			1,350				—
Reclassification of inventory to property and equipment			238				651

See notes to financial statements.

Nanosphere, Inc.

Notes to Financial Statements
As of March 31, 2011 and
For the Three Month Periods Ended March 31, 2011 and 2010
(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, 2010 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.

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, service revenue and share-based compensation. Actual results could differ from those estimates.

2. Liquidity and Capital Resources

As of March 31, 2011, the Company has incurred net losses attributable to common stock of $288.8 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. While the Company anticipates that capital resources will be sufficient to meet estimated needs for at least twelve months, the Company operates in a market that makes its prospects difficult to evaluate, and the Company will need additional financing in the future to execute on its current or future business strategies. 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.

3. 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, 2011 and 2010. 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 periods ended March 31, 2011 and 2010 excluded 679,000 and 672,500 shares of restricted stock, respectively (see Note 6). 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, 2011 and 2010 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,
		2011				2010
Restricted stock			679,000				672,500
Stock options			4,187,355				4,264,130
Common stock warrants			1,300,119				1,300,119
			6,166,474				6,236,749

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

4. Intangible Assets

Intangible assets, consisting of purchased intellectual property, as of March 31, 2011 and December 31, 2010 comprise the following (in thousands):

		March 31, 2011												December 31, 2010
						Accumulated												Accumulated
		Cost				Amortization				Net				Cost				Amortization				Net
Intellectual property — licenses		$	4,036			$	(1,258	)		$	2,778			$	4,036			$	(1,241	)		$	2,795
Patents			455				(31	)		$	424				455				(19	)		$	436
		$	4,491			$	(1,289	)		$	3,202			$	4,491			$	(1,260	)		$	3,231

Amortization expense for intangible assets was less than $0.1 million for the three month period ended March 31, 2011 and was $0.2 million for the three month period ended March 31, 2010. Estimated future amortization expense is as follows:

Years Ending December 31
2011 (Period from April 1 to December 31)		$	131
2012			176
2013			176
2014			176
2015			171
Thereafter			522

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, 2011. The amortization period related to $1.8 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.

5. Related Party Transactions

Dr. Chad Mirkin, a co-founder of the Company, provides contracted research and development services to the Company and is reimbursed for these services based upon negotiated contract rates. The Company incurred expenses of less than $0.1 million for these services in each of the three month periods ended March 31, 2011 and 2010.

6. 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 “2007 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 45% of the options granted and outstanding contain “accelerated vesting” provisions.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

The fair values of the Company’s option awards granted during the three month period ended March 31, 2011 were estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions:

Expected dividend yield			0	%
Expected volatility			94	%
Risk free interest rate			2.50	%
Weighted-average expected option life		6.1 years
Estimated weighted-average fair value on the date of grant based on the above assumptions		$	2.76
Estimated forfeiture rate for unvested options			2.8	%

The expected volatility for option awards granted in 2011 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 $0.7 million and $1.2 million in the three month periods ended March 31, 2011 and 2010, respectively.

As of March 31, 2011, the total compensation cost not yet recognized related to the nonvested awards is approximately $5.0 million, which amount is expected to be recognized over the next three 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, 2011, 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, 2011			4,208,830			$	5.60
Granted			72,000			$	4.50
Expired			(8,480	)		$	11.28
Forfeited			(84,995	)		$	5.10
Outstanding — March 31, 2011			4,187,355			$	5.58				6.80			$	280
Exercisable — March 31, 2011			2,163,030			$	5.69				6.21			$	105
Vested and Expected to Vest — March 31, 2011			4,094,236			$	5.58				6.78			$	272

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, 2011.

Included in the number of options outstanding at March 31, 2011 are 1,882,366 options with a weighted average exercise price of $5.28 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, 2011 and 2010 was $1.4 million and $0.5 million, respectively. During the three month period ended March 31, 2011, the Company achieved an accelerated vesting milestone for the FDA 510(k) clearance of the Verigene Respiratory Virus Plus Nucleic Acid Test (RV+) on the Processor SP.

As of January 1, 2011, there were 650,000 shares of restricted stock outstanding under the 2007 Plan, and the Company granted 29,000 shares of restricted stock during the three month period ended March 31, 2011. The restricted shares vest 50% on the two-year anniversary of the grant date and are subject to forfeiture until vested and vest 50% on the four-year anniversary of the grant date and are subject to forfeiture until vested. No shares were forfeited or vested during three month period ended March 31, 2011. The Company recognized $0.4 million in restricted stock compensation expense during each of the three month periods ended March 31, 2011 and 2010. As of March 31, 2011, the total compensation cost not yet recognized related to the nonvested restricted stock awards was approximately $2.2 million, which amount is expected to be recognized over the next two years, which is a weighted average term.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

7. 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, 2011, the Company has paid aggregate initial license fees of $2.8 million for these licenses, and has agreed to pay a percentage of net sales as royalties, in percentage amounts ranging from less than 1.0% to 12.0%. These initial license fees were capitalized as intangible assets (see Note 4). Certain of the license agreements have minimum annual royalty payments, and such minimum payments are $0.2 million in each of the fiscal years 2011, 2012, 2013, 2014 and 2015 and are approximately $0.1 million 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 2012 to 2027.

8. Stockholders’ Equity

As of March 31, 2011 and December 31, 2010, there were outstanding warrants to acquire 1,300,119 shares of common stock. The expiration dates of the warrants outstanding at March 31, 2011 are as follows:

Class of Stock for		Number of				Expiration
which the Warrant is Exercisable		Warrants				Date
Common — exercise price of $17.50 per share			1,135,194			April 2011
Common — exercise price of $8.75 per share			164,925			April 2013

The common stock warrants with an exercise price of $17.50 expired unexercised on April 12, 2011.

9. Commitments and Contingencies

Rent and operating expenses associated with the office and laboratory space were $0.3 million and $0.1 million for the three month periods ended March 31, 2011 and 2010, respectively.

Annual future minimum obligations for the operating leases as of March 31, 2011, are as follows (in thousands):

		Operating
Years Ending December 31		Lease
2011 (Period from April 1 to December 31)		$	322
2012			439
2013			451
2014			190
Total minimum lease payments		$	1,402

10. 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 were 12.5% for the initial twelve month period and 10.0% during the following thirty month period. This debt was satisfied at maturity in August 2010. For the three month period ended March 31, 2010, interest expense was $0.2 million and cash interest payments were $0.1 million.

Nanosphere, Inc.

Notes to Financial Statements — (Continued)
(Unaudited)

11. Supplemental Financial Information

Inventories:		March 31, 2011				December 31, 2010
		(in thousands)
Raw materials		$	947			$	760
Work-in-process			—				69
Finished goods			1,623				1,599
Total		$	2,570			$	2,428

Property and Equipment – Net:		March 31, 2011				December 31, 2010
		(in thousands)
Total property and equipment — at cost		$	18,064			$	17,759
Less accumulated depreciation			(13,214	)			(12,617	)
Property and equipment — net		$	4,850			$	5,142

Other Current Liabilities:		March 31, 2011				December 31, 2010
		(in thousands)
Accrued clinical trial expenses		$	447			$	603
All other			897				752
Total		$	1,344			$	1,355

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

This Quarterly Report on Form 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 on Form 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 on Form 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 on Form 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, 2010 and elsewhere in this Quarterly Report on Form 10-Q.

Business Overview

We develop, manufacture and market an advanced molecular diagnostics platform, the Verigene System, that enables simple, low cost and highly sensitive genomic and protein testing on a single platform. Our proprietary nanoparticle technology provides the ability to run multiple tests simultaneously on the same sample. The Verigene System includes a bench-top molecular diagnostics workstation that is a universal platform for genomic and protein testing. While many systems currently available on the market provide a diagnostic result for one test or a few tests within a specific market niche, the Verigene System provides for multiple tests to be performed on a single platform, including both genomic and protein assays, from a single sample.

The Verigene System is differentiated by its ease of use, rapid turnaround times and ability to detect many targets on a single test, referred to as “multiplexing.” It provides lower cost for laboratories already performing molecular diagnostic testing and enables smaller laboratories and hospitals without advanced diagnostic capabilities to perform genetic testing. Our ability to detect proteins, which can be as much as 100 times more sensitive than current technologies for certain targets, may enable earlier detection of and intervention in diseases associated with known biomarkers as well as the introduction of tests for new biomarkers that exist in concentrations too low to be detected by current technologies. We are focused on the clinical diagnostics market.

Our test menu is designed to fulfill the following unmet hospital laboratory needs:

	1)		the conversion of microbiology to molecular methods to more rapidly pinpoint infectious diseases;
	2)		point-of-care pharmacogenetics to ensure that appropriate therapies are prescribed; and
	3)		earlier detection of life threatening disease through ultra-sensitive protein assays.

The Verigene System is comprised of a microfluidics processor, a touchscreen reader and disposable test cartridges. Certain assays, such as the Warfarin metabolism and hyper-coagulation tests, were cleared by the U.S. Food and Drug Administration (“FDA”) for use with the original Verigene System processor (the “Original Processor”). Subsequently, we developed and launched a second generation Verigene System processor (the “Processor SP”) that handles the same processing steps as the Original Processor and incorporates sample preparation. Some of our current customers continue to use the Original Processor for hyper-coagulation testing and Warfarin metabolism testing. Our development plans are focused on expanding the menu of tests that will run on the Processor SP, and all future assays are expected to be submitted to the FDA on the Processor SP.

Our Applications

The following table summarizes the FDA and CE In-Vitro Diagnostic Mark (“CE IVD Mark”) regulatory status of our near-term genomic and protein assays on the Verigene System:

Assay		FDA Status(1)		CE IVD Mark Status(2)
Infectious Disease Assays
Respiratory Virus		510(k) cleared
Respiratory Virus with Sub-Typing		510(k) cleared		CE IVD Marked
Blood Infection Panels		In development		In development
Human and Pharmacogenetic Assays
Warfarin Metabolism		510(k) cleared(3)		CE IVD Marked
Hyper-Coagulation		510(k) cleared(3)		Pending
Plavix® Metabolism (2C19)		Premarket approval filing submitted third quarter 2010		CE IVD Marked
Ultra-Sensitive Protein Assays
Cardiac Troponin I		In development		In development
Prostate-Specific Antigen (PSA)		Research use only

Infectious Disease Assays

The conversion of microbiology to molecular methods is driven by the need to identify infectious diseases more quickly, allowing a more rapid commencement of clinical intervention. Microbiology labs need tests that can rapidly detect a wide range of potential infectious agents in an automated system. The Verigene System provides the multiplexing, rapid turnaround and ease-of-use needed by these labs. Our infectious disease menu and the Processor SP provide microbiology labs with a compelling solution for conversion to molecular testing.

We have received 510(k) clearance from the FDA for our respiratory panel that detects the presence of influenza A and B as well as respiratory syncytial 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 and fast determination of which virus is present. This test result guides the most appropriate treatment therapy.

In the fourth quarter of 2009, we received 510(k) clearance from the FDA for our respiratory panel on the Processor SP. We believe that our respiratory assay on the Processor SP offers a simple-to-use molecular test for diagnosing respiratory infections and the flu, while providing improved sensitivity over currently available rapid tests. We have received clearance for a package 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 Processor SP.

In the first quarter of 2011, we received 510(k) clearance from the FDA and CE IVD Mark for our respiratory assay that includes subtyping for seasonal H1 virus, seasonal H3 virus, and the 2009 novel H1N1 virus, commonly known as swine flu, as well as the targets on our previously cleared respiratory assay. We believe this is the first sample-to-result molecular respiratory test to include all of these viruses, thus lowering the cost of molecular respiratory testing for hospitals and demonstrating the multiplexing capability of the Verigene System. The demand for this test will be highly dependent upon the seasonality and prevalence of respiratory viruses.

We are developing three blood stream infection panels for the earlier detection of specific bacteria present within patients with blood stream infections. Currently under development are gram positive, gram negative and fungal panels. These assays are designed to enable physicians to pinpoint bacterial strains infecting patients and thus prescribe the most appropriate antibiotic regimen within 24 hours rather than after several days. Treatment is sometimes begun before assays are complete and we believe that this early detection capability will allow patients to avoid unnecessary treatments that may expose them to serious side effects. These assays will require regulatory submission to the FDA along with corresponding CE mark filings.

Our development efforts also include a C. difficile test and an enteric bacteria test. C. difficile is a bacterium that can cause symptoms ranging from diarrhea to life-threatening inflammation of the colon. Our enteric bacteria assay is being developed to detect and identify the Enterobacteriaceae species that most often result from food poisoning. The enteric assay tests for a wide spectrum of bacteria that are treated with various antibiotics and other anti-bacterial drug therapies. These assays also will require regulatory submission to the FDA and corresponding foreign regulatory bodies.

Human and Pharmacogenetic Assays

Hospitals need faster, less expensive and easier-to-use human and pharmacogenetic tests that can be run for a single patient at the point-of-care. Our Verigene System and human and pharmacogenetic test menu addresses these hospital needs. Pharmacogenomics is an emerging subset of human genetic testing that correlates gene variation with a drug’s efficacy or toxicity. These tests play a key role in the advancement of personalized medicine where drug therapies and dosing are guided by each patient’s genetic makeup. There is a growing demand on laboratories to implement molecular diagnostic testing, but the cost and complexity of existing technologies and the need for specialized personnel and facilities have limited the number of laboratories with these capabilities. The ease-of-use and reduced complexity of the Verigene System enables any hospital to perform these testing needs.

We have received 510(k) clearance from the FDA for a warfarin metabolism assay performed on our Original Processor. This is a pharmacogenetic test to determine the existence of certain genetic mutations that affect the metabolism of warfarin-based drugs, including Coumadin^®, the most-prescribed oral anticoagulant. This assay has been CE IVD Marked during the first quarter of 2011, and we plan to submit an FDA application for this assay to allow its use on the Processor SP.

In the third quarter of 2010, we filed a pre-market approval application (“PMA”) with the FDA 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 50% of the population possess variations in these genes and abnormally metabolize this drug, thus increasing the risk of adverse events. Our 2C19 assay is designed to identify patients possessing certain of these variations so that alternative therapeutic approaches can be prescribed to reduce clotting that can result in heart attack or stroke. This assay was CE IVD Marked during the first quarter of 2011.

We have also received 510(k) clearance from the FDA for a hyper-coagulation assay on the Original Processor that determines an individual’s risk, based upon genetic information, for the development of blood clots that can lead to pulmonary embolism and deep vein thrombosis. We plan to submit an additional FDA application and file for CE IVD Mark to allow its use on the Processor SP.

Ultra-Sensitive Protein Assays

Our ability to detect proteins at sensitivity levels that can be up to 100 times greater than current technologies may enable earlier detection of and intervention in diseases as well as enable the introduction of tests for new biomarkers that exist in concentrations too low to be detected by current technologies. 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 diseases.

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 myocardial infarction, or heart attack, and identification of patients with acute coronary syndromes at risk for subsequent cardiovascular events. We previously submitted a 510(k) application to the FDA to obtain clearance for the cardiac troponin assay on the Original Processor. We have withdrawn this application and plan to submit a new 510(k) application to obtain clearance for this assay on the Processor SP. We plan to use patient samples from our FAST-TRAC clinical trial to run the clinical trials in support of our new 510(k) submission. The FAST-TRAC clinical study is designed to 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.

In addition to the cardiac troponin I assay, we are developing an ultra-sensitive prostate-specific antigen (“PSA”) test for early diagnosis of recurrent prostate cancer. Early testing data suggest this assay may serve as a more specific test for PSA screening. We are also working on a multiplexed protein-based connective-tissue panel for the detection of rheumatoid arthritis, lupus and other related diseases. Finally, we are investigating new biomarkers where our ultra-sensitive protein detection technology may enable earlier detection of a broad range of diseases, such as cancer.

Financial Operations Overview

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 $8.9 million for the three month period ended March 31, 2011. As of March 31, 2011, we had an accumulated deficit of approximately $288.8 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.

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.

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, 2011 Compared to the Three month Period Ended March 31, 2010

Revenues

Revenues were $0.6 million for the three month period ended March 31, 2011, as compared to $0.8 million for the three month period ended March 31, 2010. Product sales increased from $0.4 million for the first quarter of 2010 to $0.6 million for the first quarter of 2011 due to sales of the respiratory virus with sub-typing assay. This test received FDA 510(k) clearance during the first quarter of 2011. Grant and contract revenue decreased from $0.4 million for the first quarter of 2010 to $0.1 million for the first quarter of 2011 due to the substantial completion of an assay development contract with a major pharmaceutical company during 2010.

Cost of Sales

Cost of sales decreased from $0.7 million for the three month period ended March 31, 2010 to $0.5 million for the three month period ended March 31, 2011 due to the decrease in grant and contract revenue discussed previously.

Research and Development Expenses

Research and development expenses increased to $4.7 million for the three month period ended March 31, 2011 from $4.4 million for the three month period ended March 31, 2010 due to an increase in materials spending to support clinical trials and product development.

Sales, General and Administrative Expenses

Sales, general and administrative expenses increased from $4.1 million for the first quarter of 2010 to $4.4 million for the first quarter of 2011. Sales and marketing expenses increased to support our U.S. customer base and to expand international marketing of our assays receiving CE IVD Mark approval during the first quarter of 2011.

Interest Expense

Interest expense was $0 for the three month period ended March 31, 2011, as compared to $0.2 million for the three months ended March 31, 2010. The debt financing with Venture Lending & Leasing IV, Inc., and Venture Lending & Leasing V, Inc. matured August 2010.

Liquidity and Capital Resources

From our inception in December 1999 through March 31, 2011, 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 and $10.3 million from government grants. 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, 2011, we had an accumulated deficit of approximately $288.8 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 in the foreseeable future.

Because we recently began to commercialize our products, we do not anticipate achieving positive operating cash flow in the next three years. 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 current products and future products that depend upon regulatory clearance. 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. While the Company anticipates that capital resources will be sufficient to meet estimated needs for at least twelve months, the Company operates in a market that makes its prospects difficult to evaluate, and the Company will need additional financing in the future to execute on its current or future business strategies. 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.

A customer may purchase the Verigene System instruments or lease them 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 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, 2011, we had $30.0 million in cash and cash equivalents as compared to $39.6 million at December 31, 2010. The decrease in cash and cash equivalents was principally due to the use of cash in operating activities.

Net cash used in operating activities increased from $7.7 million for the three months ended March 31, 2010 to $9.5 million for the three months ended March 31, 2011. Accounts payable at December 31, 2010 included approximately $2.0 million of legal expenses related to a patent dispute that was settled during the third quarter of 2010. These legal expenses were paid during the first quarter of 2011. The first quarter of 2011 and 2010 also included payments of $0.6 million and $0.8 million, respectively, for bonuses earned in the prior year.

Net cash used in investing activities decreased to $0.1 million for the three months ended March 31, 2011 as compared to $0.4 million for the three months ended March 31, 2010. Our capital spending in 2010 focused on manufacturing cost reduction programs.

Net cash used in financing activities was $0 for the three months ended March 31, 2011 as compared to $1.3 million for the three months ended March 31, 2010. Our spending on financing activities in 2010 related to the scheduled payments under two loan and security agreements that matured in the third quarter of 2010.

We may need to increase our capital outlays and operating expenditures over the next several years as we expand our product offering, drive product adoption, further scale-up manufacturing and implement product cost savings. The amount and the timing of the additional capital we will need to raise depends on many factors, including:

•

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

•

the amount and growth rate of our revenues;

•

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

	•		the costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;
	•		competing technological and market developments;

•

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

•

changes in regulatory policies or laws that affect our operations.

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

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, 2010 filed with the SEC on February 16, 2011.

Off-Balance Sheet Arrangements

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

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, 2011 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 to $0 for the three month period ended March 31, 2011.

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, 2011. 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, 2011.

(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.

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.

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, 2010, 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, 2011, 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 *

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.

Date: April 27, 2011

Date: April 27, 2011