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

Business Overview

We develop, manufacture and market an advanced molecular diagnostics platform, the Verigene System, that enables simple, low cost and highly sensitive genomic and protein testing on a single platform. Our proprietary nanoparticle technology 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 we plan to develop and seek regulatory approval of all future assays on the Processor SP.

During 2012, we received FDA(k) clearance for tests including new verigene tests:

• Blood Culture - Gram Positive (BC-GP)

• C. difficile

• 2C19 Genetic Variance

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 with Sub-Typing                510(k) cleared         CE IVD Marked

Blood Infection Panels

•    Blood Culture - Staphylococcus (BC-S)       510(k) cleared         CE IVD Marked

•    Blood Culture - Gram Positive (BC-GP)       510(k) cleared(4)      CE IVD Marked

•    Blood Culture - Gram Negative (BC-GN)       In development         CE IVD Pending

•    Blood Culture - Fungal (BC-F)               In development         In development

C. difficile                                     510(k) cleared         CE IVD Pending

Enteric Panel                                    In development         In development

Human and Pharmacogenetic Assays

Warfarin Metabolism                              510(k) cleared(3)      CE IVD Marked

Hyper-Coagulation                                510(k) cleared(3)      CE IVD Marked

2C19 Genetic Variance                            510(k) cleared         CE IVD Marked

Ultra-Sensitive Protein Assays

Cardiac Troponin I                               In development         In development

Prostate-Specific Antigen (PSA)                  Research use only

(2) For further description of our CE IVD Mark regulatory requirements, please refer to the section "Foreign Government Regulation" beginning on page 13 of this Annual Report on Form 10-K for the year ended December 31, 2012.

(3) Currently cleared only for use with the Original Processor.

(4) Received FDA 510(k) clearance in June 2012 and subsequent 510(k) clearance expanding the test's intended use for use with all adult blood culture bottles received September 2012.

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 510(k) 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 blood stream infection panels for the earlier detection of specific bacteria and resistance markers within patients with blood stream infections. These panels include gram positive, gram negative and fungal pathogens and resistance markers. 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. The first blood stream infection panel developed was the gram positive that represents approximately 65% of blood stream infections. In the fourth quarter of 2011 we received CE IVD Mark for the BC-GP and FDA 510(k) clearance of BC-S, a subset of the BC-GP panel. In June 2012 we received a de novo 510(k) clearance to market the full BC-GP panel. In September 2012 we received a 510(k) clearance which expanded the intended use of BC-GP for use with all adult blood culture bottles. The BC-GN and BC-F panels are in development.

We developed a test to detect C. difficile, a bacterium that can cause symptoms ranging from diarrhea to life-threatening inflammation of the colon. We received 510(k) clearance from the FDA in the fourth quarter of 2012 for our C. difficile test.

Our development efforts also include an enteric bacteria test. Our enteric bacteria assay identifies the Enterobacteriaceae species that most often result from food poisoning. The enteric assay tests for a wide spectrum of bacteria and viruses that are treated with various antibiotics and other drug therapies. This assay 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 fourth quarter of 2012 we received 510(k) clearance from the FDA for a 2C19 genetic variance test. This assay was CE IVD Marked during the first quarter of 2011.This test detects variances in the cytochrome P-450 2C19 gene. These genetic variances are associated with deficient metabolism of clopidogrel, more commonly known by the trade name Plavix.

We also have 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. This assay has been CE IVD Marked during the fourth quarter of 2011, and we plan to submit an FDA application for this assay to allow its use on the Processor SP.

Ultra-Sensitive Protein Assays

Our ability to detect proteins at sensitivity levels that can be 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, are currently developing or plan to develop 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 cardiovascular events. We may submit an assay for 510(k) clearance for use as a diagnostic tool for acute coronary syndromes, although we have no immediate plans to do so. Currently, we are focused on investigating the potential to sell this assay to commercial labs as a marker for cardiac risk. Early studies suggest that our ultra-sensitive cTnI test may also be a useful monitoring tool for chronic heart failure ("CHF") patients. Larger studies and regulatory hurdles will need to be cleared before we market the assay for CHF monitoring purposes.

In addition to the cardiac troponin I assay, we have developed an ultra-sensitive prostate-specific antigen ("PSA") test for early diagnosis of recurrent prostate cancer. We also may develop ultra-sensitive protein assays in the areas of immunology, allergy and cancer.

Intellectual Property

As of December 31, 2012, our patent portfolio is comprised, on a worldwide basis, of 186 issued patents and 14 pending patent applications which we own directly or for which we are the exclusive licensee. Some of these patents and patent applications derive from a common parent patent application or are foreign counterpart patent applications and relate to similar or identical technological claims. The issued patents cover approximately 11 different technological claims and the pending patent applications cover approximately three additional technological claims.

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

In addition, as of December 31, 2012, we have non-exclusive licenses for at least 42 U.S. patents that cover 11 different technological claims from various third parties. Most of these license agreements require us to pay the licensor royalty fees that typically expire upon the patent expiration dates, which range from 2013 to 2027. These license agreements are non-exclusive and do not create a proprietary position. The expiration of these non-exclusive licenses will result in the termination of certain royalty payments by us to the licensors.

Financial Operations Overview

Revenue

Product sales revenue is derived from the sale or rental of the Verigene System, including test instruments and cartridges and related products sold to hospitals and commercial laboratories. 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 marketing efforts are primarily focused on driving product sales rather than obtaining grants and contracts.

Cost of Sales

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

Research and Development Expenses

Research and development expenses primarily include all costs incurred during the development of the Verigene System instruments and disposable test cartridges, 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 instruments, 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. Clinical trial expenses related to regulatory filings and post marketing studies are included in sales, general and administrative expenses. 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 expect that continued low interest rates will significantly limit our interest income in the near term.

Interest Expense

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

Fiscal 2012 Compared to 2011

Revenues

Revenues were $5.1 million for fiscal 2012 as compared to $2.5 million for fiscal 2011. Product sales more than doubled, increasing from $2.4 million for 2011 to $5.0 million for 2012, driven by unit volume increases in both cartridge and system sales. The cartridge unit volume increase was driven primarily by an increase in our infectious disease customer base. Contract development and grant revenue was less than $0.1 million in 2012 as compared to $0.1 million for 2011.

Cost of Sales

For fiscal 2012, cost of sales was $3.5 million, as compared to $1.8 million for fiscal 2011, an increase proportional to the increase in product sales revenues.

Research and Development Expenses

Research and development expenses were $17.6 million for fiscal 2012 as compared to $20.0 million for fiscal 2011. This $2.4 million decrease in research and development expenses resulted from a shift in resources from development into manufacturing, with the labor cost included as inventory and cost of sales, combined with a reduction in spending on goods and materials.

Sales, General and Administrative Expenses

Sales, general and administrative expenses increased from $16.2 million for fiscal 2011 to $16.9 million for fiscal 2012 due to increased spending for the sales and customer support expansion, partially offset by a reduction in equity compensation expense.

Interest Expense

Interest expense was less than $0.1 million for 2012 and for 2011.

Interest Income

Interest income was less than $0.1 million for 2012 and for 2011.

Fiscal 2011 Compared to 2010

Revenues

Revenues were $2.5 million for fiscal 2011, as compared to $2.0 million for fiscal 2010. Product sales increased from $1.4 million for fiscal 2010 to $2.4 million for fiscal 2011, driven by an increase in consumables revenue and system sales. Contract development and grant revenue was $0.1 million for 2011 as compared to $0.6 million for 2010.

Cost of Sales

For fiscal 2011, cost of sales was $1.8 million, as compared to $2.6 million for fiscal 2010. During 2010, the Company established a valuation reserve of $0.7 million for the Original Processor inventory. This reserve was taken based on the Company's plan to submit future assay applications to the FDA for use only on the Processor SP . In addition, license amortization expense was $0.3 million lower in 2011 than 2010 due to the expiration of a licensed patent.

Research and Development Expenses

Research and development expenses were $20.0 million for fiscal 2011 as compared to $18.8 million for fiscal 2010. The $1.2 million increase was driven almost entirely by an increase in goods and materials used for assay development and pre-clinical studies.

Sales, General and Administrative Expenses

Sales, general and administrative expenses decreased from $22.0 million for fiscal 2010 to $16.2 million for fiscal 2011, a decrease resulting from a $6.1 million reduction in litigation defense and settlement expenses related to a patent dispute settled in 2010. In addition, sales, general and administrative expenses increased by $0.8 million in 2011 due to increased regulatory and customer support headcount, which was completely offset by reduced bonus expense in 2011.

U.S. Treasury Grant

During fiscal 2010, the United States Department of the Treasury awarded the Company a grant of $1.0 million for investments in qualifying therapeutic discovery projects under section 48D of the Internal Revenue Code. The proceeds from this grant are classified in "Other income (expense) - U.S. Treasury Grant" on the statement of operations.

Interest Expense

There was no interest expense for fiscal 2011, as compared to $0.3 million for fiscal 2010. The debt financing with Venture Lending and Leasing IV, Inc. and Venture Lending and Leasing V, Inc. matured August 2010.

Interest Income

Interest income was less than $0.1 million for 2011 and for 2010.

Liquidity and Capital Resources

From our inception in December 1999 through December 31, 2012, 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, $32.2 million from our May 2011 underwritten public offering, $27.0 million from our July 2012 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 December 31, 2012, we had an accumulated deficit of approximately $348.2 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.

We do not anticipate achieving positive operating cash flow in at least the next twelve months. We expect to increase investment in additional manufacturing scale-up, and to add to sales, marketing and customer support personnel during the next twelve months. 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. Management believes that its cash resources should be sufficient to support currently forecasted operations through at least the next twelve months. However, the Company operates in a market that makes its prospects difficult to evaluate, and the Company will need additional debt or equity financing in the future to execute its business plans beyond the next twelve months. Management also believes that, if necessary, it can implement plans in the short term to conserve existing cash should additional financing activities be delayed. Capital outlays and operating expenditures may increase over the next twelve months as the Company expands its infrastructure, commercialization and manufacturing capacity.

A customer may purchase the Verigene System instruments, 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. We may need to increase our investment in such systems rented to customers in order to support future customer growth. 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 market value of such systems immediately, instead of over three to five years.

As of December 31, 2012, we had $33.1 million in cash and cash equivalents, compared to $39.3 million at December 31, 2011. Cash used in operations of $31.7 million for the year ended December 31, 2012 was up slightly as compared to $31.5 million in the year ended December 31, 2011. Cash used in operations for the year ended December 31, 2011 decreased slightly to $31.5 million from $31.6 million for the year ended December 31, 2010.

Net cash used in investing activities increased to $0.8 million for the year ended December 31, 2012 compared to $0.6 million for the year ended December 31, 2011 due to increased spending on manufacturing equipment. Net cash used in investing activities decreased from $1.6 million for the year ended December 31, 2010 compared to the $0.6 million for the year ended December 31, 2011 predominantly driven by the reduction in license fees paid.

Net cash provided by financing activities decreased to $26.4 million for the year ended December 31, 2012 compared to $31.7 million in cash provided by financing activities for the year ended December 31, 2011. The difference in net . . .