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Undaunted by a Rough Q2, Nanogen Sticks to Plan for Clinical Diagnostics Market

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Nanogen recently paid out over $5 million to settle a patent infringement suit with Motorola, Genometrix, and the Massachusetts Institute of Technology. This included $2.5 million in cash, $2.5 million in stock, and over $500,000 in litigation expenses.

For a larger company like Affymetrix or Incyte, this settlement, in which the company also licensed two claims to the patent at issue, might be easily sloughed off.

But Nanogen reported only $2.7 million in earnings for the second quarter, up only incrementally from the $2.4 million the company reported for the second quarter of 2000.

A mere $300,000 of these revenues came from sales of the company’s flagship product, its NanoChip Molecular Biology Workstations, the company said during its second-quarter conference call. The company sold three Workstations, and apparently sold them at a substantial discount from its previously stated list price of $160,000 per system.

The remainder of Nanogen’s second-quarter revenues came from sponsored research programs, corporate alliances, and government grants, according to chief financial officer Gerard Wills — the kinds of revenues that could dry up as the company matures.

Meanwhile, the company’s operating expenses, exclusive of the litigation, rose to $10.1 million for the quarter, compared to $7.9 million for the year-ago period, largely due to expansion of its sales and marketing staff. Wills said Nanogen expects these expenses to “remain at this level for the foreseeable future.”

These high expenses and low revenues add up to a burn rate of $21 million for the first half of 2001, or $16 million excluding the Motorola settlement.

Nevertheless, Nanogen’s management seems resiliently optimistic, even happy about the recent developments.

“We reduced our litigation distraction during the quarter by favorably resolving our litigation with Motorola, Genometrix, and the Massachusetts Institute of Technology,” said Nanogen president Kieran Gallahue. “It is critical that we achieved this without having to provide access to Motorola to Nanogen’s own technology. We see this as a key win for the company.”

Additionally, new CEO Randy White said he still believed Nanogen could meet its original revenue target of $13 million to $15 million for the year — meaning it would have to increase revenues for the second half of the year to between $7.4 million and $9.4 million — a 32 to 68 percent increase over the first half.

Gallahue added that he believes Nanogen will see a sharp spike in installed sales of its NanoChip Workstations during the second half of the year.

“I feel comfortable with the build of [the customer] pipeline,” Gallahue said, in response to a question about the backlog of orders during the conference call.

But Gallahue did not say that any new customers had actually ordered NanoChip Workstations, nor that there was a backlog of orders. In other words, the company is still having trouble turning this technology — which uses a matrix of 100 positively charged pads to immobilize strands of negatively charged DNA and allow researchers to individually control the hybridization site — into a viable commercial product.

This is exactly the problem that Randy White, who took the reins as CEO in May, has begun to address — at least in words.

To actually sell the systems, White offered what he called “a plan of attack.” As a 28-year veteran of the medical lab business, White explained that the buy decision in a clinical lab is based primarily on clinical results, and then operational simplicity and cost. Nanogen’s platform, he said, offers the “distinct advantage” of being able “to simultaneously measure multiple mutations” in genes. This capability could make the system cost-effective in consolidating the number of screens that a lab has to perform, White said. Instead of ordering a series of tests and eliminating different diagnoses by trial and error, physicians could simply order a NanoChip-based screen and perform a number of tests at once.

Since he signed on, White has clearly steered the company in the direction of the clinical diagnostics market, and away from the research arena. Nanogen founder Michael Heller, an inventor listed on many of Nanogen’s 27 patents, has resigned to take an academic position at University of California, San Diego. The remaining members of the management team have spoken unanimously of the company’s strategy to focus on marketing efforts to users of the system who are developing clinical assays using the NanoChip Workstation.

“Nanogen will devote a larger portion of its revenue to this [clinical screening] market,” said Gallahue.

The company itself is developing clinical assays for the Workstation, in collaboration with 13 development partners. Nanogen said it still hopes to have the first assays developed by the end of the year, and to “aggressively work to convert these tests to [Analyte Specific Reagent] models in 2001,” White said. “We believe this group will drive cartridge volume up.”

With $78 million in cash, cash equivalents, and short-term investments, down from $95.1 million as of December 31, 2000, Nanogen has a couple of years to turn profitable. But White still demurred that it’s “too early to tell” when the eight-year old company expects to break even.

Indeed, while the NanoChip technology still sounds promising, it is also too early to tell when and if White can transform it from a foundering innovator into a profitable diagnostic biochip instrument provider.

— MMJ

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