Competition

 Competitors

The markets in which our Biosystems operating segment operates are highly competitive, and characterized by rapidly changing technological advances. A number of Transgenomic’s competitors possess substantial resources and are able to develop and offer a much greater breadth of products and/or services, coupled with significant marketing and distribution capabilities. Transgenomic competes principally on the basis of uniquely enabling technical advantages in specific but significant market segments.

Competition for our Biosystems segmentWAVE Systems arises primarily from DNA sequencing and genotyping technologies. Competitors in these areas include several companies including Varian, Waters, Agilent, Applied Biosystems, Beckman Coulter, Amersham Biosciences(now part of GE Healthcare), Affymetrix, Agilent Technologies, Nanogen, Illumina, Sequenom, Pyrosequencing (now part of Biotage AB), Varian, and Invitrogen. Theseothers. Competition for some of our non-WAVE consumable products comes from numerous well-diversified life sciences reagents providers, including, among others, Invitrogen, Qiagen, Roche, Stratagene, and Promega. Our Discovery Services unit faces competition from a number of companies provide various productsoffering contract DNA sequencing and other genomic analysis services, that compete either directly withincluding Genaissance Pharmaceuticals, GeneLogic, Agencourt, SeqWright, Gentris, and Perlagen. In addition, several clinical diagnostics service providers, such as Labcorp, Quest, and Specialty Laboratories, also offer related laboratory services in support of clinical trials. Finally, additional competition arises from academic core laboratory facilities.

Competition is also intense in the markets in which our systems, bioconsumablesNucleic Acids operating segment functions, and services, or indirectly through alternative technologies and/or methods. Competitors for ourincreasingly driven by price. Transgenomic competes on the basis of its ability to develop and manufacture synthetic nucleic acid segment vary depending on the product. In the standard chemical building blocks market, we compete with Applied Biosystems,used to make DNA and RNA oligonucleotides. Competitors include Proligo andDegussa, Pierce Nucleic Acid Technologies. The competitors for our pharmaceutical grade oligonucleotide synthesis productsTechnologies, and services include primarily Proligo and Avecia.Applied Byosystems. In addition, competition is expected in the future from new overseas entrants focusing on low cost production.

Employees

As of December 31, 2002,2004 and 2003, we had 326 full-time employees. The following sets forth178 and 244 employees, respectively. Certain of those employees at December 31, 2004 were terminated during January and February 2005 in connection with the number2004 restructuring plan. As of persons employedFebruary 28, 2005, we had 157 employees and expect our headcount to be relatively stable throughout the remainder of 2005. These employees are focused in the principalfollowing areas of our operation:

We supplement our workforce through the use of independent contractors and consultants. As of February 28, 2005 and December 31, 2002,2004, we have engaged independent contractors or consultants who provide services to us approximately equivalent to 5 full time employees.five and four full-time employees, respectively.

 The Company began a restructuring process during the fourth quarter of 2002 that resulted

Our employees were employed in the eliminationfollowing geographical locations.

General Information

We were incorporated in Delaware on March 6, 1997. Our principal office is located at 12325 Emmet Street, Omaha, Nebraska 68164 (telephone: 402-452-5400). We maintain manufacturing facilities in Omaha, Nebraska, San Jose, California, Glasgow, Scotland and Cramlington, England. We maintain research and development offices in Gaithersburg, Maryland and Omaha, Nebraska.

Our Internet address iswww.transgenomic.com. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports available free of a significant number of job positions. A large number of employees that had been notified of termination had not yet reached their termination datecharge through our website as soon as reasonably practicable after we file these documents with the Securities and thus are included in the 12/31/02 employee counts shown above. Additionally, further job eliminations were to occur during the first quarter of 2003. The total employee count following these further reductions is expected to be approximately 270 to 280.Exchange Commission.

Risks Related to Our Business

We may not have adequate financial resources available to execute our business plan.plan and may be need to terminate some operations.

We have historicallyexperienced net losses and had an accumulated deficit of $107,101 at December 31, 2004. As of March 31, 2005, we had cash and cash equivalents of $1.37 million plus an additional $2.29 million available under our Credit Line. Based on our 2005 operating plan, we believe existing sources of liquidity will be sufficient to meet cash needs during 2005. If necessary, we believe we can manage costs and expenses at reduced levels to conserve working capital. The need for any such cost and expense reductions during 2005 would likely delay implementation of our business plan. Additionally, we may pursue additional financing alternatives. Ultimately, we must achieve sufficient revenue levels to support its cost structure.

Not withstanding our beliefs, there is no assurance that we will be able to achieve all of these steps or that any of these steps will allow us to meet our cash needs. Accordingly, our existing cash balances, cash generated by operations, and available borrowings under the Credit Line may be insufficient to satisfy our liquidity requirements if our operating plan is not met. In addition, there is no assurance that we will be able to obtain additional debt or equity financing to meet future cash needs. If we are not able to meet our needs for working capital, we may not be able to execute parts or all of our business plan and may need to discontinue operations in one or both of our operating segments.

We have a history of operating losses and may incur losses in the future.

We have experienced losses from operations since inception of our operations. Our operating losses for each of the last three fiscal years were $29.06 million, $22.59 million and negative cash flows.$21.70 million, respectively. These results were mostlylosses have been due principally to the high levels of research and development expenses and sales and marketing expenses relatedthat we have incurred in order to the developmentdevelop and marketing ofmarket our products. We couldproducts, restructuring charges and impairment charges. In addition, markets for our products have developed more slowly than expected in many cases and may continue to do so. As a result, we may incur operating losses forin the foreseeable future, and we may never be profitable. To date,

We may issue a substantial amount of our stock in conversion of our debt and exercise of options and warrants and this could reduce the market price for our stock.

As of April 14, 2005, we have financed our operations and capital expenditures primarily from the proceeds of a $77.3had outstanding 34,234,922 million public offeringshares of common stock. In March 2003,We also had obligations to issue approximately 6.2 million shares of common stock under outstanding stock options and warrants. Additionally, we entered into a loan commitment agreement with a financial institution for up to a $5.0may issue shares of common stock upon conversion of all or part of the Laurus Loans. Currently, Laurus may acquire 2.8 million secured lineshares of credit. We will continue to need substantial amountsour common stock upon conversion of cash for research and development and to expand our sales and manufacturing infrastructure. We may need to raise the additional capital in the future through bank financing or strategic investments. Additional financing may not be available to us when we need it, or, if available, we cannot assure that we will be able to obtain such financing on terms favorable to our stockholders or us. If we raise additional capital by issuing equity securities, thethis debt. The issuance of such securities would result in ownership dilutionadditional shares of common stock may be dilutive to our stockholders.current shareholders and could negatively impact the market price of our common stock.

WeMarkets for our products and services may not have adequate organizational resources available to execute our business plan.develop slowly.

 During

There are many factors that affect the fourth quarter of 2002market demand for our products and the first quarter of 2003, we restructured the Company, which resulted in a net reduction in staff and facilities, and the abandonment of certain intellectual property. While we feel we have retained and redeployed existing resources and secured additional resources necessary to successfully conduct our business,services that we cannot assure youcontrol. This is especially true in our Nucleic Acids operating segment where the demand for our products depends to a large degree on the success that the net reduction will not impair our abilitycustomers and potential customers have in developing useful pharmaceutical products based on genetic intervention. A central strategy for our Nucleic Acids operating segment is to achieve our planned revenue levels.

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Our business strategy includes positioning ourselves as a unique partnersell synthetic nucleic acid products to biopharmaceutical and pharmaceutical companies that are seeking to develop commercially viable genomic-based diagnostic and therapeutic products. We have invested a significant amount of capital into acquiring and developing manufacturing facilities and other assets to allow us to pursue this market. However, this is a new field of commercial development, and many of these biopharmaceutical and pharmaceutical companies are in the early stages of their efforts to develop genomic-based diagnostics and therapeutics.

therapeutics and have encountered difficulties in these efforts. As a result, the demand for our synthetic nucleic acid products is difficult to forecast and may develop slowly or sporadically. In addition, we cannot assure you that these companies will not internally develop the chemistries and manufacturing capabilities to produce the products they could buy from us. Demand for our WAVE System is similarly affected by the needs and budgetary resources of research institutions, universities, hospitals and others who use the WAVE System for genetic-variation research. The WAVE System represents a significant expenditure by these types of customers and often requires a long sales cycle. If revenues from the sales of our products and services continue at current levels, we may need to take steps to further reduce operating expenses or raise additional working capital. We cannot assure you that sales will increase or that we will be able to reduce operating expenses or raise additional working capital.

A single customer accounts for a significant portion of consolidated net sales and net sales in our Nucleic Acids operating segment.

During 2004, sales to Geron Corporation totaled $4.15 million and represented 12% of total consolidated net sales and 49% of total net sales within our Nucleic Acids operating segment. We do not have a long-term sales agreement with Geron Corporation and, accordingly, the amount of nucleic acid products we sell to it is subject to change. Revenues from our Nucleic Acids operating segment business would be substantially reduced if Geron Corporation’s need for our products declined or if it decided to obtain these products from other suppliers.

No other customer currently accounts for more than 10% of total consolidated or operating segment net sales.

Customer clinical trials may be delayed or discontinued.

A significant percentage of our Nucleic Acids operating segment and Discovery Services revenues are generated by sales to customers involved in drug development. Our products and services are generally used by these customers in the manufacture of drug candidates in varying stages clinical trials. If these clinical trials are delayed or cancelled or are otherwise not successful, this could have a significant impact on revenues.

The sale of our products and business operations in international markets subjects us to additional risks.

During the last three fiscal years, our international sales have been approximately 55-65% of our net sales. As a result, a major portion of our revenues and expenses are subject to risks associated with international sales and operations. These risks include:

• payment cycles in foreign markets are typically longer than in the U.S. and capital spending budgets for research agencies can vary over time with foreign governments;

• changes in foreign currency exchange rates can make our products more costly and operating expenses higher in local currencies since our foreign sales and operating expenses are typically paid for in U.S. Dollars, British Pounds or the Euro; and

• the potential for changes in U.S. and foreign laws or regulations that result in additional import or export restrictions, higher tariffs or other taxes, more burdensome licensing requirements or similar impediments to our ability to sell products and services profitably in these markets.

Our WAVE System includes hardware components and instrumentation manufactured by a single supplier and if we are no longer able to obtain these components and instrumentation our ability to manufacture our products could be impaired.

We currently rely on a single supplier, Hitachi High Technologies America, to provide the basic instrument used in our WAVE Systems. While other suppliers of instrumentation and computer hardware are available, we believe that our arrangement with Hitachi offers strategic advantages. Hitachi is replacing its current instrument line with a new instrument line. While we presently plan to convert our technology and applications to this new instrument line, such conversion may not be successful and, therefore, we may incur additional costs for the custom manufacturing of the current instrument line. If we were required to seek alternative sources of supply, it could be time consuming or expensive or require significant and costly modification of our WAVE System. Also, if we were unable to obtain instruments from Hitachi in sufficient quantities or in a timely manner, our ability to manufacture our products could be impaired, which could limit our future revenues.

We may not have adequate personnel to execute our business plan.

In order to reduce our operating costs, we have significantly reduced the number of employees, including reductions in our research and development staff and our sales and marketing personnel. In addition, we may lose other key management, scientific, technical, sales and manufacturing personnel from time to time. It may be very difficult to replace personnel if they are needed in the future, and the loss of key personnel could harm our business and operating results. We cannot assure you that our employee reductions will not impair our ability to continue to develop new products and refine existing products in order to remain competitive. In addition, these reductions could prevent us from successfully execute this strategy. Additionally,marketing our products and developing our customer base.

Our markets are very competitive.

As described above, we compete with many other companies in both our Biosystems and Nucleic Acids operating segments. Many of these competing companies have greater resources than we do or may enjoy other competitive advantages. This may allow them to more effectively market their products to our customers or potential customers, to develop products that make our products obsolete or to produce and sell products less expensively than us. As a result of these competitive factors, demand for and pricing of our products and services could be negatively affected.

The price for our common stock is volatile and may drop further.

The trading price for our common stock has fluctuated significantly over recent years. The volatility in the price of our stock is attributable to a number of factors, not all of which relate to our operating results and financial position. Nevertheless, continued volatility in the market price for our stock should be expected and we cannot assure you that the companies we seek to partner with will not decide to develop novel chemistries and manufacturing capabilities for themselves. Lastly, we cannot assure that these companies will have consistent success in this relatively new area of developing commercially viable genomic-based diagnostic and therapeutic products. In fact, the biopharmaceutical and pharmaceutical companies involved have encountered difficulty in accomplishing this and we have seen varying demand for the products and services we seek to provide to them.

        In positioning ourselves to partner with such companies we must:

•

Attract and retain world-class nucleic acid chemistry expertise,



•

Develop and maintain world-class research and development facilities,



•

Qualify and maintain cGMP manufacturing facilities,



•

Obtain numerous permits associated with the chemicals used in various manufacturing processes, and



•

Establish long-term partner relationships with various companies.

We will need to effectively manage our growth if we are to successfully implement our strategy.

        The scopeprice of our business operations has andstock will continue to change and evolve. Such changesincrease in our business and the growth that may accompany them may place a strain on our management and operations. Our ability to manage our growth will depend onfuture. Fluctuations or further declines in the abilityprice of our officers and key employees to continue to implement and improve our operational, management information and financial control systems and to expand, train and manage our work force both in the U.S. and abroad. Our inability to manage our growth effectively couldstock may affect our ability to pursue business opportunities and expand our business.

Item 2.    Properties.

        Our four principal manufacturing facilities are located in Omaha, Nebraska, San Jose, California, Boulder, Colorado and Glasgow, Scotland. Additionally, corporate administration offices are located in Omaha, Nebraska. The following table summarizes information related to property occupied in these locations.

        We lease additional facilities for manufacturing, sales, customer support and research and development in Crewe, England, Cramlington, England, Tokyo, Japan, Paris, France, Berlin, Germany, Cambridge, Massachusetts, Gaithersburg, Maryland, Atlanta, Georgia, San Diego, California, Wayne, Pennsylvania and Denver, Colorado.

        As a partsell shares of our restructuring plans developed in the fourth quarter of 2002stock and to raise capital through future equity financing.

If we are unable to maintain our office space requirements have been reduced. As a result, some of our locations will be closed or the amount of space

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        At March 24, 2003, there were 23,532,049trade shares of our common stock outstanding and approximately 3,300 holders of record. The outstanding shares consist of 24,026,653 shares issued less 494,604 shares of treasury stock.could suffer.

 We have never declared or paid any cash dividends on our capital stock and we do not anticipate paying any cash dividends on

In order for our common stock into remain listed on the foreseeable future. We currently expect to retain all earnings, if any,Nasdaq National Market (“Nasdaq”), we must meet the minimum listing requirements for investment in our business. Dividends oncontinued listing, including, among other requirements, minimum bid price and market value of public float requirements. On March 31, 2005, we were notified that the bid price for our common stock over a 30-day period was below the $1.00 minimum required for continued listing of our common stock on the Nasdaq. In order to remain listed, the minimum bid price for our common stock must be at least $1.00 per share over ten consecutive business days before September 27, 2005. If we are not able to regain compliance with this listing requirement, we may be delisted from the Nasdaq. If our common stock is delisted from the Nasdaq, transactions in our common stock would likely be conducted only in the over-the counter market, or potentially on regional exchanges, which could negatively impact the trading volume and price of our common stock, and investors may find it more difficult to purchase or dispose of, or to obtain accurate quotations as to the market value of, our common stock. In addition, if our common stock were not listed on the Nasdaq and the trading price of our common stock fell below $1.00 per share, trading in our common stock would also be subject to the requirements of certain rules which require additional disclosures by broker-dealers in connection with any trades involving a stock defined as a “penny stock.” In such event, the additional burdens imposed on broker-dealers to effect transactions in our common stock could further limit the market liquidity of our common stock and the ability of investors to trade our common stock.

Our patents may not protect us from others using our technology that could harm our business and competitive position.

Patent law relating to the scope of claims in the technology fields in which we operate is still evolving. The degree of future protection for our proprietary rights is uncertain. Furthermore, we cannot be certain that others will not independently develop similar or alternative products or technology, duplicate any of our products, or, if patents are issued to us, design around the patented products developed by us. Our patents or licenses could be challenged by litigation and, if the outcome of such litigation were

adverse to us, our competitors could be free to use our technology. We may not be able to obtain additional patents for our technology, or if we are able to do so, patents may not provide us with substantial protection or be commercially beneficial. In addition, we could incur substantial costs in litigation if we are required to defend ourselves in patent suits brought by third parties or if we initiate such suits.

We cannot be certain that other measures taken to protect our intellectual property will be paid only ifeffective.

We rely upon trade secret protection, copyright and when declared bytrademark laws, non-disclosure agreements and other contractual provisions for some of our board of directors. The board'sconfidential and proprietary information that is not subject matter for which patent protection is being sought. Such measures, however, may not provide adequate protection for our trade secrets or other proprietary information. If they do not protect our rights, third parties could use our technology and our ability to declarecompete in the market would be reduced.

We are dependent upon our licensed technologies and may need to obtain additional licenses in the future to offer our products and remain competitive.

We have licensed key components of our technologies from third parties. If these agreements were to terminate prematurely due to our breach of the terms of these licenses or we otherwise fail to maintain our rights to such technology, we may lose the right to manufacture or sell a dividendsubstantial portion of our products. In addition, we may need to obtain licenses to additional technologies in the future in order to keep our products competitive. If we fail to license or otherwise acquire necessary technologies, we may not be able to develop new products that we need to remain competitive.

The patent underlying our nonexclusive license to manufacture standard nucleic acid building blocks expired as of March 15, 2005. The expiration of this patent could result in additional manufacturers entering the market for these products. Some of these manufacturers may have lower cost structures or other competitive advantages which may reduce our market share and/or our operating margins related to these products.

The protection of intellectual property in foreign countries is uncertain.

A significant percentage of our sales are to customers located outside the U.S. The patent and other intellectual property laws of some foreign countries may not protect our intellectual property rights to the same extent as U.S. laws. We may need to bring proceedings to defend our patent rights or to determine the validity of our competitors’ foreign patents. These proceedings could result in substantial cost and diversion of our efforts. Finally, some of our patent protection in the U.S. is not available to us in foreign countries due to the laws of those countries.

Our products could infringe on the intellectual property rights of others.

There are a significant number of U.S. and foreign patents and patent applications submitted for technologies in, or related to, our area of business. As a result, any application or exploitation of our technology could infringe patents or proprietary rights of others and any licenses that we might need as a result of such infringement might not be available to us on commercially reasonable terms, if at all. This may lead others to assert patent infringement or other intellectual property claims against us.

Our failure to comply with any applicable government regulations or otherwise respond to claims relating to improper handling, storage or disposal of hazardous chemicals that we use may adversely affect our results of operations.

Our research and development and manufacturing activities involve the controlled use of hazardous materials and chemicals. We are subject to limits imposed by Delaware corporate law. In determining whetherfederal, state, local and international laws and regulations governing the use, storage, handling and disposal of hazardous materials and waste products. If we fail to declare dividends, the board may considercomply with applicable laws or regulations, we could be required to pay penalties or be held liable for any damages that result and this liability could exceed our financial condition, results ofresources. We cannot assure you that accidental contamination or injury will not occur. Any such accident could damage our research and manufacturing facilities and operations, working capital requirements, future prospectsresulting in delays and other relevant factors.increased costs.

Item 6.    Selected Financial Data.

        The statement of operations data for the years ended December 31, 2002, 2001 and 2000 and the balance sheet data as of December 31, 2002 and 2001 are derived from our historical consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K, which have been audited by Deloitte & Touche LLP, our independent auditors. The statement of operations data for the years ended December 31, 1999 and 1998 and the balance sheet data as of December 31, 2000, 1999 and 1998 are derived from our audited historical consolidated financial statements that are not included in this Annual Report on Form 10-K. In May 2001, we acquired Annovis, Inc., a specialty chemicals company that develops, manufactures and markets a wide variety of nucleic acid-based products and services for the life science industry, for a total purchase price of approximately $16.9 million. Annovis's results of operations have been included in the accompanying financial statements beginning on May 1, 2001. Additionally, our financial statements include the results from our non-life sciences product line which was sold effective April 1, 2000.

        The following selected financial data should be read in conjunction with our consolidated financial statements and the related notes thereto and the information under "Management Discussion and

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Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.

Item 7. Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations.

The following analysis gives effect to the restatement of our statements of cash flows for the years ended December 31, 2004 and 2003, as discussed in Note P to the consolidated financial statements.

Overview

 We provide innovative products and services for the synthesis, purification and analysis

Since 2000 (the year of nucleic acids. Our products and services include automated instrument systems, associated consumables, nucleic acid chemical building blocks, nucleic acid synthesis products, novel chemistry development for nucleic acids, process development services and genetic variation discovery services. Our technologies center around three core competencies: separation chemistries, enzymology, and nucleic acid chemistries. We develop, assemble, manufacture and market our products and servicesinitial public offering), we have incurred net losses of $94.76 million generally related to the life sciences industry to be used in research focused on molecular genetics of humans and other organisms. Such research could lead to development of new diagnostics and therapeutics. Our products can be used to analyze DNA or RNA at the molecular level, amplify, separate, and isolate nucleic acid fragments of particular interest and synthesize conventional or chemically-modified nucleic acid molecules. These capabilities are central to research seeking to discover and understand variations in the genetic code, the relationship of these variations to disease and, ultimately, to develop diagnostics and therapeutics based on this understanding. Our business plan is to participate in the value chain associated with these activities by providing key technology, tools, consumables, and biochemical reagents to those entities engaged in basic biomedical research and the development of diagnostics and therapeutic agents.

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        Prior to 2002 the Company was managed and operated on a fully integrated basis in one operating segment. During 2002, management determined it was appropriate to evaluate the Company's operations based upon the nature of the products and services provided. Accordingly, the Company has determined that it operates in two reportable segments, BioSystems and Nucleic Acids. Operations for these segments are evaluated based upon specific identification of revenues and expenses associated with the business activities resulting in a segment operating income. Expenses that cannot be directly identified to an operating activity or are considered corporate overhead are not allocated to the segments in arriving at operating income for the segment.

        The BioSystems operating segment generates revenue from the sale of automated instrument systems and associated consumable products and services. This segments products are based upon two of the Company's three core competencies, separations chemistries and enzymology. Specifically, this segment's main products are the WAVE system, related bioconsumables and research services.

        Theour Nucleic Acids operating segment, generates revenue from the sale of products and services based upon all three of the Company's core competencies, nucleic acid chemistries, separations chemistries and enzymology. Specifically, this segments main products are nucleic acid building blocks or "phosphoramidites", oligonucleotides, fluorescent markers, dyes and associated reagents and novel chemistry and process development services.

        During the fiscal year ended December 31, 2002, we sold over 185 WAVE Systems to major academic and government research centers and commercial and biopharmaceutical companies. Since the WAVE System product introduction in 1997 we have sold over 900 instruments to customers in over 30 countries. Revenues from the sale of consumable and nucleic acid products increased during 2002 and represented approximately 50% of our net sales as compared to approximately 40% in 2001. We expect that over the next five years, sales from consumable and nucleic acid products will increase both in amount and as a percentage of our net sales.

        We have incurred significant losses resulting principally from costs incurred in research and development and selling, general and administrative costs associated withcosts. Our liquidity and working capital positions continued to deteriorate during 2004 predominately due to operating losses that were funded during the year primarily by borrowings under our operations.Credit Line and the sale of our specialty oligonucleotides facility in Boulder, Colorado. At December 31, 2002,2004, we had an accumulated deficit of $49.8$107.10 million.

To respond to changes in the overall business climate for our products, our liquidity position and our demand for capital, we instituted significant changes during 2004 designed to, among other things, align our cost structure with projected revenues, focus on opportunities in our BioSystems operating segment, and minimize the adverse financial effect of our Nucleic Acids operating segment. While the primary goals of these changes were to provide the foundation for a self-sustaining, growth-oriented company with positive cash flows and earnings, there can be no assurances that we can achieve these goals.

We determined that our Nucleic Acids operating segment was impaired and sold our specialty oligonucleotide facility.

Based upon information obtained through the process of evaluating strategic alternatives for our Nucleic Acids operating segment, we determined that it was more likely than not that the value of the assets associated with this business were impaired. We engaged an external valuation firm to assist us in conducting an interim period impairment test that resulted in a non-cash charge of $11.97 million related to these assets during the three months ended June 30, 2004. The charge consisted of $9.87 million related to the impairment of goodwill and $2.10 million related to the impairment of property and equipment.

On November 11, 2004, we sold the assets associated with our specialty oligonucleotides manufacturing facility in Boulder, Colorado to a subsidiary of Eyetech Pharmaceuticals, Inc. (“Eyetech”). The sale price was $3.00 million in cash plus the assumption of the lease on the Boulder facility and certain equipment leases with a gross value of $2.38 million. Substantially all of the 27 employees at the Boulder facility became Eyetech employees. Net proceeds from the sale (after transaction expenses and fees paid to our investment advisors) equaled approximately $2.70 million. In conjunction with this transaction, we recorded a gain on sale of $1.47 million in the fourth quarter of 2004.

We implemented a restructuring plan to better align costs with expected revenues.

On November 13, 2004, our Board of Directors approved a restructuring plan designed to refocus the Company on its BioSystems business segment and to better align our cost structure with anticipated revenues. The plan (which is incremental to the sale of our Boulder, Colorado facility) included a workforce reduction of approximately 60 positions and the closure of two domestic research and development facilities associated with our nucleic acids operating segment and two European field offices. Additionally, we eliminated 11 positions at our chemical building blocks manufacturing facility in Glasgow, Scotland. In conjunction with these changes, we incurred a charge of $3.57 million during the quarter ending December 31, 2004 related primarily to severance, benefits and facility closures.

We expect the 2004 restructuring plan and the sale of our specialty oligonucleotide manufacturing facility to have a significant impact on our ongoing costs. The pro forma effects on our 2004 loss from operations are as follows.

Results of Operations

Changes in Results of Operations

Years Ended December 31, 2004 and 2003

Net Sales. Net sales during 2004 decreased $0.08 million or 1% from 2003 as a result of a $0.80 million or 3% decrease in sales in our BioSystems operating segment offset by a $0.72 million or 9% increase in sales in our Nucleic Acids operating segment.

The decrease in sales in our BioSystems operating segment resulted from a decrease of $3.58 million or 20% from bioinstruments that was partially offset by increases in sales of bioconsumables of $1.58 million or 22% and Discovery Services of $1.15 million or 133%. The decrease of bioinstrument sales was primarily the result of a decline in the number of WAVE Systems sold from 122 in 2003 to 107 in 2004. The selling prices of our instruments vary based on the specific model and optional accessories. We had an installed base of approximately 1,200 units at December 31, 2004. The increase in the installed base of instruments

continues to drive increases in sales of bioconsumables used with these instruments. The increase in Discovery Services revenue during 2004 was primarily attributable to the discovery services agreements that we entered into with pharmaceutical companies to support their clinical development of oncology therapeutics. We plan to continue to seek opportunities to provide genetic variation discovery and analysis services to pharmaceutical and other customers and believe that these services provide us a significant opportunity to expand revenues in the future.

Nucleic Acids operating segment sales increased by $0.72 million or 9% in 2004 compared to 2003 as a result of a substantial increase in sales of specialty oligonucleotides produced by our facility in Boulder, Colorado as raw materials in DNA-based drug candidates. As a result of the sale of this facility in November 2004, we will no longer manufacture or sell oligonucleotides. Sales of our chemical building block products produced in our Glasgow, Scotland facility were essentially the same in 2004 as in 2003. During 2004, sales of chemical building blocks to Geron Corporation totaled $4.15 million and represented 12% of total consolidated net sales, 49% of total net sales within our Nucleic Acids operating segment and 61% of chemical building blocks revenue. We do not have long-term sales commitments from Geron Corporation and, accordingly, the amount we sell them is subject to change. Revenues from our Nucleic Acids operating segment would be substantially reduced if Geron’s need for our products declined or if it decided to obtain these products from other suppliers.

Costs of Goods Sold.Costs of goods sold include material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs and supplies) associated with our Discovery Services product line. Depreciation expense included in costs of goods sold totaled $2.10 million and $1.74 million in 2004 and 2003, respectively.

Costs of goods sold during 2004 decreased $0.28 million or 1% from 2003 as a result of a $0.62 million or 5% increase in our BioSystems operating segment offset by a $0.34 million or 3% decrease in our Nucleic Acids operating segment. The overall decrease is consistent with the decrease in net sales.

Gross profit was $9.19 million or 27% of total net sales during 2004 compared to $9.55 million and 28% during 2003. A summary of margins by operating segment follows (dollars in thousands):

We expect gross profits from our BioSystems operating segment to be within historic ranges of 50% to 60%. As a result of the sale of our Boulder, Colorado facility and the restructuring plan implemented in November 2004, we anticipate that our cost of goods sold will be significantly improved. However, our Nucleic Acids operating segment continues to have excess capacity in its Glasgow, Scotland manufacturing facility that will adversely impact costs of goods sold and margins until demand for our Nucleic Acids building block products increase.

Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily include personnel costs, marketing, travel and entertainment costs, professional fees, and facility costs. These costs totaled $17.50 million in 2004 compared to $17.32 million in 2003, an increase of $0.18 million or 1%. This increase related to a $1.26 million increase in selling expenses offset by a $1.09 million reduction in general and administrative expenses. As a percentage of revenue, selling, general and administrative expenses totaled just over 51% in both 2004 and 2003. Depreciation expense include in selling, general and administrative expenses totaled $1.02 million and $1.28 million in 2004 and 2003, respectively.

Research and Development Expenses. Research and development expenses primarily include personnel costs, supplies, and facility costs. These costs totaled $6.69 million in 2004 compared to $9.31 million in 2003, a decrease of $2.62 million or 28%. As a percentage of revenue, research and development expenses totaled 20% and 27% of revenue in 2004 and 2003, respectively. These decreases related to our focus on expense control, the sale of our Boulder, Colorado facility and the restructuring plan implemented in November 2004. Depreciation expense included in research and development expenses included $0.88 million and $0.89 million in 2004 and 2003, respectively. We expect to continue to invest a substantial portion of our revenues in research and development activities primarily associated with our BioSystems operating segment. Research and development costs are expensed in the year in which they are incurred.

Restructuring Charges. On November 13, 2004, our Board of Directors approved a restructuring plan designed to refocus on the BioSystems operating segment and to better align the Company’s cost structure with anticipated revenues. The plan (which is incremental to the sale of the specialty oligonucleotide manufacturing facility in Boulder, Colorado) included a workforce reduction of approximately 60 positions and the closure of two domestic research and development facilities associated with our Nucleic Acids

operating segment and two European field offices. Additionally, we eliminated approximately 10 positions at its chemical building blocks manufacturing facility in Glasgow, Scotland. In conjunction with these changes, we incurred a charge of $3.57 million during the quarter ending December 31, 2004 consisting of severance benefits of $1.41 million, future rents on closed facilities (net of projected sublease rents) of $1.24 million, the write-off of property and equipment specifically attributable to closed facilities of $0.74 million and other costs of $0.18 million. We had accrued expenses associated with this restructuring plan of $1.91 million at December 31, 2004 of which $1.49 million is expect to be paid in 2005.

Impairment Charges.During the second quarter of 2004, our Board of Directors directed us to explore strategic alternatives for the Nucleic Acids operating segment. The process included significant due diligence by us, our advisors and prospective independent buyers and other interested parties. Based upon information obtained through this process, we determined that it was more likely than not that the value of the assets associated with this business were impaired. We engaged an external valuation firm to assist us in conducting an interim period impairment test that resulted in us recording a non-cash charge of $11.97 million related to these assets during the three months ended June 30, 2004. The charge consisted of $9.87 million related to the impairment of goodwill and $2.10 million related to the impairment of property and equipment.

Gain on Sale of Facility. On November 11, 2004, we sold the assets associated with our specialty oligonucleotides manufacturing facility in Boulder, Colorado to a subsidiary of Eyetech Pharmaceuticals, Inc. (“Eyetech”). The sale price was $3.00 million in cash plus the assumption of the lease on the Boulder facility and of certain equipment leases with a gross value of $2.38 million. Net proceeds from the sale (after transaction expenses and fees paid to our investment advisors) equaled approximately $2.70 million. In conjunction with this transaction, we recorded a gain on sale of $1.47 million in the fourth quarter of 2004.

Other Income (Expense). Other expense during 2004 of $5.41 million consisted of interest expense of $2.38 million, loss on debt extinguishment of $2.86 million, and other net expense of $0.16 million which consisted primarily of net investment losses associated with available-for-sales securities (Geron stock). Other expense during 2003 of $0.31 million consisted of interest income of $0.20 million, interest expense of $0.31 million and other net expenses of $0.20 million.

The increase in interest expense resulted from higher average debt balances and interest rates. Gross debt totaled $8.95 million at December 31, 2004 compared to $4.69 million at December 31, 2003. Our Credit Line and Term Note had average balances during 2004 of $5.69 million and $2.73 million, respectively, with weighted average interest rates of 6.39% and 6.48%, respectively. The high and low borrowings under our Credit Line during 2004 were $7.23 million and $2.63 million, respectively. Interest expense in 2004 and 2003 includes amortization of related premiums and discounts of $1.64 million and $0, respectively.

Loss on debt extinguishment totaled $2.86 million during 2004. As described in Note E to the accompanying consolidated financial statements, certain August 31, 2004 modifications to our Laurus Loans were treated as extinguishments for financial reporting purposes since the change in present value of expected cash flows between the original and modified agreements is greater than 10%. As such, we recorded a loss on extinguishment of debt of $2.86 million at August 31, 2004 reflecting the difference between (i) the recorded amount of debt, net of related discounts, of $7.43 million and (ii) the fair value of the new debt instrument of $10.29 million plus the fair value of the new warrants of $0.11 million. The difference between the fair value of the new debt of $10.29 million and the face value of the debt of $8.57 million represents a premium, which will be reflected as a reduction of interest expense over the life of the new debt.

Income Tax Expense.Income tax expense relates solely to our operations in certain foreign countries and certain states. In addition to income tax expense in these jurisdictions, we do not record any income tax benefits due to our cumulative losses in recent years, expected losses in future years and the uncertainty as to whether we will be able to utilize any additional losses as carrybacks. We will continue to assess the recoverability of deferred tax assets and the related valuation allowance. We expect to continue to incur substantiallosses and expect to continue to provide valuation allowances against deferred tax assets. To the extent we begin to generate income in future years and it is determined that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized. Our deferred tax assets as of December 31, 2004 were $38.29 million and were entirely offset by a valuation allowance. As of December 31, 2004, we had federal net operating loss carryforwards of approximately $91.47 million. Our net operating loss carryforwards will expire at various dates from 2008 through 2024, if not utilized. We also had state income tax loss carryforwards of $37.62 million at December 31, 2004. These carryforwards will also expire at various dates beginning in 2005 if not utilized.

Years Ended December 31, 2003 and 2002

Net Sales.Net sales decreased in 2003, as compared to 2002, due to a significant decline in demand for our Nucleic Acids products. Sales in our Nucleic Acids operating segment decreased due to a significant decline in demand for our chemical building block products. These products are used by our biopharmaceutical and pharmaceutical customers as raw materials in DNA based drug candidates. The decrease in demand is largely attributable to the timing of completion and/or failure of Phase III clinical trials by certain of our large customers. This decrease in demand for DNA building blocks in 2003 was partially offset by sales of oligonucleotides generated by our start-up manufacturing facility in Boulder, Colorado.

Sales in our BioSystems operating segment increased in 2003. Revenues from sales of WAVE systems and related services were relatively flat with 2002. However, bioconsumable product sales strength resulted from increased WAVE related consumable usage as the installed base of WAVE Systems has increased and as researchers begin to use them more extensively in place of other methods of DNA analysis. Also contributing to the increase were revenues generated by new product sales including our Optimase product line that was launched in 2002 and began to see increased usage in 2003. Sales of WAVE systems declined slightly from 2002 to 2003 offset by an increase in related services revenues. The slight decline in systems sales was mainly due to continued low sales volumes to our North American customer base. Increased services revenue was attributable to our focus on providing genetic variation discovery and analysis services to our pharmaceutical base of customers.

Cost of Goods Sold.Cost of goods sold increased in 2003 over 2002 despite the decline in our revenues. This increase was anticipated and was attributable mainly to excess manufacturing capacity in our Nucleic Acids operating segment. The BioSystems operating segment cost of goods sold as a percentage of sales declined year over year but remained within historical ranges at approximately 43%. The margins in our Nucleic Acids operating segment were negatively impacted by higher manufacturing costs and excess capacity due largely to our plant expansion efforts in Glasgow, Scotland and Boulder, Colorado.

Selling, General and Administrative Expenses.Selling, general and administrative expenses decreased significantly from 2002 to 2003 as a result of our restructuring activities and focus on expense control. Nearly half of the total decrease was in personnel and personnel related expenses as we significantly reduced our employee headcount. Additionally, reductions in outside services, advertising, sales promotions, depreciation and travel expenses accounted for approximately 30% of the total decrease.

Research and Development Expenses.Research and development expenses decreased significantly as a result of our restructuring activities and focus on expense control. Over 60% of the total decrease was in personnel and personnel related expenses as we significantly reduced our employee headcount. Additionally, significant reductions in outside services, supplies, depreciation and travel expenses were realized. During 2003 there were no capitalized software costs, whereas in the prior year we capitalized approximately $1.13 million of development costs. Research and development expenses consist of salaries and related personnel costs of researchers and software developers, material costs for prototypes and test units, legal expenses relating to intellectual property research and application development activities, testing and enhancement of our products, and amortization of intellectual property. We expense our research and development costs in the year in which they are incurred with the exception of certain capitalized software development costs.

Restructuring Charges.During the fourth quarter of 2002 management formulated and selling, generalexecuted a significant portion of a restructuring plan. The plan was developed to reduce expenses thereby better aligning the Company’s expense structure with current business prospects. The plan included employee terminations, office closures, termination of collaborations and administrative costs.write-offs of abandoned intellectual property. We continued to execute the plan during the first half of 2003 resulting in the additional charges recorded in 2003. These charges consisted of mainly employee severance costs and the write-off of a note receivable related to the abandonment of a product development collaboration. The note receivable write-off was a non-cash charge of $0.35 million.

Goodwill Impairment Charge.Statement of Financial Accounting Standard (SFAS) No. 142,Goodwill and Other Intangible Assets, establishes guidelines for accounting for goodwill and other intangible assets and provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be evaluated for impairment annually. The Company engaged an external valuation firm to assist with the completion of its annual impairment test during the fourth quarter of 2003. As a result of this test we recorded a non-cash goodwill impairment charge of $4.77 million related to our nucleic acids segment.

Income Taxes.The Company’s tax expense relates to its operations in certain foreign countries and certain states. No tax benefits are being recorded due to our cumulative losses in recent years, expected losses in future years and the uncertainty as to whether we will be able to utilize any additional losses as carrybacks. We will continue to assess the recoverability of deferred tax assets and the related valuation allowance. We expect to continue to incur losses and expect to continue to provide valuation allowances against deferred tax assets. To the extent we begin to generate income in future years and it is determined that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized. Our deferred tax assets as of December 31, 2003 were $30.60 million and were entirely offset by a valuation allowance. As of December 31, 2003, we had federal net operating loss carryforwards of approximately $78.50 million. We also had state income tax loss carryforwards of $28.70 million at December 31, 2003.

Liquidity and Capital Resources

Our working capital (deficiency) positions at December 31, 2004 and 2003 were as follows:

The deterioration of our working capital position during 2004 was predominately due to operating losses that were funded primarily by borrowings under our Credit Line, the sale of our specialty oligonucleotides facility in Boulder, Colorado and the reclassification at December 31, 2004 of a portion of our chemical building blocks inventory with a book value of $2.86 million as a long-term asset rather than as a current asset. The reclassification of these inventories was based on sales forecasts for these products. As of March 31, 2005, we had cash and cash equivalents of $1.37 million plus an additional $2.29 million available under our Credit Line.

We have experienced recurring net losses and had an accumulated deficit of $107,101 at December 31, 2004. Based on our 2005 operating plan, we believe existing sources of liquidity will be sufficient to meet cash needs during 2005. If necessary, we believe we can manage costs and expenses at reduced levels to conserve working capital. The need for any such cost and expense reductions during 2005 would likely delay implementation of our business plan. Additionally, we may pursue additional financing alternatives. Ultimately, we must achieve sufficient revenue levels to support our cost structure.

Laurus Loans. The Credit Line is a $7.50 million line of credit that we entered into with Laurus in December 2003. The term of the Credit Line is three years carrying an interest rate of 2.0% over the prime rate or a minimum of 6.0%. Funds available under the Credit Line are determined by a borrowing base equal to 90% of eligible accounts receivable balances plus up to $1.00 million related to inventory balances. The Credit Line is secured by most of our assets. Prior to amendments to the Credit Line discussed below, payment of interest and principal could, under certain circumstances, be made with shares of our common stock at a fixed conversion price of $2.20 per share. Conversion of this debt to common stock may be made at the election of Laurus or the Company. We could elect to convert only if our shares trade at a price exceeding $2.42 per share for ten consecutive trading days, and such conversion is further subject to trading volume limitations and a limitation on the total beneficial ownership by Laurus of our common stock. Upon entering into the Credit Line, we issued warrants to Laurus to acquire 550,000 shares of the our common stock at an exercise price exceeding the average trading price of our common stock over the ten trading days prior to the date of the warrant.

In February 2004, we entered into the $2.75 million Term Note with Laurus. The Term Note carries an interest rate of 2.0% over the prime rate or a minimum of 6.0% and has a term of 3 years. Prior to amendments to the Term Note discussed below, the principal and interest on the Term Note could be converted into our common stock at a fixed conversion price of $2.61 per share. Upon entering the Term Note, we issued warrants to Laurus to acquire 125,000 shares of our common stock. Borrowings under the Term Note were primarily used to retire the mortgage debt on our Glasgow, Scotland facility. Remaining borrowings of approximately $0.75 million were used to complete the build-out of the Glasgow facility, complete the consolidation our Glasgow operations into the new facility and provide funds for operations.

In February 2004, Laurus waived the borrowing base limitation on the Credit Line, thereby making the full $7.50 million facility available to us regardless of the available collateral. On August 31, 2004, Laurus agreed to extend the borrowing base waiver on the Credit Line through March 19, 2005. In addition, Laurus deferred certain payments due under the Term Note and reduced the interest rate on both of the Laurus Loans to 0% for any day the closing sale price of our common stock is at or above $1.75 per share. In return, we lowered the conversion price on each of the Laurus Loans to $1.00 per share and issued a warrant to Laurus covering an additional 400,000 common shares at an exercise price of $1.25 per share. The closing price of our common stock on August 31, 2004 was $1.20 per share.

On March 18, 2005, Laurus agreed to further extend the borrowing base waiver on the Credit Line until March 31, 2006. In connection with this waiver, we agreed to allow Laurus to convert $1.88 million of the outstanding principal balance under the Credit Line into 3,600,000 shares of common stock. In addition, on March 24, 2005 we agreed to allow Laurus to convert $0.65 million of the outstanding principal balance of the Term Note into 1,250,000 shares of common stock. As a result, we have increased the amount available under the Credit Line by $1.88 million and have eliminated substantially all remaining 2005 scheduled principal payments on the Term Loan.

Analysis of Cash Flows

Cash flows used in operating activities totaled $12.75 million during 2004 compared to $13.02 million during 2003. The use in 2004 related primarily to a net loss of $34.37 million offset by non-cash charges of $21.80 million. Non-cash charges consisted of depreciation and amortization, certain restructuring charges, impairment charges, certain financing costs and loss on debt extinguishment. Working capital and other adjustments decreased cash flows from operating activities by $0.18 million.

Cash flows from investing activities totaled $6.03 million during 2004 compared to cash flows used in investing activities of $2.95 million during 2003. The investing cash flows generated in 2004 were from the sale of available for sale securities received from Geron for goods and services and the sale of our specialty oligoneucleotide manufacturing facility and reductions in other assets that were offset by purchases of property and equipment.

Cash flows from financing activities totaled $6.00 million during 2004 compared to $7.30 million during 2003. The cash from financing activities in 2004 relate primarily to net draws on our Credit Line and proceeds from the Term Note that were offset by payments of long-term debt.

Obligations and Commitments

Our ongoing capital commitments consist of debt service requirements and obligations under capital leases. The following table sets forth our contractual obligations as of December 31, 2004 along with cash payments due in each period indicated:

At December 31, 2004, we had firm commitments totaling $0.80 million to Hitachi High Technologies America to purchase components used in our WAVE Systems. These commitments will be fulfilled during 2005.

Off Balance Sheet Arrangements

At December 31, 2004 and 2003, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies

Accounting policies used in the preparation of the consolidated financial statements may involve the use of management judgments and estimates. Certain of the Company'sCompany’s accounting policies are considered critical as they are both important to the portrayal of the Company'sCompany’s financial statements and they require significant or complex judgments on the part of management. Our judgments and estimates are based on experience and assumptions that we believe are reasonable under the circumstances. Further, we evaluate our judgments and estimates from time to time as circumstances change. Actual financial results based on judgment or estimates may vary under different assumptions or circumstances. The following are certain critical accounting policies that may involve the use of judgment or estimates.

Allowance for Doubtful AccountsAccount.Accounts receivable are shown net of an allowance for doubtful accounts. In determining an allowance for doubtful accounts, we consider the following.

•

The age of the accounts receivable,



•

Customer credit history,



•

Customer financial information,



•

Reasons for non-payment, and



•

Our knowledge of the customer.

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If our customers'customers’ financial condition were to deteriorate, resulting in a change in their ability to make payment, additional allowances may be required.

Inventories.Inventories are stated at the lower of cost or market. Cost is computed using standard costs for finished goods and average or latest actual cost for raw materials and work in process.

Depreciation and Amortization of Long-Lived Assets.The Company'sCompany’s long-lived assets consist primarily of property, plant and equipment, goodwill, patents, intellectual property and capitalized software development costs. We believe the useful lives we assigned to these assets are reasonable. If our assumptions about these assets change as a result of events or circumstances and we believe the assets may have declined in value we may record impairment charges resulting in lower profits. Property and equipment are carried at cost. Depreciation and amortization are computed using the straight-line and accelerated methodsmethod over the estimated useful lives of the related assets ranging from 3 to 15 years. The Company capitalizes the external and in-house legal costs and filing fees associated with obtaining patents on its new discoveries and amortizes these costs using the straight-line method over the shorter of the legal life of the patent or its economic life, generally 17 years, beginning on the date the patent is issued. Intellectual property, which is purchased technology, is recorded at cost and is amortized over its estimated useful life.

Impairment of Long-Lived Assets.The Company evaluates goodwill for impairment on an annual basis. The Company assesses the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. These computations utilize judgments and assumptions inherent in management'smanagement’s estimate of future undiscounted and discounted cash flows to determine recoverability of these assets. If management'smanagement’s assumptions about these assets were to change as a result of events or circumstances, the Company may be required to record an impairment loss.

Revenue Recognition.Revenue on the sales of products is recognized in accordance with the terms of the sales arrangement. Such recognition is based on receipt of an unconditional customer order and transfer of title and risk of ownership to the customer, typically upon shipment of the product. Our sales terms do not provide for the right of return unless the product is damaged or defective. Revenues from certain services associated with our analytical instruments, to be performed subsequent to shipment of the products, is deferred and recognized when the services are provided. Such services, mainly limited to installation and training services that are not essential to the functionality of the instruments, typically are performed in a timely manner subsequent to shipment of the instrument.

Results of OperationsRecently Issued Accounting Pronouncements

Years Ended

On December 31, 2002 and 2001

        Net Sales.    Net sales decreased 2% to $37.6 million in 2002 from $38.5 million in 2001. Sales in our BioSystems operating segment decreased 14% to $24.2 million in 2002 from $28.0 million in 2001. Total revenues from sales of WAVE Systems decreased 19% to $18.8 million in 2002 from $23.1 million in 2001. Bioconsumable product sales included in this operating segment increased 10% to $5.4 million in 2002 from $4.9 million in 2001. Sales in our Nucleic Acid operating segment increased 28% to $13.3 million in 2002 from $10.4 million in 2001. Sales of WAVE systems declined mainly due to lower sales volumes to our commercial and industrial customer base and our North American customer base. Systems sold to our commercial and industrial customers accounted for approximately 6% of unit sales in 2002 as compared to approximately 34% in 2001. Systems sold in North America accounted for approximately 25% of unit sales in 2002 as compared to approximately 40% in 2001. Sales of WAVE related consumable products increased as16, 2004, the installed base of WAVE Systems has increased and as researchers begin to use them more extensively in place of other methods of DNA analysis. The increase in nucleic acid product sales is attributable to the timing of our acquisition of Annovis, Inc. in May 2001. Part of our business strategy for

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2003 is to position ourselves as a unique partner to biopharmaceutical and pharmaceutical companies in the early stages of their efforts to develop genomic-based diagnostics and therapeutics. As part of this strategy we are focusing our sales efforts on large consumers of our Synthetic Nucleic Acid products who are willing to commit to long-term supply agreements. While we expect to see increased sales of these products based upon this strategy, we also may see varying demand depending largely on the success of the biopharmaceutical and pharmaceutical companies on which we are targeting our sales efforts and thus we may see large variations in revenue flows for these products.

        Cost of Goods Sold.    Cost of goods sold increased 14% to $19.6 million in 2002 from $17.2 million in 2001, representing 52% of net sales in 2002 and 45% of net sales in 2001. Both total cost of goods sold and cost of goods sold as a percent of sales increased year over year due to the mix of products sold. BioSystems sales margins improved year over year mainly due to higher average selling prices per system resulting from greater sales of our higher margin high throughput WAVE system. The average sales price per instrument increased approximately 10% in 2002. The higher margins on our BioSystems products were offset by lower margins in our nucleic acid operating segment. Currently our nucleic acid products, which have become a larger percentage of our total revenues, are sold at lower margins compared to our WAVE systems. The margins in our Nucleic Acids operating segment are lower due to bulk sales of nucleic acid building block products and higher manufacturing costs due largely to our plant expansion efforts in Glasgow, Scotland and Boulder, Colorado. In 2003 we anticipate that our cost of goods sold for our BioSystems products will remain within historical averages or improve slightly. Overall we anticipate that our cost of goods sold will be consistent with 2002 or slightly higher. This is the result of the under utilization of our new oligonucleotide production facility in Boulder, Colorado. After 2003, we anticipate that the overall cost of goods sold percentage will improve as we refine our systems configurations potentially reducing material costs, improve upon production methods in our Nucleic Acid operating segment which currently result in higher overall manufacturing costs and as product revenues increase thereby spreading our fixed production costs over a larger revenue base.

        Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased 12% to $24.1 million in 2002 from $21.5 million in 2001. This increase is the result of additional personnel and personnel-related expenses, bad debt expense and the write-off of a portion of notes receivable. These increases were offset by a reduction in goodwill amortization and foreign currency exchange rate gains. Combined these items accounted for over 90% of the total increase. Direct personnel expenses increased due to our expanded employee base during 2002. Bad debt expense increased as we felt it was appropriate to increase the allowance for bad debt given our increased levels of accounts receivable. The decrease in goodwill amortization is the result of our adoption ofFinancial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS)(“SFAS”) No. 142,Goodwill and Other Intangible Assets. Total selling, general and administrative expenses represented 64% of net sales123R, Share-Based Payment. SFAS No.123R addresses the accounting for share-based payment transactions in 2002 versus 56% of net saleswhich an enterprise receives employee services in 2001. During the fourth quarter of 2002 management formulated a restructuring planexchange for the Company and executed a significant portion(a) equity instruments of the plan. The plan included employee terminations, office closures,enterprise or (b) liabilities that are based on the termination of collaborations and write-offs of intellectual property. It is expected that, as a resultfair value of the restructuring, our total operating expenses willenterprise’s equity instruments or that may be initially decreasedsettled by 20%the issuace of such equity instruments. SFAS No. 123R eliminates the ability to 25% from 2002 levels.

        Researchaccount for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and Development Expenses.    Research and development expenses increased 30% to $12.2 million in 2002 from $9.4 million in 2001. Research and development expenses consist of salaries and related personnel costs of researchers and software developers, material costs for prototypes and test units, legal expenses relating to intellectual property research and application development activities, testing and enhancement of our products, and amortization of intellectual property. We expense our research and development costs in the year in which they are incurred with the exception of certain capitalized software development costs. The increase in these expenses is attributable to increased personnel and personnel related expenses resulting from an expanded employee base during 2002, depreciation, amortization and supplies offset by increased amounts of capitalized software expenses related to the WAVE system operating software. Combined these itemsgenerally requires that such transactions be accounted for over 90% of the total increase. Total research and

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development expenses represented 32% of net sales in 2002 versus 24% of net sales in 2001. During the fourth quarter of 2002 management formulatedusing a restructuring plan for the Company and executed a significant portion of the plan. The plan included employee terminations, office closures, the termination of collaborations and write-offs of intellectual property. It is expected that, as a result of the restructuring, our total operating expenses will be initially decreased by 20% to 25% from 2002 levels.

        Stock Based Compensation.    Stock based compensation expense was $131,000 in 2002 as compared to $139,000 in 2001. This expense represents the amortization of deferred compensation related to stock options issued.

        Restructuring Charges.    During the fourth quarter of 2002 management formulated and executed a significant portion of a restructuring plan. The plan was developed to reduce expenses thereby better aligning the Company's expense structure with current business prospects. The plan included employee terminations, office closures, termination of collaborations and write-offs of abandoned intellectual property. Specifically, in the fourth quarter of 2002 the Company notified approximately 60 employees of their termination, notified landlords of our intent to close four facilities and reduce our space commitment under lease at two other facilities, terminated certain consulting and collaboration agreements and abandoned certain patents. As a result of the plan $3.3 million in restructuring charges were recorded and are included in operating expenses. These charges consisted of approximately $800,000 of employee severance costs, $1.2 million in office closure related costs, $400,000 of collaboration and other agreement termination charges and $900,000 in write-offs of abandoned intellectual property. Approximately 45% of the total charges were for non-cash items. We expect that, as a result of the restructuring, our total operating expenses will be initially decreased by 20% to 25% from 2002 levels. Additional restructuring charges totaling between $500,000 and $700,000 are expected in the first half of 2003.

        Other Income (Expense).    Other income and expense, which consists mainly of net interest income and expense, decreased to income of $437,000 in 2002 from income of $2.4 million in 2001. Interest income for the year was $626,000 as compared to $2.5 million in 2001. Interest expense for the year was $62,000 as compared to $58,000 in 2001. The decrease in interest income is a result of declining interest rates on investments and reductions in our short-term investment balances. We expect interest income to decline in 2003 as short-term interest rates are expected to continue to be low and as we continue to use cash in our operating and investing activities. Additionally, interest expense will increase in 2003 due to the long-term debt obtained by the Company during 2002 and the recently committed line of credit.

        Income Taxes.    No income tax benefit was recorded in 2002 or 2001. No further tax benefits are being recorded due to our cumulative losses in recent years, expected losses in future years and the uncertainty as to whether we will be able to utilize any additional losses as carrybacks. We will continue to assess the recoverability of deferred tax assets and the related valuation allowance.fair-value-based method. We expect to continue to incur losses and expect to continue to provide valuation allowances against deferred tax assets. To the extent we begin to generate income in future years and it is determined that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized. Income tax expense in 2002 was $105,000 while in 2001 income tax expense was $24,000. During 2002 the Company recorded current tax expense related to its Japan branch operations and certain state taxes. Our deferred tax assets as of December 31, 2002 were $23.2 million and were offset by a valuation allowance of $23.2 million. Our deferred tax assets as of December 31, 2001 were $14.9 million and were offset by a valuation allowance of $14.9 million. As of December 31, 2002, we had federal net operating loss carryforwards of approximately $60.3 million. We also had federal research and development tax credit carryforwards of approximately $0.9 million. The net operating loss and credit carryforwards will expire at various dates from 2008 through 2022, if not utilized. We also had state income tax loss carryforwards of $22.2 million at December 31, 2002. These carryforwards will also expire at various dates beginning in 2008 if not utilized.

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Years Ended December 31, 2001 and 2000

        Net Sales.    Net sales increased 49% to $38.5 million in 2001 from $25.9 million in 2000. Total revenues from sales of WAVE® Systems increased 25% to $23.5 million in 2001 from $18.8 million in 2000. Consumable product sales and other revenue increased to $15.0 million in 2001 from $4.9 million in 2000. Most of the increase in consumable sales and other revenue came from our Synthetic Nucleic Acid products, obtained through our acquisition of Annovis, Inc. in May 2001, which accounted for approximately 64% of our consumable product sales and other revenue. Additionally, WAVE related consumable products revenue increased approximately 32% to $3.1 million in 2001 from $2.1 million in 2000. Sales of WAVE related consumable products increased as the installed base of WAVE® Systems has increased and as researchers begin to use them more extensively in place of other methods of DNA analysis. Sales of our non-life sciences instrument products were $2.2 million in 2000. There were no sales in 2001 as a result of our divestiture ofadopt this product line effective Aprilstandard on January 1, 2000.

        Cost of Goods Sold.    Cost of goods sold increased 34% to $17.2 million in 2001 from $12.8 million in 2000, representing 45% of net sales in 2001 and 49% of net sales in 2000. Cost of goods sold as a percent of sales improved year over year due to improved margins on our WAVE systems sales offset by the lower margin bulk sales of our Synthetic Nucleic Acid products. Systems sales margins improved due to lower combined material and manufacturing costs for our life science instruments, higher average selling prices per systems and the sale of our lower margin non-life sciences instrument product line in 2000. The average sales price per instrument increased approximately 5% in 2001. The improved margins in systems sales were offset by a lower margin on consumable sales. The consumable sales margin was lower due mainly to bulk sale pricing discounts.

        Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased 53% to $21.5 million in 2001 from $14.0 million in 2000. This increase is the result of additional personnel and personnel-related expenses and depreciation. The average selling, general and administrative personnel counts increased 32% to 131 in 2001 from 99 in 2000. This personnel increase was due largely to the acquisition of Annovis. Direct personnel expenses and increased travel and travel related expenses associated with the activities of our expanded staff accounted for approximately 37% of the total increase. Increased rent and depreciation expense associated with investments in offices and equipment supporting our expanded staff accounted for approximately 34% of the total increase. Total selling, general and administrative expenses represented 56% of net sales in 2001 versus 54% of net sales in 2000.

        Research and Development Expenses.    Research and development expenses increased 23% to $9.4 million in 2001 from $7.7 million in 2000. Research and development expenses consist of salaries and related personnel costs of researchers and software developers, material costs for prototypes and test units, legal expenses relating to intellectual property research and application development activities, testing and enhancement of our products, and amortization of intellectual property. We expense our research and development costs in the year in which they are incurred with the exception of certain capitalized software development costs. The increase in these expenses is attributable to increased personnel and personnel related expenses and professional services fees associated with the expanded activities of the staff. The average research and development personnel count increased 27% to 73 in 2001 from 57 in 2000. This increase in personnel was due largely to the acquisition of Annovis. Salaries, payroll taxes and benefits accounted for approximately 49% of the total increase. We supplement the expanded activities of our staff through the engagement of external consultants. Increased professional services fees accounted for approximately 51% of the total increase in research and development expenses. Total research and development expenses represented 30% of net sales in 2000 versus 24% of net sales in 2001.

        Stock Based Compensation.    Stock based compensation expense was $139,000 in 2001 as compared to $861,000 in 2000. Stock based compensation expense was higher in 2000 as we accelerated the vesting of 71,700 options in connection with the sale of our non-life sciences instrument product line. Former

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employees who were associated with our non-life sciences product line held these options. The acceleration resulted in the recording of $600,000 of stock based compensation expense in the first quarter of 2000.

        Gain on Sale of Product Line.    Effective April 1, 2000 we sold the assets related to our non-life sciences instrument product line to enable us to focus our business plan on the genomics segment of the life sciences industry. The assets were sold for a total adjusted purchase price of $5.65 million plus reimbursement by the buyer of approximately $400,000 of expenses paid by us since March 31, 2000 in connection with this product line. At the date of the transaction the gain to be recognized on the sale of the assets was deferred until we received all proceeds from the buyer. All such proceeds were received on December 29, 2000 and a gain on the sale of $784,000, before taxes, was recognized.

        Other Income (Expense).    Other income and expense, which consists mainly of net interest income and expense, increased to income of $2.4 million in 2001 from income of $212,000 in 2000. Interest expense for the year was $58,000 as compared to $1.8 million in 2000. During 2000 we carried a large amount of debt that was either paid or converted into common stock subsequent to our initial public offering in July 2000. As a result of the elimination of debt from our balance sheet we incurred little interest expense in 2001. Interest income for the year was $2.5 million as compared to $2.0 million in 2000. The increase in interest income is a result of the investment of the net proceeds from our initial public offering. Interest income on investments during 2001 was negatively impacted by the significant decline in short-term interest rates

        Income Taxes.    Income tax expense in 2001 was $24,000 as compared to $180,000 in 2000. The expense recorded in 2000 relates to the recognized gain on the sale of the assets related to our non-life sciences product line. Income tax expense in 2001 is related to our sales branch in Japan. Our deferred tax assets as of December 31, 2001 were $14.9 million and were offset by a valuation allowance of $14.9 million. Our deferred tax assets as of December 31, 2000 were $7.6 million and were offset by a valuation allowance of $7.6 million. No tax benefit related to our net operating losses is being recorded due to our cumulative losses in recent years, expected losses in the future and the uncertainty as to whether we will be able to utilize any additional losses as carryforwards. We will continue to assess the recoverability of deferred tax assets and the related valuation allowance. We expect to continue to incur losses and expect to continue to provide valuation allowances against deferred tax assets. To the extent we begin to generate income in the future and it is determined that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized. As of December 31, 2001, we had federal net operating loss carryforwards of approximately $38.0 million. We also had federal research and development tax credit carryforwards of approximately $0.7 million. The net operating loss and credit carryforwards will expire at various dates from 2008 through 2021, if not utilized. We also had state income tax loss carryforwards of $15.4 million at December 31, 2001. These carryforwards will also expire at various dates beginning in 2008 if not utilized.

Liquidity and Capital Resources

        We have experienced net losses and negative cash flows from operations during the past three years. As a result, we had an accumulated deficit of $49.8 million as of December 31, 2002. As of December 31, 2002 and 2001, we had approximately $9.7 million and $19.6 million, respectively, in cash and cash equivalents. In addition, as of December 31, 2002 and 2001, we had approximately $3.6 million and $23.9 million in short-term investments for total cash and short-term investments of approximately $13.3 million and $43.5 million, respectively.

        During 2002 our major cash expenditures were the funding of our operations that resulted in an operating loss and capital projects. A total of approximately $30.2 million of cash and investments was used with approximately $17.9 million used to fund our operations and $11.5 million for capital projects. Operating activities were funded through existing cash while capital projects were funded through existing cash, a long-term mortgage loan and an operating lease line of credit. Major capital projects during the

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year included facility build-out, expansion and improvement at our two nucleic acid production facilities in Boulder, Colorado and Glasgow, Scotland. The Boulder facility project is designed to bring on line a cGMP (Good Manufacturing Practices) facility for the synthesis of oligonucleotides. This facility began non-GMP production operations during the first quarter of 2003 and is expected to begin cGMP production in the second quarter of 2003. The Glasgow facility project, which produces nucleic acid building blocks, included 2 main objectives, the upgrading of equipment and processes at the current production facility and the opening of a new facility that will include significant capacity expansion along with further equipment and process improvements. The current production facility improvements were completed during the year and the first production line, or pilot line, in the new facility is expected to be completed in the first half of 2003.

        Our operating activities resulted in net outflows of $17.9 million in 2002, $11.1 million in 2001 and $4.7 million in 2000. The operating cash outflows for these periods resulted mainly from our operating losses. Significant investments in research and development and sales and marketing contributed to the operating losses. The operating cash outflows for 2002 are significantly higher than those in the prior year due in large part to increased operating losses and increased inventory balances offset by a reduction in accounts receivable and an increase in accounts payable. Inventory balances increased as raw materials, work in process and finished goods inventory related to our specialty chemicals consumable products were increased as we continue to expand production capabilities and plan for production needs.

        Net cash provided by investing activities was $5.9 million in 2002 as compared to cash used of $9.4 million for 2001 and $22.2 million in 2000. The investing cash flow in 2002 is due primarily to the net transfer of short-term investment funds to cash offset by investment in property, plant and equipment. Cash used in investing activities in 2001 was due primarily to investments in property, plant and equipment and cash used in the acquisition of Annovis, Inc. Cash used in investing activities in 2000 was due primarily to the net transfer of cash to short-term investments and investment in property, plant and equipment. During 2003 we expect to continue to make significant investments in property, plant and equipment. Our capital expenditures budget for 2003 is approximately $8.4 million and includes expenditures for the completion of our facility expansion projects in Glasgow, Scotland, and Boulder, Colorado and for general facility and equipment improvements. Additional expansion projects for the Glasgow and Boulder production facilities may be incurred over the next 2 to 3 years as business demand dictates.

        Net cash provided by financing activities was $1.7 million in 2002, $1.9 million for 2001 and $64.9 million in 2000. The financing cash inflows in 2002 were the result of proceeds from long-term debt and the sale of common stock through the exercise of warrant and options offset by the purchase of treasury stock. The financing cash inflows in 2001 were the result of proceeds from the sale of common stock through the exercise of warrant and options offset by the repayment of acquired company debt. The financing cash inflows in 2000 were the result of our initial public offering offset by the repayment of bank debt and our purchase of treasury stock. Our initial public offering and subsequent sales of common stock for the exercise of warrants and options resulted in cash inflow, net of expenses, of approximately $72.7 million. The repayment of debt resulted in cash outflow of approximately $5.2 million and the purchase of treasury stock resulted in cash outflow of approximately $2.7 million.

        As of December 31, 2002, we did not have any significant contractual purchase obligations. We are party to a number of lease agreements mainly for office, research and development and production facilities. Such lease agreements expire at various dates through 2007. At December 31, 2002, the future minimum lease payments required under noncancellable lease provisions are approximately $2.9 million in 2003; $2.6 million in 2004; $2.2 million in 2005; $1.4 million in 2006; and a total of approximately $700,000 in rental payments for the year 2007.

        In March 2003 the Company entered into a loan commitment agreement with a financial institution for up to a $5.0 million secured line of credit. Collateral for the line consists of qualified accounts receivable balances. Funds available under the line are equal to 80% of eligible accounts receivable

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balances. Management expects to finalize the line of credit agreement in the second quarter of 2003. The proposed term of the agreement is 1 year carrying a variable interest rate of 2.25% over prime.

        We expect to devote substantial capital resources to continue our research and development efforts, to expand our marketing and sales and customer support activities, and for other general corporate activities. Our capital requirements for operations depend on a number of factors, including the level of our research and development activities, market acceptance of our products and services, the resources we devote to developing and supporting our products and services, normal capital expenditures and other factors. The restructuring plan developed in 2002 is expected to reduce our operating expenses and thereby reduce the cash needed to fund our operations until such time as we become cash flow positive. Capital expenditures for production expansion projects have been planned in phases. It is our intention to initiate the phased expansions when we have identified specific business opportunities that would require such expansion. We may elect to advance these phases ahead of the business opportunities if we can obtain additional financing on favorable terms.2006. We are currently investigating various financing vehicles for these projects.assessing the final impact of this standard on our financial position, results of operations or cash flows. This assessment includes evaluating option valuation methodologies and assumptions as well as potential changes to compensation strategies.

 In fiscal year 2003, current financial

On November 24, 2004, the FASB issued SFAS No. 151, Inventory Costs – an amendment of ARB No. 43. SFAS No. 151 requires idle facility expenses, freight, handling costs, and cash flow projections indicatewasted material (spoilage) costs to be excluded from the cost of inventory and expensed when incurred. It also requires that we expect to use approximately $14.0 million in cash to fund further operating losses and our capital expenditures budgetallocation of approximately $8.4 million. The current capital expenditures budget mainly relatesfixed production overheads to the completioncosts of conversion be based on the normal capacity of the current projects in Boulder and Glasgow duringproduction facilities. SFAS No. 151 will be effective at the first halfbeginning of 2003. We expect to meet this total cash need from existing cash as of December 31, 2002 of $13.3 million, additional cash generated from operations during 2003 and funds available to us under our new $5.0 million credit facility expected to be available during the second quarter of 2003. Current financial and cash flow projections indicate that operating cash is expected to turn positive during the fourth quarter of 2003. These projections may or may not be realized based upon actual operating results and project requirements, thus, during or after this period, if our existing cash and short-term investments, cash generated by operations and available borrowings under credit agreements is insufficient to satisfy our liquidity requirement, we may need to sell additional equity or debt securities, or obtain additional credit arrangements.2006. We are currently pursuing additional financingassessing the final impact of up to $5.0 million beyond the committed linethis standard on our financial position, results of credit. We feel that such additional financing will be secured in 2003. However, we cannot assure you that any financing arrangement will be available in amountsoperations or on terms acceptable to us.cash flows

Impact of Inflation

We do not believe that price inflation had a material adverse effect on our financial condition or results of operations during the periods presented.

Recent Account Pronouncements

        Effective January 1, 2002, we adopted Statement of Financial Accounting Standard (SFAS) No. 142,Goodwill and Other Intangible Assets. SFAS No. 142 establishes new guidelines for accounting for goodwill and other intangible assets and provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be evaluated for impairment annually. The provisions of SFAS No. 142 require the completion of a transitional impairment test within six months of adoption, with any impairment treated as a cumulative effect of a change in accounting principle. The Company has performed the transitional goodwill impairment test during the second quarter of 2002 and determined that no impairment exists at the time of adoption of SFAS No. 142. The Company also completed its annual impairment test during the fourth quarter of 2002 and determined that no impairment existed at the time of the annual test.

        In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 143,Accounting For Asset Retirement Obligations. SFAS No. 143 requires the Company to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and is effective for the Company's

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fiscal year beginning January 1, 2003. Management is in the process of evaluating the impact, if any, this standard will have on the Company's consolidated financial statements.

        In July 2002, the FASB issued SFAS No. 146,Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 addresses the accounting and reporting related to exit or disposal activities and is effective for the Company beginning January 1, 2003. The Company believes the adoption of this standard will not have a significant impact on the financial statements of the Company.

        In November 2002, the FASB issued FASB Interpretation (FIN) No. 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing certain guarantees. FIN No. 45 also expands the disclosures to be made by a guarantor in its financial statements about its obligations under certain guarantees that it has issued. The recognition provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Management believes that FIN No. 45 will not have a significant impact on the Company's Consolidated Financial Statements.

Foreign Currency Rate Fluctuations

 Historically,

During the last three fiscal years, our international sales have represented approximately 50%50-65% of our net sales. These sales have been to customers in the United States. While we do sellof products in many foreign countries most of these sales are mainly completed by our wholly-ownedin either British Pounds Sterling or the Euro. Additionally, we have two wholly owned subsidiaries, Transgenomic, LTD., orand Cruachem, LTD., and are made in theirwhose operating currency is British pounds sterling, orPounds Sterling and the Euro. Results of operations for the Company'sCompany’s foreign subsidiarysubsidiaries are translated using the average exchange rate during the period. Assets and liabilities are translated at the exchange rate in effect on the balance sheet dates. To further limit our exposure to exchange rate risk all sales quotes issued by Transgenomic, Ltd. are based upon the United States dollar pricing converted at prevailing exchange rates at the time of the quote. Additionally, such quotes will have short expiration dates. As a result although we are subject to exchange rate risk,risk. The operational expenses of our foreign subsidiaries help to reduce the currency exposure we have based on our sales denominated in foreign currencies by converting foreign currencies directly into goods and services. As such management feels we do not have a material exposure to foreign currency rate fluctuations at this time.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.

        The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the market value of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the market value of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. The average duration of all of our investments in 2002 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. Therefore, no quantitative tabular disclosure is presented. We recently committed to a secured line of credit that carries a variable interest rate. This line of credit will expose us to interest rate risk in 2003.

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Item 8. Financial Statements and Supplementary Data.

INDEPENDENT AUDITORS' REPORT

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors
and Stockholders of Transgenomic, Inc.

Omaha, Nebraska

We have audited the accompanying consolidated balance sheets of Transgenomic, Inc. and subsidiaries (the Company)“Company”) as of December 31, 20022004 and 20012003, and the related consolidated statements of operations, stockholders'stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2002.2004. Our audit also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on thesethe financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with auditingthe standards generally accepted inof the United States of America.Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includesstatements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Transgenomic, Inc. and subsidiaries as ofat December 31, 20022004 and 2001,2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 20022004, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note A, in 2002O, during the first quarter of 2005, the Company changed its methodobtained an extension of accounting for goodwill and other intangible assets in connection with the adoptionwaiver of Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets. Also, asthe borrowing base limit through March 31, 2006.

As discussed in Note Q, on March 31, 2003,P, the Company received a commitment letterrestated its consolidated statements of cash flows for a new revolving credit agreement.the years ended December 31, 2004 and 2003.

/s/ DELOITTE & TOUCHE LLP

Deloitte & Touche LLP

Omaha, Nebraska
February 4, 2003 (March 31, 2003

April 14, 2005 (May 25, 2005, as to the second paragrapheffects of the restatement discussed in Note Q)P)

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TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 20022004 and 2001

2003

(InDollars in thousands except share and per share data)