We supplement our workforce through the use of independent contractors and consultants. As of February 28, 2005 and December 31, 2003,2004, we have engaged independent contractors or consultants who provide services to us approximately equivalent to 4 full time employees.five and four full-time employees, respectively.

Our employees were employed in the following 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 internetInternet 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 charge through our website as soon as reasonably practicable after we file these documents with the Securities and Exchange Commission. The information contained in our website is not part of this Report on Form 10-K.

Risks Related to Our Business

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

We have historically experienced operatingnet losses and negative cash flows.had an accumulated deficit of $107,101 at December 31, 2004. As of DecemberMarch 31, 2003,2005, we had approximately $1.2 million in cash and cash equivalents andof $1.37 million plus an accumulated deficit of $72.7 million. To date, we have financedadditional $2.29 million available under our operations and capital expenditures primarily from the proceeds of public and private placements of common stock. Additionally, in December 2003 and February 2004, we entered into loan agreements with Laurus Master Fund, Ltd. for a $7.5 million secured line of credit and a $2.75 million convertible note, respectively. In February 2004, Laurus issued us a letter which waived the borrowing base limitationCredit Line. Based on our line2005 operating plan, we believe existing sources of credit, thereby making the full $7.5 million facility availableliquidity will be sufficient to us regardlessmeet 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 collateral. Laurus has committedour business plan. Additionally, we may pursue additional financing alternatives. Ultimately, we must achieve sufficient revenue levels to keeping the waiver open through the endsupport its cost structure.

Not withstanding our beliefs, there is no assurance that we will be able to achieve all of 2004. We expect to continue to need substantial amountsthese steps or that any of cash to fund our operations and capital expenditures in the future. Based upon our current projections, we expectthese steps will allow us to meet our future cash needs from existing cash, additional cash generated from our working capital, funds available to us under our $7.5 million credit facility and the net proceeds of the convertible note. These projections may or may not be realized based upon actual operating results and capital project requirements. Thus,needs. Accordingly, our existing cash balances, cash generated by our working capital,operations, and available borrowings under our secured line of credit and net proceeds of the convertible noteCredit Line may be insufficient to satisfy our liquidity requirements. Accordingly,requirements if our operating plan is not met. In addition, there is no assurance that we may need to raise additional capital. However, we cannot assure you that additional financing will be availableable to us when we need itobtain additional debt or on acceptable terms. If we raise additional capital by issuing common stock or other equity securities, the issuance of these securities would result in dilutionfinancing to our existing stockholders. If we borrow additional money, we will incur additional interest costs and may become subject to covenants that restrict our operations and capital expenditures.meet future cash needs. If we are not able to obtain additionalmeet our needs for working capital, as needed, we may need to take further steps to reduce our operating costs, and may not be able to execute parts or all of our business plan.plan and may need to discontinue operations in one or both of our operating segments.

We have a history of operating losses and expect tomay 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 $22.6$29.06 million, $21.7$22.59 million and $9.7$21.70 million, in 2003, 2002 and 2001, respectively. These losses have been due principally to the high levels of research and development expenses and sales and marketing expenses that we have incurred in order to develop and market our products, restructuring charges and goodwill impairment charges. In addition, markets for our products have developed more slowly than expected in somemany cases and may continue to do so. As a result, we expect tomay incur operating losses in the future, and we may never be profitable.

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 had outstanding 34,234,922 million shares of common stock. We also had obligations to issue approximately 6.2 million shares of common stock under outstanding stock options and warrants. Additionally, we may issue shares of common stock upon conversion of all or part of the Laurus Loans. Currently, Laurus may acquire 2.8 million shares of our common stock upon conversion of this debt. The issuance of such additional shares of common stock may be dilutive to our current shareholders and could negatively impact the market price of our common stock.

Markets for our products and services may develop slowly.

There are many factors that affect the market demand for our products and services that we cannot control. This is especially true in our Nucleic AcidAcids operating segment where the demand for our products depends to a large degree on the success that our customers and potential customers have in developing useful pharmaceutical products based on genetic intervention. A central strategy for our Nucleic AcidAcids operating segment is to sell 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 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 internally 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 raise additional working capital or take steps to further reduce operating expenses.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 or reduce operating expenses.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 Acid business unitAcids 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 drugsdrug 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 our revenues generated by the Nucleic Acid business unit.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 representedbeen approximately 50-65%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:

closures, termination of collaborations and 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 $350,000. Management does not expect to incur further restructuring charges in 2004.$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 $4.8$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 $30.6$30.60 million and were entirely offset by a valuation allowance of $30.6 million. Our deferred tax assets as of December 31, 2002 were $23.2 million and were offset by a valuation allowance of $23.2 million.allowance. As of December 31, 2003, we had federal net operating loss carryforwards of approximately $78.5$78.50 million. Our net operating loss carryforwards will expire at various dates from 2008 through 2023, if not utilized. We also had state income tax loss carryforwards of $28.7$28.70 million at December 31, 2003. These carryforwards will also expire at various dates beginning in 2008 if not utilized.

Years Ended December 31, 2002 and 2001

Net Sales.    Net sales decreased in 2002 due to weakness in demand for our Biosystems business unit products. Sales in our BioSystems business unit decreased as a decline in sales of WAVE Systems was offset by an increase in Bioconsumable product sales. 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 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 in our Nucleic Acid operating segment increased in 2002 due to the timing of our acquisition of Annovis, Inc. in May 2001.

Cost of Goods Sold.    Cost of goods sold increased in 2002 due mainly 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 BioSystems products. 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.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased as a 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 of Statement of Financial Accounting Standards (SFAS) No. 142,Goodwill and Other Intangible Assets.

Research and Development Expenses.    Research and development expenses increased in 2002 due 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. During 2002 we capitalized approximately $1.2 million of software development costs as compared to approximately $700,000 in the prior year. 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 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.

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.

Liquidity and Capital Resources

OverviewOur 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 historically experienced recurring net losses and negative cash flows. As a result, we had an accumulated deficit of $72.7 million as of$107,101 at December 31, 2003. As2004. Based on our 2005 operating plan, we believe existing sources of December 31, 2003liquidity will be sufficient to meet cash needs during 2005. If necessary, we believe we can manage costs and 2002,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 had approximately $1.2 million and $9.7 million, respectively, in cash and cash equivalents. In addition, as of December 31, 2003 and 2002,may pursue additional financing alternatives. Ultimately, we had no short-term investments and $3.6 million in short-term investments, respectively, for total cash and short-term investments of approximately $1.2 million and $13.3 million, respectively.

The following table summarizes our short-term liquidity and sources and uses of cash, as of and for the years ended December 31, 2003, 2002 and 2001:

We expect to devote substantial capital resources to continue our research and development efforts,must achieve sufficient revenue levels to support 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 sales levels, 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 and normal capital expenditures. The restructuring plan developed in 2002 has reduced our operating expenses and thereby reduced the cash needed to fund our operations. Additionally, our capital budget 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. During 2003, our major capital projects were substantially completed and we expect our capital expenditures to decrease significantly in 2004. Our original capital expenditures budget for 2003 was approximately $8.4 million while our actual cash utilized on capital expenditures for the year was $6.4 million. Currently, we project capital expenditures for 2004 to be in the range of $1.7 million to $2.5 million, depending largely upon demand for our nucleic acid products.cost structure.

During the second halfLaurus Loans. The Credit Line is a $7.50 million line of 2003, we began to pursue a sale/leaseback opportunity for our manufacturing facility in Glasgow, Scotland. As negotiations continued, it became apparent to uscredit that the terms offered by the purchasing entity were unacceptable, which caused management to seek alternative financing vehicles with better terms. As a result, in February 2004, we entered into a $2.75 million convertible note with Laurus Master Trust, Ltd. (“Laurus”), our line of credit provider. Management determined that the terms of the convertible note with Laurus were more favorable to the Company as compared to the proposed sale/leaseback transaction.in December 2003. The note carries an interest rate of prime plus 2% over the prime rate or a minimum of 6.0% and has a term of 3 years. The principal and interest on the note may be converted into common stock of the Company at a fixed conversion price of $2.61 per share. Proceeds from this transaction will be used to retire the current mortgage debt on the Glasgow facility, complete the build-out of the Glasgow facility, complete the consolidation our operations into the new facility and provide funds for operations. Proceeds, net of transaction costs and amounts used to repay our existing mortgage debt on the Glasgow facility, were approximately $750,000.

In December 2003, we entered into a new line of credit facility with Laurus. Under the terms of the agreement, we can borrow up to $7.5 million based on eligible accounts receivable and inventory balances. The

term of the agreementCredit 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 lineCredit Line are determined by a borrowing base equal to 90% of eligible accounts receivable balances plus up to $1.0$1.00 million related to inventory balances. This line of creditThe Credit Line is secured by most of our assets. PaymentPrior to amendments to the Credit Line discussed below, payment of interest and principal can,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 January and February 2004, Laurus exercised its conversion rightswe 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 lineTerm Note could be converted into our common stock at a fixed conversion price of credit and converted $2.0 million of amounts outstanding on$2.61 per share. Upon entering the line into approximately 910,000Term Note, we issued warrants to Laurus to acquire 125,000 shares of our common stockstock. 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 Company. As of December 31, 2003, we had approximately $3.0 million outstanding on this line of credit. 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 our line,the Credit Line, thereby making the full $7.5$7.50 million facility available to us regardless of the available collateral. ThisOn August 31, 2004, Laurus agreed to extend the borrowing base waiver will expire on Decemberthe Credit Line through March 19, 2004. This waiver,2005. In addition, Laurus deferred certain payments due under the Term Note and reduced the resulting accessinterest rate on both of the Laurus Loans to 0% for any day the full amountclosing sale price of our linecommon stock is at or above $1.75 per share. In return, we lowered the conversion price on each of credit, isthe Laurus Loans to $1.00 per share and issued a positive development in termswarrant to Laurus covering an additional 400,000 common shares at an exercise price of access to liquidity for the Company.$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, of our cost control measureswe have increased the amount available under the Credit Line by $1.88 million and reduced capital expenditures, we expect our cash usage to decrease during 2004. Based upon our current projections, we expect to meet our cash needs for 2004 from existing cash, additional cash generated from our working capital, additional funds available to us under our $7.5 million credit facility and the proceeds of the $2.75 million convertible note entered into in February 2004, net of debt repayment costs. These projections assume continued revenue strength from our Biosystems business unit. We believe growth will result from increased consumable product offerings and continued strength in demand for our instruments. These projections also assume that revenues from our Nucleic Acid business unit have reached a base level in the third quarter of 2003 and will begin to increase in the future. Much of the anticipated increase in the Nucleic Acid business unit revenues will come from new customers and additional business from existing customers of our Boulder, Colorado facility that began production in 2003. More specifically, our current financial and cash flow projections indicate that we expect to use approximately $2.5 million in cash to fund further operating losses and an additional $1.7 million to $2.5 million for capital expenditures. The majority of the capital expenditures will be associated with our Nucleic Acids business unit. These projections indicate a cash need of $4.2 million to $5.0 million for the year. Our cash balance at December 31, 2003 of $1.2 million, plus the net proceeds from our new convertible note of approximately $750,000 received in February 2004, additional advances available on our line of credit and the conversion by Laurus of $2.0 million of amounts outstandingeliminated substantially all remaining 2005 scheduled principal payments on the line into approximately 910,000 shares of common stock of the Company are sufficient to meet this projected cash need. As of December 31, 2003, additional advances available on our line of credit were $1.7 million based upon eligible collateral as of that date. Based upon the waiver received in February 2004, an additional $4.5 million was available when calculated as the total line of credit available of $7.5 million less $3.0 million outstanding at December 31, 2003. These projections may or may not be realized based upon actual operating results and capital project requirements. Thus, during or after this period, if our existing cash balances, cash generated by our working capital, and available borrowings under credit agreements are insufficient to satisfy our liquidity requirements, we may need to sell additional equity or debt securities, or obtain additional credit arrangements. We are monitoring our liquidity position and are prepared to take appropriate measures, as needed, to address liquidity. Such measures may include, but are not limited to, further expense reductions, an expansion of our line of credit, asset sales and the placement of equity or debt. We cannot assure you that any financing arrangement will be available in amounts or on terms acceptable to us. Our failure to raise additional capital, if needed, would harm our financial condition, results of operations and our business.Term Loan.

Analysis of Cash Flows

During 2003 our major cash expenditures were the funding of our operations and capital projects. Cash and investments decreased by a total of approximately $12.1flows used in operating activities totaled $12.75 million in 2003 asduring 2004 compared to approximately $30.2$13.02 million during 2003. The use in 2002. In 2003 approximately $13.22004 related primarily to a net loss of $34.37 million was used to fund our operations and $6.4 million used for capital projects offset by $3.0non-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 provided by advances on our lineduring 2004 compared to cash flows used in investing activities of credit and $4.3$2.95 million provided byduring 2003. The investing cash flows generated in 2004 were from the sale of common stock. Major capital projects included facility build-out, expansionavailable for sale securities received from Geron for goods and improvement atservices and the sale of our two nucleic acid production facilities in Boulder, Colorado and Glasgow, Scotland. The Boulder facility project is designed to be 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 cGMP production in the

second quarter of 2003. The Glasgow facility project, which produces nucleic acid building blocks, included the upgrading of equipment and processes at the current productionspecialty oligoneucleotide manufacturing facility and the build-out of a new facilityreductions in other assets that provides significant capacity expansion along with further equipment and process improvements.

Our operating activities resulted in net outflows of $13.2 million in 2003 and $17.9 million in 2002. The operating cash outflows for these periods resulted mainly from our operating losses. Significant investments in manufacturing operations, research and development and sales and marketing contributed to the operating losses. Notwithstanding the higher operating losses, operating cash outflows for 2003 are lower than those in the prior year due in large part to more effective management of working capital, specifically, improved accounts receivable management and decreased inventory levels.

Net cash used by investing activities was $2.7 million in 2003 compared to net cash provided by investing activities of $5.9 million for 2002. The investing cash out flow in 2003 is due primarily to the investment in property, plant and equipmentwere offset by the maturitypurchases of short-term investment funds. Cash provided in investing activities in 2002 was due primarily to the net maturity of funds in short-term investments offset by investments in property plant and equipment.

Net cash provided byCash flows from financing activities was $7.3totaled $6.00 million during 2004 compared to $7.30 million during 2003. The cash from financing activities in 20032004 relate primarily to net draws on our Credit Line and $1.7 million for 2002. The financing cash inflows in 2003 were the result of proceeds from the sale of common stock and advances on our line of credit. Financing cash inflows in 2002Term Note that were the result of the sale of common stock and proceeds from long-term debt offset by the purchasepayments of treasury stock.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, and 2002, the Companywe 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’s accounting policies are considered critical as they are both important to the portrayal of the Company’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.

If our 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’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’s estimate of future undiscounted and discounted cash flows to determine recoverability of these assets. If management’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.

Recently Issued Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. SFAS No.123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuace of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair-value-based method. We expect to adopt this standard on January 1, 2006. We are currently 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.

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 wasted material (spoilage) costs to be excluded from the cost of inventory and expensed when incurred. It also requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 will be effective at the beginning of 2006. We are currently assessing the final impact of this standard on our financial position, results of operations or 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.

Foreign Currency Rate Fluctuations

During the last three fiscal years, our international sales have represented approximately 50-65% of our net sales. These sales of products in foreign countries are mainly completed in either British Pounds Sterling or the Euro. Additionally, we have two wholly-ownedwholly owned subsidiaries, Transgenomic, LTD., orand Cruachem, LTD., whose operating currency is British pounds sterlingPounds Sterling and the Euro. Results of operations for the Company’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. As a result we are subject to exchange rate 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.

In 2003, we obtained a secured line of credit that carries a variable interest rate. This line of credit exposes us to interest rate risk. If the prime lending rate in the United States were to increase we would experience higher interest costs. Based upon our total available credit of $7.5 million, a 1% increase in the prime rate would increase our annual interest expense by approximately $75,000. We no longer have short-term investments in debt securities that subject us to the market risks described in our 2002 Annual Report on Form 10-K.

Item 8. Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT AUDITORS’ REPORTREGISTERED 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, 20032004 and 20022003, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2003.2004. 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’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, 20032004 and 2002,2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 20032004, 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 R,O, during the first quarter of 2004,2005, the Company obtained aan extension of the waiver of the borrowing base limit on its existing line of credit and entered into a convertible note agreement. through March 31, 2006.

As discussed in Note A, in 2002P, the Company changedrestated its methodconsolidated statements of accountingcash flows for goodwillthe years ended December 31, 2004 and other intangible assets in connection with the adoption of Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets.2003.

/s/ DELOITTE & TOUCHE LLP

Omaha, Nebraska

March 26, 2004

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

TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 20032004 and 20022003

(InDollars in thousands except share and per share data)