UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 20042005

OR

For the transition period from            to            

Commission File Number 000-30975

TRANSGENOMIC, INC.

(Exact Name of Registrant as Specified in its Charter)

(402) 452-5400

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes¨    Nox

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes¨    Nox

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yesx    No¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form10-K  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerate filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  ¨            Accelerated Filer  ¨            Non-Accelerated Filer  x

Indicate by check mark whether the registrant is an accelerated filera shell company (as defined in Exchange Act Rule 12b-2 of the Act)12b-2).    Yes¨    Nox

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant based on the last reported closing price per share of Common Stock as reported on The Nasdaq National Market on the last business day of the registrant’s most recently completed second fiscal quarter was approximately $38.37$23.28 million.

As of April 14, 2005,At March 30, 2006, the registrant had 34,234,92249,189,672 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant Proxy Statement relating to the Registrant’s May 25, 2005its 2006 Annual Meeting of Stockholders Meeting are(the “Proxy Statement”) have been incorporated by reference into Part III.Parts II and II of this Report on Form 10-K.

TRANSGENOMIC, INC.

Index to Form 10-K for the Fiscal Year Ended December 31, 20042005

This annual reportAnnual Report on Form 10-K references the following registered trademarks which are the property of Transgenomic: DNASEP^® Columns, WAVE^® System, WAVEMAKER^® Software, TRANSFORMING THE WORLD^® for Laboratory Equipment, TRANSGENOMIC^® and the Globe Logo^®; MutationDiscovery.com^® Website, OLIGOSEP^® for Systems and Reagents, OPTIMASE^® Polymerase, RNASEP^® Columns, WAVE OPTIMIZED^® reagents, and WAVE^® MD Systems. Additionally, this Annual report on Form 10-K references the following trademarks which are the property of Transgenomic: MitoScreen^™MitoScreen™ Kits, ProtocolWriter^™ProtocolWriter™ Software, Navigator^™Navigator™ Software, THE POWER OF DISCOVERY^™DISCOVERY™ for Lab Reagents and Educational Programs, and Surveyor^™Surveyor™ Nuclease. All other trademarks or trade names referred to in this Annual Report on Form 10-K are the property of their respective owners.

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PART I

FORWARD-LOOKING STATEMENTS

This annual reportAnnual Report on Form 10-K contains or incorporates by reference certain forward-looking statements. Many of these forward-looking statements refer to our plans, objectives, expectations and intentions, as well as our future financial results and are subject to risk and uncertainty. You can identify these forward-looking statements by words such as “expects,” “anticipates,” “intends,” “plans,” “may,” “will,” “believes,” “seeks,” “estimates” and similar expressions. Because these forward-looking statements involve risks and uncertainties, there are many factors that could cause our actual results to differ materially from those expressed or implied by these forward-looking statements, including those discussed under “Risks Related to Our Business” and other factors identified by cautionary language used elsewhere in the annual reportAnnual Report on Form 10-K.

Item 1. Our Business

We develop, assemble, manufacture and market versatile products and provide analytical services to the medical research, clinical and pharmaceutical markets for use in genetic variation analysis. Products and services are sold through a direct sales force in the United States and throughout much of Western Europe. For the rest of the world, products and services are sold through more than 25 dealers and distributors located in those local markets. Net sales are categorized as bioinstruments, bioconsumables and discovery services.

Historically, we operated a segment (the “Nucleic Acids operating segment”) that developed, manufactured and other related consumable products. Our Nucleic Acids products consist principally ofmarketed chemical building blocks for nucleic acid synthesis. Both business units have service offerings as well, including genetic variation discoverysynthesis to biotechnology, pharmaceutical and analysis services and customoligonucleotide synthesis of specialty nucleic acids.

Our technologies center around three core competencies: separation chemistries, enzymology, and nucleic acid chemistries. We employ novel chemistries for separating nucleic acids, proteins, peptides, amino acids and carbohydrates. Our most significant separation technology is currently embodied in the WAVE System. The WAVE System is a versatile instrument that can be used for genetic variation detection, size-based double-strand DNA separation and analysis, single-strand DNA separation and analysis and DNA purification. The WAVE System requires the use of various consumable products that we manufacture and sell separately.

Our second core competency is expertise in developing novel enzymes. Enzymes are proteins that act as catalysts for biochemical reactions. Several of these reactions are useful in genomics. The ability to develop enzymes useful in the experimental manipulation of genes provides powerful tools for producing genetic material in the form needed for further analysis or incorporation into diagnostics and therapeutics. These products can also expand the sale of consumable products to WAVE System users and may also be sold for other applications. Our SURVEYOR^® product line of mutation detection kits allow for the cleaving of DNA at points where DNA sequence variations exists. The resulting DNA fragments can then be analyzed by our WAVE System, fluorescent capillary electrophoresis or standard gel electrophoresis. SURVEYOR Kits provide a simple and robust method of scanning relatively large DNA fragments for both known and novel sequence variations.

Our third core competency is nucleic acid chemistries. Our synthetic nucleic acid products consist of chemical building blocks of nucleic acids (known as phosphoramidites). We also manufacture related specialty chemicals such as fluorescent markers and molecular tags, dyes, quenchers, linkers, and solvents used to modify nucleic acids for subsequent detection or manipulation. These products are used by research organizations, diagnostic companies and pharmaceutical companies. These products are produced primarily in our Glasgow, Scotland facility. Priorresearch institutions throughout the world. In the fourth quarter of 2005, we implemented a plan to November 11, 2004, we had also manufactured synthesized segments of nucleic acids (known as oligonucleotides) in a facility in Boulder, Colorado. On November 11, 2004, we sold the assets associated withexit this facility to a subsidiary of Eyetech Pharmaceuticals, Inc. (“Eyetech”). As a resultoperating segment. Accordingly, results of this sale, we no longer manufacture and sell these specialized oligonucleotides.

Ourbusiness are reflected as discontinued operations are managed based upon the nature of the products and services provided. Accordingly, we operate 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 or loss. See Note K to the accompanying consolidated financial statements for detailed segment information.

all periods presented.

Business Strategy

Since inception, our business strategy has been to provide products and services to biomedical researchers, medical institutions, diagnostic and pharmaceutical companies that are tied to advancements in the field of genetics. The movementgenomics. Advances in the field of genomics have fueled efforts to understand individual differences in disease susceptibility, disease progression, and related market opportunities, has shifted from gene discoveryresponse to the analysis of variations in gene sequences. Researchers are beginning to link variations in the gene sequences to disorders and diseases.therapy. Accordingly, a principal component of our strategy has been to establish our WAVE SystemWAVE® system as thean industry standard in the geneticbiomedical research market and to develop additional

markets for the WAVE SystemWAVE® system such as clinical research and diagnostics. Through an expanding base of installed systems, we expect to increase the sales of consumable products used with the WAVE.WAVE® system and create opportunities to market additional products to this customer base. In addition, through our Discovery Services offerings, we have gained exposure to the translational and clinical research markets, laying the foundation for increasing our participation in the full value chain associated with activities ranging from basic biomedical research to development of diagnostic and therapeutic products.

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Significant 2005 Events

We have also historically soughtdecided to position ourselves as a partnerexit our former Nucleic Acids operating segment.

On December 22, 2005, the Company’s Directors voted to biopharmaceuticaleither sell or close and pharmaceutical companies inliquidate the early stages of their efforts to develop genomic-based diagnostics and therapeutics, thereby allowing us to participate in future successes of products derived from the expanding knowledge of genomics. While we continue to believe that the long-term prospects for this business segment are favorable, we concluded that near-term revenues from this segment would generate neither positive cash flows nor profits from operations. Consequently, in the second quarter of 2004, our Board of Directors directed management to explore strategic alternatives for our Nucleic Acids operating segment, including the possible salewhich consists primarily of one or both of the facilities in Glasgow, Scotland and Boulder, Colorado. On November 11, 2004, we sold the assets associated with our specialty oligonucleotidea manufacturing facility in Boulder, Colorado. We continueGlasgow, Scotland. This decision was made after an evaluation of, among other things, short and long-term sales projections for products sold by this operating segment, including estimates of 2006 sales to operate ourthe operating segment’s largest customer. While opportunities to sell this operating segment as a going concern are being evaluated, we have commenced procedures, including notification of affected employees, which may lead to closure and liquidation of the facility in Glasgow, ScotlandScotland. During 2006, we expect to incur costs of approximately $0.72 million related to statutory payments to affected employees and other costs specifically attributable to closure of the facility which primarily produces chemical building blocks usedhave been accrued at December 31, 2005. In addition, the Company expects to incur additional period costs of approximately $0.25 million in each of the synthesisfirst two quarters of nucleic acids. However, we have taken steps2006 attributable to consolidate theseclosure of the facility that will be recorded in discontinued operations andin 2006. In conjunction with the decision to reduce costs in order to better align operating expenses with anticipated revenues.

Our business strategy going forward is to achieve revenue growth in our BioSystemsexit this operating segment, andthe Company recorded an impairment charge of $8.02 million consisting of valuation adjustments to better align our cost structure with anticipated revenues in both of our operating segments. We have already taken steps to implement this strategy as more fully discussed under “Significant 2004 Developments,” below.

Significant 2004 Developments

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

Based upon information obtained throughreflect the process of evaluating strategic alternatives for our Nucleic Acids segment, we determined that it was more likely than not that thecarrying value of the related net assets associated withat estimated fair market value. We now reflect the results of this business were impaired. operating segment as discontinued operations for all periods presented.

We engaged an external valuation firmcompleted a private placement of our common stock in the fourth quarter.

On October 31, 2005, we issued securities to assist us in conducting an interim period impairment test that resultedinstitutional investors in a non-cash charge of $11.97 million related to these assets during the three months ended June 30, 2004.private placement (the “2005 Private Placement”). The chargesecurities issued 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 Eyetech. The sale price was $3.00 million in cash plus the assumptionof: (i) 14,925,743 shares of the lease onCompany’s common stock, plus (ii) five-year, non-callable warrants to purchase another 5,970,297 shares of common stock with an exercise price of $1.20 per share. The aggregate purchase price for the Boulder facility andsecurities sold was $1.01 per share of 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 $2.70common stock initially being sold or $15.08 million. In conjunction with this transaction, we recordedissued a gainwarrant to Oppenheimer & Co., Inc. to purchase 932,859 shares at $1.20 per share as part of their placement fee.

The net proceeds from the 2005 Private Placement were $13.90 million after transaction costs of $1.18 million. These proceeds were partially used to repay all outstanding principal and accrued interest on saleour loans to Laurus Master Funds, Ltd. (“Laurus”) including fees paid to Laurus to facilitate the 2005 Private Placement and prepayment penalties to Laurus in the sum of $1.47$0.82 million. The remaining proceeds of $5.35 million inwill be used for future working capital needs.

One of our laboratories was certified under the Clinical Laboratory Improvement Amendment, and we began to offer molecular-based testing to physicians and third-party laboratories.

During the fourth quarter of 2004.

2005, our laboratory in Omaha, Nebraska was certified under the Clinical Laboratory Improvement Amendments and we received our first patient samples for molecular-based testing for hematology, oncology and certain inherited diseases for physicians and third-party laboratories. We believe there is a significant opportunity for us to capitalize on the increasing demand for molecular-based personalized medicine by leveraging on our technologies and experience gained from the genomic biomarker analysis that our Discovery Services Group has and will continue to provide to pharmaceutical and biopharmaceutical companies.

We implemented a restructuring planintroduced the newest generation of our flagship product, the WAVE^® system 4500.

During September 2005, we introduced the newest version of our WAVE^® platform, the WAVE^® system 4500. The WAVE^® 4500 includes enhancements that are designed to better align costs with expected revenues.optimize sensitivity and throughput for our customers while reducing our overall product and maintenance cost. In addition to new product sales, certain enhanced components of the WAVE^® 4500, including the oven and software, will provide modular upgrade opportunities for our existing customers.

On November 13, 2004, our Board3

In the first quarter, Laurus converted $2.52 million of Directors approved a restructuring plan designed to refocus the Company on its BioSystems operating segment and to better align our cost structure with anticipated revenues. The plan (which is incremental to the saleloans into shares 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 approximately 10 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 ended December 31, 2004 related primarily to severance, benefits and facility closures.

Together, the sale of our specialty oligonucleotide manufacturing facility and the implementation of our restructuring plan are expected to result in $10.00 million to $12.00 million in annual cost savings.

We revised our credit facilities with Laurus Master Funds, Ltd.common stock.

We have entered into a $7.50 million convertible line of credit (the ”Credit Line”) and a separate $2.75 million convertible note (the ”Term Note”) with Laurus Master Fund, Ltd. (“Laurus”)(collectively, the “Laurus Loans”). In February 2004, Laurus waived the borrowing base limitation on the Credit Line, thereby making the full $7.50 million facility available to the Company 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 has 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 the Company’s 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 the Company’s common stock on August 31, 2004 was $1.20 per share.

Subsequent to December 31, 2004, we further amended our Credit Line. On March 18, 2005, Laurus agreed to extend the borrowing base waiver on the Credit Line through March 31, 2006. In addition, we agreed to allowallowed Laurus to convert $1.87 million of the outstanding principal balance under the Credit Lineour convertible line of credit (the “Credit Line”) into 3,600,000 shares of our common stockstock. In addition, on March 18,24, 2005 andwe allowed Laurus to convert $0.65 million of the outstanding principal balance of the Term Noteour convertible term note (the “Term Note”) into 1,250,000 shares of our common stock on March 24, 2005. As a result, we have increased the amount available under thestock. The Credit Line by $1.87 million and have eliminated substantially all remainingTerm Note (collectively, the “Laurus Loans”) were subsequently repaid in September 2005 scheduled principal payments on the Term Loan.

and are no longer available to us.

Sales and Marketing

We currently sellhave sold our products to customers in over 30 countries. We use a direct sales and support staff for sales in the U.S., U.K. and most countries in Western Europe. For the rest of the world, we sell our products through dealers and distributors located in those local markets. We currently have over 25 dealers and distributors. We also maintain regionally-based technical support staffs and applications scientists to support our sales and marketing activities throughout the U.S. and Europe.

Customers

Customers include numerous leading academic and medical institutions in the U.S. and abroad. In addition, our customers also include a number of large, established U.S. and foreign pharmaceutical, biotech and commercial companies.

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 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.

Research and Development

We maintain an active program of research and development and expect to continue to incur significant expense for these activities going forward. Our research and development activities includeprimarily directed toward the improvement of the DNA separation media used in our WAVE System,^® system, the refinement of the hardware and software components of the WAVE System,^® system, the creation of unique enzymes and WAVE-Optimized^® enzymes, and to a lesser extent, the improvementdevelopment of chemical and biochemical reaction techniques for synthetic nucleic acids.assays on the WAVE^® system.

Consistent with our business strategy discussed above, we have taken steps to reduce researchFor the years ended December 31, 2005, 2004 and development expenditures to levels that are more consistent with our current levels of revenue. For 2004,2003, our research and development expendituresexpenses were approximately $6.69 million. This represents a substantial reduction from our prior levels of expenditures that were $9.31$2.20 million, $12.20$4.50 million and $9.37$6.83 million, in 2003, 2002 and 2001, respectively. We expect that we will further curtail ourneed to continue to invest in research and development activities untilin order to remain competitive and to take advantage of new business opportunities as they arise. During 2006, we are ableexpect research and development expense to increasebe approximately equal to the 2005 levels.

In addition to the amounts reflected above, our revenues or otherwise improve our liquiditydiscontinued operations incurred no research and working capital positions.

development expenses during the year ended December 31, 2005 and $2.18 million and $2.47 million during the years ended December 31, 2004 and 2003, respectively.

Manufacturing

We manufacture bioconsumable products including our separation columns, liquid reagents, enzymes and nucleic acid products.enzymes. The major components of our WAVE^® systems are manufactured for us by a third party. We integrate our own hardware and software with these third party manufactured components. Our manufacturing facilities for our WAVE^® systems and bioconsumables are located in Omaha, Nebraska, San Jose, California, and Cramlington, England. Our phosphoramiditesThe nature of our instruments and related synthetic nucleic acid products are manufactured in our Glasgow, Scotland facility.bioconsumables business does not generally lend itself to tracking and reporting sales backlog.

Intellectual Property

To establish and protect our proprietary technologies and products, we rely on a combination of patent, copyright, trademark and trade-secret laws, as well as confidentiality provisions in our contracts. We presently own rights to more than 8040 issued patents and 5020 pending applications in both the U.S. and abroad. Our BioSystems operating segment products, comprising the WAVE^® System and related

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consumables, are protected by patents and in-licensed technologies with remaining lives of 9 to 18 years. Intellectual property related to our Synthetic Nucleic Acid business unit, other than production trade secrets, is almost entirely

in-licensed. A number of these in-licensed patents have recently, or will soon, expire. As a result, we expect price competitionthat expire in the Nucleic Acids operating segment to intensifyvarious periods beginning in the next year.2013 through 2022. We will continue to file patent applications and seek new licenses as warranted to protect and develop new technologies of interest to our customer base in the coming years.

Competition

The markets in which our Biosystems operating segment operateswe operate are highly competitive and characterized by rapidly changing technological advances. A number of Transgenomic’sour 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 competesWe compete principally on the basis of uniquely enabling technical advantages in specific but significant market segments.

Competition for our WAVE Systems^® systems arises primarily from DNA sequencing and genotyping technologies. Competitors in these areas include Applied Biosystems, Beckman Coulter, Amersham (now part of GE Healthcare), Affymetrix, Agilent Technologies, Nanogen, Illumina, Sequenom, Pyrosequencing (now part of Biotage AB), Varian, and others. 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 unitdiscovery services product line faces competition from a number of companies offering contract DNA sequencing and other genomic analysis services, including 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 Nucleic Acids operating segment functions, and increasingly driven by price. Transgenomic competes on the basis of its ability to develop and manufacture synthetic nucleic acid building blocks used to make DNA and RNA oligonucleotides. Competitors include Proligo Degussa, Pierce Nucleic Acid Technologies, and Applied Byosystems. In addition, competition is expected in the future from new overseas entrants focusing on low cost production.

Employees

As of December 31, 2005, 2004 and 2003, we had 178 and 244 employees respectively. Certain of those employees at December 31, 2004 were terminated during January and February 2005 in connection with the 2004 restructuring plan. As of February 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 following areas of our operation:

Our employees were employed in the following geographical locations.

Patent law relating toreduce the scope of claims in the technology fields in which we operate is still evolving. The degree of future protectionmarket price for our proprietary rights is uncertain. Furthermore,stock.

At December 31, 2005, we cannothad obligations to issue 13,625,675 shares of common stock including outstanding stock options representing 5,563,098 shares and warrants representing 8,062,577 shares. The issuance of these additional shares of common stock may be certain that others will not independently develop similar or alternative products or technology, duplicate anydilutive to our current shareholders and could negatively impact the market price 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.

common stock.

We cannot be certain that other measures taken to protect our intellectual property will be effective.

We rely upon trade secret protection, copyrightOur common stock is thinly traded and trademark laws, non-disclosure agreements and other contractual provisions for some of our confidential 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 compete 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 substantial 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 significantlarge percentage of our salesshares are held by a small group of unrelated, institutional owners.

At March 30, 2006, we had 49,189,672 shares of common stock outstanding. Fewer than ten unrelated, institutional holders own 50% to customers located outside70% of these shares. The sale of significant shares into the U.S. The patent and other intellectual property lawspublic market has potential to cause significant downward pressure on the price of some foreign countries may not protect our intellectual property rightscommon stock. This is particularly the case if the shares being placed into the market exceed the market’s ability to absorb the stock. Such an event could place further downward pressure on the price of our common stock. This presents an opportunity for short sellers to contribute to the same extent as U.S. laws. We may need to bring proceedings to defend our patent rights or to determine the validityfurther decline of our competitors’ foreign patents. These proceedings could result in substantial cost and diversionstock price. If there are significant short sales of our efforts. Finally, somestock, the price decline that would result from this activity will cause the share price to decline more so, which, in turn, may cause long holders of our patent protectionthe stock to sell their shares thereby contributing to sales of stock in the U.S. is not available to us in foreign countries due to the laws of those countries.

market.

Our products could infringe on the intellectual property rights of others.Item 1B. Unresolved Staff Comments

None.

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 federal, state, local and international laws and regulations governing the use, storage, handling and disposal of hazardous materials and waste products. If we fail to comply 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 resources. We cannot assure you that accidental contamination or injury will not occur. Any such accident could damage our research and manufacturing facilities and operations, resulting in delays and increased costs.

We own one facility in Glasgow, Scotland and lease 1410 facilities throughout the world under non-cancelable leases with various terms. As a result of restructuring initiatives initiated in 2004 and 2002, a significant amount of leased space is currently unoccupied, and may in certain cases be sublet, to independent third parties.

The following table summarizes occupied locations. Annual rent amounts presented in the table are reflected in thousands.

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Item 3. Legal Proceedings

Legal Proceedings

We have been named as a defendant in a lawsuit filed in Spain by a prospective distributor who claims that the Company breached a promise to grant the plaintiff a distributorship for certain of the Company’s products in a specific geographic area in Europe. The plaintiff is seeking monetary relief of approximately $0.50 million. We believe the lawsuit is without merit and intend to vigorously defend this matter.

We are subject to a number of other claims of various amounts, which arise out of the normal course of business. In our opinion, the disposition of pending claims currently pending will not have a material adverse effect on our financial position, results of operations or cash flows, after considering amounts already reflected in the consolidated financial statements.flows.

We did not submit any matters to our stockholders for a vote or other approval during the fourth quarter of the fiscal year covered by this report.

Our executive officers are appointed annually by the Board of Directors at the first meeting following the annual stockholders’ meeting. Other officers are appointed by the Board of Directors from time to time. Each officer holds office until a successor has been duly appointed and qualified or until the death, resignation or removal of such officer.

Our currentexecutive officers and their ages as of December 31, 2004 are listed below followed by a brief biography.

Collin J. D’Silva.Mr. D’Silva has served as our Chairman of the Board and Chief Executive Officer since 1997 and is also a Director. Mr. D’Silva, a co-founder of Transgenomic, has worked for the Company and its predecessors since 1988. Mr. D’Silva was employed by AT&T from 1980 to 1988. At AT&T, he held various positions in engineering, materials management, sales support and business development. His last position at AT&T was Business Unit Manager and Engineering Manager for a network distribution products division. Mr. D’Silva holds a B.S. degree and a M.Eng. degree in industrial engineering from Iowa State University and an M.B.A. from Creighton University.

Michael A. Summers.Mr. Summers joined Transgenomic, Inc. in August 2004 and currently serves as Chief Financial Officer. Mr. Summers was employed with C&A Industries, Inc. from 2003 to 2004 where as General Manager he was responsible for the operations of various divisions that provided human capital management and consulting services. From 2001 to 2003, he was

Executive Vice President and Chief Financial Officer for Nexterna, Inc., a wholly-owned technology subsidiary of the Union Pacific Corporation. From 2000 to 2001, he was the Chief Accounting Officer for Able Telcom Holding Corp., a publicly-owned project management and construction company. Prior to 2000, Mr. Summers held various positions including eight years as an auditor for the Omaha, Nebraska office of Deloitte & Touche, LLP. Mr. Summers graduated from Creighton University in 1987 with a B.S. degree in business administration with an accounting major. He is a Certified Public Accountant.

Keith A. Johnson.Mr. Johnson joined us in 2002 as Vice President, General Counsel. Mr. Johnson has a B.A. in Biochemistry from Kalamazoo College, an M.B.A. in International Business and Marketing from Michigan State, and a law degree from the University of San Diego. Before joining Transgenomic Mr. Johnson was Director of Intellectual Property, Technology Development and Licensing at Integra LifeSciences in Plainsboro, NJ, from 1999 to 2001. Mr. Johnson’s previous experience also includes Senior Licensing Manager, Rutgers University, from 1998 to 1999 and Technology Licensing Officer, Washington State University, from 1995 to 1998. Mr. Johnson is a member of the state bars of California, Washington, New Jersey and Nebraska and is admitted to practice before the United States Patent and Trade Office.10

Mitchell L. Murphy.Mr. Murphy joined us in 1992. His current duties include the overall corporate administration and shareholder relations. Prior to joining Transgenomic, he held accounting and financial management positions for 15 years with companies involved in manufacturing, steel distribution and rebar fabrication. He spent over two years as an auditor for the Omaha, Nebraska office of Deloitte, Haskins & Sells (now Deloitte & Touche LLP) working in a broad range of industries. Mr. Murphy graduated with honors from Creighton University in 1978 with a B.S. degree in business administration with an accounting major.

Item 5. Market for the Registrant’s Common Stock, Related Stockholder Matters and Issuer Repurchases of Equity Securities

Part II

(a)Market Information.Our common stock is listed for trading on the Nasdaq under the symbol TBIO. The following table sets forth the high and low closing prices for our common stock during each of the quarters of 20032004 and 2004.2005.

(b)Holders.At April 14, 2005,March 30, 2006, there were 34,234,922are 49,189,672 shares of our common stock outstanding and approximately 3,2003,475 holders of record.

(c)Dividends.We have never declared or paid any cash dividends on our common stock and we do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently expect to retain all earnings, if any, for investment in our business. Dividends on our common stock will be paid only if and when declared by our Board of Directors. The Board’s ability to declare a dividend is subject to limits imposed by Delaware corporate law. In determining whether to declare dividends, the Board may consider our financial condition, results of operations, working capital requirements, future prospects and other relevant factors.

(d)Securities authorized for issuance under equity compensation plans. The information required by this item is incorporated herein by reference to the section of the Proxy Statement relating to our 2006 Annual Meeting of Shareholders captioned “Equity Compensation Plan Information.”

Sale of Unregistered Securities

Information regarding sales of equity securities by the Company during the year ended December 31, 2005 that were not registered under the Securities Act of 1933 have been previously reported by the Company on Form 8-Ks filed on March 18, 2005, March 30, 2005 and October 31, 2005.

Issuer Purchase of Equity Securities

The Company made no purchases of its common stock during the quarter ended December 31, 2005. Therefore, tabular disclosure is not presented.

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Item 6. Selected Consolidated Financial Data

The statementselected consolidated balance sheet data at December 31, 2005 and 2004 and the selected consolidated statements of operations data for the yearseach year ended December 31, 2004, 2003 and 2002 and the balance sheet data as of December 31,2005, 2004 and 2003 arehave been derived from our historicalaudited consolidated financial statements and notes theretothat are included elsewhere in this Annual Report on Form 10-K, which have been audited by Deloitte & Touche LLP, our independent registered public accounting firm.10-K. The statementselected consolidated balance sheet data at December 31, 2003, 2002 and 2001 and the selected consolidated statements of operations data for the yearseach year ended December 31, 2002 and 2001 and 2000 and the balance sheet data as of December 31, 2002, 2001 and 2000 arehave been derived from our audited historical consolidated financial statements that are not included in this Annual Report on Form 10-K.

The following selected financial Dollar amounts, except per share data, should be readare presented in conjunction with our consolidated financial statements and the related notes thereto and the information under “Management Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.thousands.

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OverviewItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the Consolidated Financial Statements and applicable Notes to Consolidated Financial Statements and other information in this report, including Risk Factors set forth in Item 1A and Critical Accounting Policies at the end of this Item 7.

Since 2000 (the yearThe Company has one reportable operating segment. Although revenue is analyzed by type, net financial results are analyzed as one segment due to the integrated nature of our initial public offering), we have incurred net lossesthe products. The Consolidated Financial Statements also include discontinued operations. In the fourth quarter of $94.76 million generally related2005, the Company implemented a plan to ourexit the former Nucleic Acids operating segment. Accordingly, results of this operating segment researchare reflected as discontinued operations for all periods presented.

Executive Summary

2005 Results

We have experienced recurring net losses and development and selling, general and administrative costs. 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 Credit Line and the sale of our specialty oligonucleotides facility in Boulder, Colorado. At December 31, 2004, we had an accumulated deficit at December 31, 2005 of $107.10$122.09 million.

To respond to changes in the overall business climate for our products, our liquidity position and our demand for capital structure, we have 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 assuranceschange 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 millionbegan in the fourth quarter of 2004.

We implemented a restructuring plan to better align costs2004 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 and a wide-reaching restructuring plan. We continued implementing positive change during 2005 by executing on the following:

We decided to exit our former Nucleic Acids operating segment.

On December 22, 2005, we decided to sell or close and liquidate the Nucleic Acids operating segment, which consists primarily of a manufacturing facility in Glasgow, Scotland. This decision was made after an evaluation of, among other things, short and long-term sales projections for products sold by this operating segment, including estimates of 2006 sales to the operating segment’s largest customer. While opportunities to sell the operating segment as a going concern are being evaluated, procedures have commenced, including notification to affected employees, which is expected to lead to closure of the facility in Glasgow, Scotland. During 2006, we expect to incur costs of approximately $0.72 million related to statutory payments to affected employees and other costs specifically attributable to closure of the facility which have been accrued at December 31, 2005. In addition, the Company expects to incur additional period costs of approximately $0.25 million in each of the first two quarters of 2006 attributable to closure of the facility that will be recorded in discontinued operations in 2006. In conjunction with the decision to exit this operating segment, the Company recorded an impairment charge of $8.02 million consisting of valuation adjustments to reflect the carrying value of the related net assets at estimated fair market value. We now reflect the results of this operating segment as discontinued operations for all periods presented.

We completed a significant impactprivate placement of our common stock in the fourth quarter.

On October 31, 2005, we issued securities to institutional investors in a private placement (the “2005 Private Placement”). The securities issued consisted of: (i) 14,925,743 shares of the Company’s common stock, plus (ii) five-year, non-callable warrants to purchase another 5,970,297 shares of common stock with an exercise price of $1.20 per share. The aggregate purchase price for the securities sold was $1.01 per share of common stock initially being sold or $15.08 million. In conjunction with this transaction, we issued a warrant to Oppenheimer & Co., Inc. to purchase 932,859 shares at $1.20 per share as part of their placement fee.

The net proceeds from the 2005 Private Placement were $13.90 million after transaction costs of $1.18 million. These proceeds were partially used to repay all outstanding principal and accrued interest on our ongoing costs.Laurus Loans including fees paid to Laurus to facilitate the 2005 Private Placement and prepayment penalties to Laurus in the sum of $0.82 million. The pro forma effectsremaining proceeds of $5.35 million will be used for future working capital needs.

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In the first quarter, Laurus converted $2.52 million of its loans into shares of our common stock.

On March 18, 2005, we allowed Laurus to convert $1.87 million of the outstanding principal balance under our Credit Line into 3,600,000 shares of our common stock. In addition, on March 24, 2005 we allowed Laurus to convert $0.65 million of the outstanding principal balance of our Term Note into 1,250,000 shares of our common stock. The Credit Line and Term Note (collectively, the “Laurus Loans”) were subsequently repaid in September 2005 and are no longer available to us.

In summary, the 2005 results reflected improvement, but we are not satisfied.

As a result of the actions undertaken since the fourth quarter of 2004, loss from continuing operations has gone from $9.51 million and $13.75 million in 2003 and 2004, respectively, to $4.98 million in 2005. Net cash flows used by operating activities have gone from $13.02 million and $12.75 million in 2004 to $3.63 million in 2005. Additionally, sales of Geron stock received as payment for goods and services and included in net cash flows from investing activities provided $2.15 million in positive cash flows. Because these shares are considered available-for-sale securities, related sales are recorded as follows.investing activities.

2006 Outlook

Timing of the demand for our products, particularly our flagship WAVE^® systems, has been difficult to predict due largely to ongoing changes in the market place and the funding arrangements of our customers. Because our net sales are largely dependent upon sales of a limited number of products, including WAVE^® systems, and our cost structure is largely fixed, historical results have been somewhat sporadic. For these reasons, it is not our practice to provide prospective financial guidance related specifically to revenues, costs, net income (loss) or cash flows. However, our financial objectives are to generate income from continuing operations and positive cash flows from continuing operations. To accomplish these goals we must generate sequential growth in net sales, convert manufacturing expenses from fixed to variable costs and continue to better control operating expenses.

Develop sequential growth in net sales.

We will work to continue to leverage on and strengthen our core instrument business. Challenges exist for WAVE^® system and consumable growth in traditional markets. However, we intend to continue to diversify into new markets, including the personalized medicine market (particularly in oncology), where the sensitivities of our technologies are essential. In the short-term, we believe that the introduction of the newest generation of our flagship product, the WAVE^® system 4500 will provide upgrade opportunities to our current installed base. In the intermediate to longer-term, we believe that newly developed “targeted” consumable products will increase usability of our installed base and enhance net sales of consumables. Additionally, we have developed credibility and momentum with several third-party platforms that will allow us to leverage on our direct sales force and distribution network.

On the discovery services front, we will seek to leverage on past customer successes with pharmaceutical customers to diversify our customer base. Challenges also exist for these service offerings. While our large pharmaceutical customer representation has increased steadily with pilot or “proof of concept” projects, the lead time to major contracts has proven lengthy. To mitigate this risk, we believe there is a significant opportunity for us to capitalize on the increasing demand for molecular-based personalized medicine by leveraging on our technologies and experience gained from the genomic biomarker analysis that discovery services has and will continue to provide to pharmaceutical and biopharmaceutical companies. During the fourth quarter of 2005, our laboratory in Omaha, Nebraska was certified under the Clinical Laboratory Improvement Amendments, and we received our first patient samples from physicians and third-party laboratories for molecular-based testing for hematology, oncology and certain inherited diseases. This capability also allows us to offer a vertically-integrated suite of services that can support activities ranging from discovery research to clinical trials to diagnostic testing. As the need for drug/diagnostic combination products increases, we believe this suite of service offerings will prove attractive to various customers.

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Convert manufacturing expenses from fixed to variable costs.

A significant portion of our manufacturing costs relate to fixed overhead associated with personnel and facilities. We continue to evaluate consolidation and outsourcing opportunities designed to convert these costs from fixed to variable costs.

Continue to control operating expenses.

Operating expenses include selling, general and administrative expenses and research and development expenses. We will need to continue to invest in research and development activities in order to remain competitive and to take advantage of new business opportunities as they arise. During 2006, we expect operating expenses, including research and development expense, to be approximately equal to 2005 levels.

Results of Continuing Operations

Changes in Results of Operations

Years Ended December 31, 20042005 and 20032004

Net Sales.Sales. Net sales duringfor the years ended December 31, 2005 and 2004 decreased $0.08 million or 1% from 2003 as a resultconsisted of a $0.80 million or 3% decreasethe following (dollars in sales in our BioSystems operating segment offset by a $0.72 million or 9% increase in sales in our Nucleic Acids operating segment.thousands):

The decrease in sales in our BioSystems operating segment resulted from a decreaseWAVE^® systems sold totaled 97 during the year ended December 31, 2005 compared to 107 during the same period 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 in2004. Although the number of Wave SystemsWAVE^® systems sold declined, overall bioinstrument net sales increased slightly due primarily to net sales increases from 122 in 2003 to 107 in 2004.product upgrades and service contracts. The selling prices of our instruments vary based on the specific model and optional accessories. We had an installed base of approximately 1,2001,290 units at December 31, 2005 compared to 1,193 units at December 31, 2004. The increase in the installed base of instruments continues to drive increaseswas primarily responsible for the 2% increase in sales of bioconsumables used with these instruments.bioconsumables. The increase in Discovery Servicesdiscovery services revenue during 20042005 was primarily attributable to the discovery services agreements that we entered into with a large pharmaceutical companiescompany 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 costsdiscovery services operations. Cost of goods sold totaled $2.10 millionfor the years ended December 31, 2005 and $1.74 million2004 consisted of the following (dollars in 2004 and 2003, respectively.thousands):

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$12.33 million or 27%43% of total net sales during 2004the year ended December 31, 2005 compared to $9.55$13.25 million and 28%52% during 2003. A summarythe same period of margins by operating segment follows (dollars2004. The decrease in thousands):gross profit as a percent of revenue is largely attributable to changes in the composition of products sold. Generally, sales of WAVE^® systems and ancillary instrumentation generate higher gross profits than sales of third party platforms. Sales of specialty consumables (SURVEYOR Nuclease, HPLC separation columns, etc.) generate higher gross profits than base buffers and enzymes. Gross profits from discovery services have been less than expected due to the continuing build out of capacity and expansion of product offerings.

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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$12.22 million in 2004during the year ended December 31, 2005 compared to $17.32$15.96 million in 2003, an increaseduring the same period of $0.182004, a decrease of $3.74 million or 1%23%. 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%43% and 63% during the year ended December 31, 2005 and 2004, respectively. This decrease resulted primarily from termination of personnel and the elimination of facilities related costs in bothconjunction with the 2004 and 2003. Depreciation expense include in selling, general and administrativeRestructuring Plan. Foreign currency transaction adjustments increased operating expenses totaled $1.02by approximately $0.33 million and $1.28 million induring the year ended December 31, 2005 compared to the same period of 2004 and 2003, respectively.when foreign currency transaction adjustments reduced operating expenses by approximately $0.45 million.

Research and Development Expenses. Research and development expenses primarily include personnel costs, supplies, and facility costs. These costs totaled $6.69$2.20 million in 2004during the year ended December 31, 2005 compared to $9.31$4.50 million in 2003,during the same period of 2004, a decrease of $2.62$2.30 million or 28%51%. The decrease related primarily to the 2004 Restructuring Plan.

As a percentage of revenue, research and development expenses totaled 20%8% and 27%18% of revenue induring the year ended December 31, 2005 and 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 portionup to 10% of our revenues in research and development activities primarily associated with our BioSystems operating segment.activities. 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.DuringImpairment charges totaled $0.43 million during the second quarteryear ended December 31, 2005 and consisted 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$0.25 million associated with this businesscertain international patent pursuits that 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 $11.97no longer consistent with our strategic plan and $0.18 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 assetscertain inventory 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.third party platforms.

Other Income (Expense). Other expense during 2004the year ended December 31, 2005 of $5.41$2.45 million consisted of interest expense of $2.38$1.98 million, loss on debt extinguishment of $0.54 million net of other income of $0.07 million. Other expense during the year ended December 31, 2004 consisted of interest expense of $2.37 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$0.38 million.

Interest expense during 2003 of $0.31 million consisted of interest income of $0.20 million, interest expense of $0.31 millionthe following for the years ended December 31, 2005 and other net expenses of $0.20 million.2004 (dollars in thousands):

The increase in interest expense resulted from higher average debt balances and interest rates. Gross debt totaled $8.95On March 18, 2005, we allowed Laurus to convert $1.87 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 borrowingsthe outstanding principal balance under our Credit Line during 2004into 3,600,000 shares of our common stock at $0.52 per share. In addition, on March 24, 2005 we allowed Laurus to convert $0.65 million of the outstanding principal balance of our Term Note into 1,250,000 shares of our common stock at $0.52 per share. Laurus agreed to apply this Term Note conversion against substantially all remaining 2005 scheduled principal payments on such loan. The closing market price of our common stock the day before each of these conversions was $0.58 per share. No other provisions of our Credit Line or Term Note were $7.23 million and $2.63 million, respectively. Interest expense in 2004 and 2003 includesmodified, including the $1.00 conversion price for remaining debt. In conjunction with these conversions we accelerated amortization of $0.41 million of related debt premiums and discounts and recorded a charge to interest expense of $1.64$1.37 million and $0, respectively.related to the fair value of incremental shares received by Laurus.

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Contemporaneously with the closing of the 2005 Private Placement our common stock on October 31, 2005, we repaid all outstanding principal and accrued interest on the Laurus Loans which have been cancelled and are no longer available to us. In conjunction with this prepayment, we recorded a loss on debt extinguishment of $0.54 million. This loss consisted of prepayment penalties and fees paid to Laurus to facilitate the 2005 Private Placement of $0.84 million offset by the elimination of associated net debt premiums of $0.30 million.

Loss on debt extinguishment totaled $2.86 million during the year ended December 31, 2004. As described in Note Ethe Notes 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 iswas 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 solelyrecorded during the years ended December 31, 2005 and 2004 related to our operationsincome taxes in certainstates, foreign countries and certain states. In additionother local jurisdictions. Due to income tax expense in these jurisdictions, we do not record any income tax benefits due tothe our cumulative losses, in recent years, expected losses in future years and the uncertainty as to whether we will be ableinability to utilize any additional losses as carrybacks.carrybacks, we did not provide for an income tax benefit during the years ended December 31, 2005 or 2004 based on our determination that it was more likely than not that such benefits would not be realized. 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 taxable income in future yearsperiods and it is determineddetermine that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized.recognized at such time. 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 from continuing and discontinued operations of approximately $91.47 million. Our net operating loss carryforwards$99.64 million will expire at various dates from 2008 through 2024,2025, if not utilized. We also had state income tax loss carryforwards from continuing and discontinued operations of $37.62$39.00 million at December 31, 2004.2005. These carryforwards will also expire at various dates beginning in 20052006 if not utilized.

Years Ended December 31, 20032004 and 20022003

Net Sales.Net sales decreasedfor the years ended December 31, 2004 and 2003 consisted of the following (dollars 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.thousands):

Sales inWAVE^® systems sold totaled 107 during the year ended December 31, 2004 compared to 122 during the same period of 2003. The selling prices of our BioSystems operating segment increasedinstruments vary based on the specific model and optional accessories. We had an installed base of 1,193 units at December 31, 2004 compared to 1,086 units at December 31, 2004. The increase 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 begininstruments continues to use them more extensivelydrive increases in placesales of other methods of DNA analysis. Also contributingbioconsumables used with these instruments. The increase in Discovery Services revenue during 2004 was primarily attributable to the increase were revenues generated by new product sales including our Optimase product linediscovery services agreements that was launched in 2002 and beganwe entered into with pharmaceutical companies to see increased usage in 2003. Salessupport their clinical development 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.

oncology therapeutics.

CostCosts of Goods Sold.Cost of goods sold increasedfor the years ended December 31, 2004 and 2003 consisted of the following (dollars in 2003 over 2002 despite the decline inthousands):

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Overall, 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 increased despite an overall decline in net sales due to the fixed-cost burden associated with our manufacturing facilities.

Gross profit was $13.25 million or 52% of total net sales during the year ended December 31, 2004 compared to $14.67 million and 56% during the same period of 2003. The decrease in gross profit as a percentagepercent of revenue is largely attributable to changes in the composition of products sold. Generally, sales declined year over year but remained within historical ranges at approximately 43%. The margins in our Nucleic Acids operating segment were negatively impacted byof WAVE^® systems and ancillary instrumentation generate higher manufacturing costsgross profits than sales of third party platforms. Sales of specialty consumables (SURVEYOR Nuclease, HPLC separation columns, etc.) generate higher gross profits than base buffers and excessenzymes. Gross profits from discovery services have been less than expected due to the continuing build out of capacity due largely to our plantand expansion efforts in Glasgow, Scotland and Boulder, Colorado.of product offerings.

Selling, General and Administrative Expenses.Selling, general and administrative expenses decreased significantly from 2002totaled $15.96 million in 2004 compared to $16.59 million in 2003, as a resultdecrease of our restructuring activities$0.63 million or 4%. As a percentage of revenue, selling, general and focus on expense control. Nearly half of the total decrease wasadministrative expenses totaled just over 63% in personnelboth 2004 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.2003.

Research and Development Expenses.Research and development expenses decreased significantly astotaled $4.50 million in 2004 compared to $6.83 million in 2003, a resultdecrease of $2.33 million or 34%. As a percentage of revenue, research and development expenses totaled 18% and 26% of revenue in 2004 and 2003, respectively. These decreases related to our restructuring activities and focus on expense control. Over 60% ofcontrol and the total decrease wasrestructuring plan implemented 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.November 2004. 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 costsare expensed in the year in which they are incurred with the exception of certain capitalized software development costs.incurred.

Restructuring Charges.During the fourth quarter On November 13, 2004, our Board of 2002 management formulated and executed a significant portion ofDirectors approved a restructuring plan. The plan was developeddesigned to reduce expenses therebyrefocus and to better aligningalign the Company’s expensecost structure with current business prospects.anticipated revenues. The plan included employee terminations, office closures, terminationa workforce reduction and the closure of collaborationsvarious facilities and write-offsfield offices. In conjunction with these changes, we incurred a charge of abandoned intellectual property. We continued to execute the plan$1.23 million during the first halfquarter ending December 31, 2004.

Other Income (Expense). Other expense during 2004 of $5.26 million consisted of interest expense of $2.37 million, loss on debt extinguishment of $2.86 million, and other net expense of $0.04 million. Other expense during 2003 resultingof $0.18 million consisted of interest expense of $0.17 million and other net expense of $0.01 million.

Interest expense consisted of the following for the years ended December 31, 2004 and 2003 (dollars in thousands):

Loss on debt extinguishment totaled $2.86 million during 2004. As described in the additional charges recorded in 2003. These charges consisted of mainly employee severance costs and the write-off of a note receivable relatedNotes to the abandonmentaccompanying 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 a product development collaboration. The note receivable write-offexpected cash flows between the original and modified agreements 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.greater than 10%. As a result of this testsuch, we recorded a non-cash goodwill impairment chargeloss on extinguishment of $4.77debt 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 represented a premium, which was reflected as a reduction of interest expense over the life of the new debt.

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Income Tax Expense. Income tax expense recorded during the years ended December 31, 2004 and 2003 related to our nucleic acids segment.

Income Taxes.The Company’s tax expense relates to its operationsincome taxes in certainstates, foreign countries and certain states. No tax benefits are being recorded dueother local jurisdictions. Due to our cumulative losses, in recent years, expected losses in future years and the uncertainty as to whether we will be ableinability to utilize any additional losses as carrybacks.carrybacks, we did not provide for an income tax benefit during the years ended December 31, 2004 or 2003 based on our determination that it was more likely than not that such benefits would not be realized. 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 taxable income in future yearsperiods and it is determineddetermine that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized. Our deferred tax assetsrecognized at such time.

Results of Discontinued Operations

In the fourth quarter of 2005, we implemented a plan to exit our Nucleic Acids operating segment. Accordingly, we now reflect the results of these businesses as discontinued operations for all periods presented. Expenses that are not directly identified to this operating segment or are considered corporate overhead have not been allocated in arriving at loss from discontinued operations. Summary results of operations of the former Nucleic Acids operating segment were as follows (dollars in thousands):