On September 20, 2006, Michael A. Summers, resigned as our Chief Financial Officer in order to pursue another professional opportunity. On December 4, 2006, Debra A. Schneider, age 48, joined 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. Ms. Schneider also serves as the Secretary and Treasurer of the Company. Ms. Schneider was most recently employed by First Data Corporation, a provider of processing and related services to institutions issuing credit and debit cards. Ms Schneider’s tenure at First Data Corporation covered seventeen years during which she served in a number of roles including finance planning, accounting and Chief Financial Officer for Nexterna, Inc.,various business units. Most recently she served as Senior Vice President of Finance.

The Company has been engaged in a wholly-owned technology subsidiaryprocess of exploring strategic alternatives, which it recently terminated.

The Company’s Board of Directors hired an independent financial advisor to assist the Board in its evaluation of potential strategic alternatives available to the Company that included but were not

limited to (i) the sale of all or a portion of the Union Pacific Corporation. From 2000 to 2001, he wascontinuing business or related assets; (ii) the Chief Accounting Officer for Able Telcom Holding Corp.,acquisition of complementary businesses or assets; (iii) a publicly-owned projectmerger; and (iv) other complementary business partnerships and collaborations. Although the financial advisor contacted a substantial number of companies, both in and outside of the genomics industry, regarding a potential strategic transaction, and management and construction company. Mr. Summers graduated from Creighton University in 1987entered into negotiations with a B.S. degree in business administrationnumber of these companies, no agreements were reached with an accounting major. He isany company with respect to such 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.

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.

Section16(a) Beneficial Ownership Reporting Compliance. Item 405 of Regulation S-K requires disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Securities Exchange Act of 1934. We believe all Section 16 reports were filed in a timely manner during 2004.

Code of Ethics.transaction. The Board of Directors has adoptedelected to terminate its contract with the independent financial advisor effective April 25, 2007.

We exited our former Nucleic Acids operating segment.

On December 22, 2005, the Company’s Directors voted to either sell or close and liquidate the Nucleic Acids operating segment, which consisted primarily of a codemanufacturing facility in Glasgow, Scotland. This decision was made after an evaluation of, ethical conduct that appliesamong other things, short and long-term sales projections for products sold by this operating segment, including estimates of 2006 sales to our principal executive officersthe operating segment’s largest customer. While opportunities to sell this operating segment as a going concern were evaluated, we did not receive any offers to purchase the Nucleic Acids operating segment. Accordingly, we closed the Glasgow facility and senior financial officers as required by Section 406began the liquidation of the Sarbanes Oxley Act of 2002. This code of ethical conduct is embodied within our Business Ethics Policy, which applies to all personsassets associated with the Company,Nucleic Acids operating segment. All employees of this operating segment were either dismissed or redeployed to our Bioinstruments operating segment. The Glasgow facility was sold on February 28, 2007 for approximately $2.7 million after associated selling costs. Proceeds will be used in the normal operations of the Company.

We have continued to work to reduce operating costs

On February 20, 2007, we announced a cost reduction plan designed to align our cost structure with anticipated revenues. The plan is expected to yield annualized savings of approximately $1.5 million once all components of the plan are fully implemented. The closing of the Company’s Cramlington, England production facility is the principal component of this plan. We expect to incur aggregate charges estimated at $1.2 to $1.4 million during the first and second quarters of 2007, relating primarily to severance, benefits and facility closure costs.

Our stock has been delisted from the Nasdaq Capital Market and is now trading on the OTC Bulletin Board (OTCBB)

On February 1, 2007, we received a staff determination letter from Nasdaq’s Listing Qualifications Department indicating that we no longer met the minimum bid price requirement for continued listing on the Nasdaq Capital Market. As a result, the listing of our common stock on the Nasdaq Capital Market was ended on February 22, 2007. Trading information about our common stock became available on the OTC Bulletin Board beginning on February 26, 2007.

Sales and Marketing

We have sold our products to customers in over 50 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 have over 35 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. The nature of our instruments and bioconsumables business does not generally lend itself to tracking and reporting sales backlog.

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. No customer accounts for more than 10% of consolidated net sales.

Research and Development

We maintain an active program of research and development primarily directed toward the improvement of the DNA separation media used in our WAVE System, the refinement of the hardware and software components of the WAVE System, the creation of unique enzymes and WAVE-Optimized enzymes, and the development of assays on the WAVE System. We have also focused on further refinements and process manufacturing improvements for our Surveyor DNA mismatch cutting enzyme. Most importantly, we completed a large cancer mutation scanning study where we employed our SURVEYOR and WAVE System technology to discover a significant number of cancer linked mutations which we believe may have commercial value in the future. We plan to prepare patent submissions on discovered mutations for up to 40 key cancer regulating and signaling genes.

For the years ended December 31, 2006, 2005 and 2004, our research and development expenses were $2.36 million, $2.20 million and $4.50 million, respectively. 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 2007, we expect research and development expense to be approximately equal to the 2006 levels.

In addition to the amounts reflected above, our discontinued operations incurred no research and development expenses during the years ended December 31, 2006 and 2005 and $2.18 million during the year ended December 31, 2004.

Manufacturing

We manufacture bioconsumable products including our directors, officers,separation columns, liquid reagents, and 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 (through December 31, 2006). As noted earlier, we plan to close the Cramlington, England facility in 2007.

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 70 issued patents and 13 pending applications in both the U.S. and abroad. Our WAVE System and related consumables are protected by patents and in-licensed technologies that expire in various periods beginning in 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 we operate are highly competitive and characterized by rapidly changing technological advances. A number of our 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. We compete principally on the basis of uniquely enabling technical advantages in specific but significant market segments.

Competition for our WAVE 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 face 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.

Employees

As of December 31, 2006, 2005 and 2004, we had employees focused in the following areas of our operation:

common stock was listed for trading on the Nasdaq Capital Market 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 2005 and 2006.

Holders.    At March 30, 2007, there are 49,189,672 shares of our common stock outstanding and approximately 3,310 holders of record.

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 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.

Securities authorized for issuance under equity compensation plans.

The following equity compensation plan information summarizes plans and securities approved and not approved by security holders as of December 31, 2006.

(1)	Consists of our 2006 Equity Compensation Plan

Five Year Performance Comparison:    The following graph provides an indicator of cumulative total shareholder returns for the Company as compared to a peer group index comprised of Argonaut Technologies, Caliper Life Sciences, Cepheid, Cipergen Biosystems, Inc,Harvard Bioscience IC, Illumina, Inc., Luminex Corporation, Nuvelo, Inc., Orchid Biosciences, Inc. and Sequenom, Inc and to the Nasdaq Market Index. The graph assumes that the value of the investment in the Company’s common stock, the Nasdaq Market Index and the Peer Group Index, was $100 on December 31, 2001, and that all dividends were reinvested.

Sale of Unregistered Securities.    The Company made no sales of its common stock during the years ended December 31, 2006 and 2004 that were not registered under the Securities Act of 1933 (the “Securities Act”). Information regarding sales of equity securities by the annualCompany during the years 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, 2006. Therefore, tabular disclosure is not presented.

Item 6.

Selected Consolidated Financial Data

The selected consolidated balance sheet data as of December 31, 2006 and 2005 and the selected consolidated statements of operations data for each year ended December 31, 2006, 2005 and 2004 have been derived from our audited consolidated financial statements that are included elsewhere in this Annual Report on Form 10-K. The selected consolidated balance sheet data as of December 31, 2004, 2003 and 2002 and the selected consolidated statements of operations data for each year ended December 31, 2003 and 2002 have been derived from our audited consolidated financial statements that are not included in this Annual Report on Form 10-K. Dollar amounts, except per share data, are presented in thousands.

(3)

Other income (expense) for all years presented primarily includes interest expense and interest income, loss on debt extinguishment of $0.5 million in 2005 related to the repayment of long-term debt and $2.9 million resulting from certain modifications to long-term borrowing agreements that were treated as extinguishments for financial reporting purposes. Refer to Note F to the accompanying consolidated financial statements.

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.

The Company’s continuing operations consist of the manufacture and sale of its WAVE System and related consumable products and discovery services which make use of the Company’s WAVE System to perform genomic research on a contract basis and disease testing services. These functions are categorized as one reportable operating segment. Although revenue is analyzed by type, the Company’s net financial results are analyzed as a single segment due to the integrated nature of the products and services that we sell. The Consolidated Financial Statements also reflect the assets and results of our former Nucleic Acids operating segment, which are shown as discontinued operations in all periods as a result of the implementation of a plan to exit this operating segment in the fourth quarter of 2005.

Executive Summary

2006 Results

Sales of bioinstruments and associated consumables continued to decline in 2006, due to a number of factors including competition from sequencing and other evolving technologies. Sales from our discovery services group during the year were down substantially from 2005 as we completed a significant engagement for a large pharmaceutical company and were not able to replace these sales in 2006. Although we have taken significant steps to reduce our operating expenses in response to declining revenues, we continued to operate at a loss and to generate a negative cash flow during the year. However, our loss and use of cash were reduced significantly over each of the last three years.

We continue to work to respond to changes in the overall business climate for our products and our liquidity position. On December 22, 2005, we decided to sell or close and liquidate the Nucleic Acids operating segment, which consisted primarily of a manufacturing facility in Glasgow, Scotland. This decision was made after an evaluation of, among other things, short and long-term compensation paidsales 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 were evaluated, we ultimately ended up closing the facility and terminating or redeploying all of the employees of this business segment. In February of 2007, we completed the sale of the facility in Glasgow, Scotland. We now reflect the results of this operating segment as discontinued operations for all periods presented.

As a result of the actions undertaken since the fourth quarter of 2004, including the reclassification of the Nucleic Acids operating segment as a discontinued operation, our losses from

continuing operations have gone from $13.75 million and $4.98 million in 2004 and 2005, respectively, to $2.96 million in 2006. Net cash flows used by operating activities have gone from $12.75 million and $3.63 million in 2004 and 2005, respectively to $1.21 million in 2006.

2007 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 marketplace 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 OEM Instruments, 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, leverage manufacturing expenses and continue to better control operating expenses. We will continue to look for opportunities, through consolidation or otherwise, to reduce our operating expenses related to our core business.

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. We believe emerging markets and novel applications will provide for opportunities for our WAVE System. 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 addition, we are also selling refurbished WAVESystems in order to allow an opportunity for customers that may not be able to afford the cost of a new system. 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 third-party platforms that will allow us to leverage on our Chief Executive Officer,direct sales force and distribution network.

On the discovery services front, we will seek to leverage past successes with pharmaceutical customers to diversify our customer base. While we have performed discovery services for a number of large pharmaceutical customers, these engagements do not materialize at a constant rate and the lead time to develop major contracts is often 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 our technologies and experience gained from the genomic biomarker analysis that discovery services provides 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. We have recently added some new customers in this area of the business.

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 2007, we expect operating expenses, including research and development expense, to be approximately equal to 2006 levels.

Results of Continuing Operations

Years Ended December 31, 2006 and 2005

Net Sales.    Net sales for the years ended December 31, 2006 and 2005 consisted of the following (dollars in thousands):

Bioinstrument sales consist of sales of our WAVE System and associated equipment that we manufacture or assemble, revenues from service contracts that we enter into with purchasers of our instruments, as well as sales of instruments we distribute for other manufacturers (“OEM equipment”). We also sell refurbished WAVE Systems in order to access customers that may not be able to afford new systems. We sold 68 WAVE Systems during the year ended December 31, 2006 compared to 97 systems during the same period of 2005. This decrease resulted from lower demand in all major geographic markets and among both research and diagnostic users particularly in our largest markets throughout Western Europe. Demand for the WAVE has been affected by significant competitive challenges from traditional (i.e. sequencing) and evolving technologies. The decrease in WAVE System sales was largely offset by OEM instrument sales, increased net sales from product upgrades and service contracts.

Bioconsumable net sales decreased during year ended December 31, 2006 compared to 2005. Despite the increase in installed base of WAVE instruments from 1,290 units at December 31, 2005 to 1,358 units at December 31, 2006, we do not believe that all of these instruments are being fully utilized. In addition, consumable products are available from other manufacturers which can be used in place of many of our consumable products. Some of these competitive products sell at prices below the prices we charge for our products, which have caused us to have some price compression, principally in Europe.

The decrease in discovery services net sales was primarily attributable to the expiration of certain research contracts with a large pharmaceutical company in 2005, of $2,188 that was partially offset by increased net sales from research projects from other pharmaceutical companies and services provided by our CLIA lab, of $384.

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) as well as the wholesale price we pay manufacturers of OEM equipment that we distribute. It also includes direct costs (primarily personnel costs, rent, supplies and depreciation) associated with our discovery services operations. Cost of goods sold for the years ended December 31, 2006 and 2005 consisted of the following (dollars in thousands):

Gross profit equaled $11.37 million or 49% of total net sales during the year ended December 31, 2006 compared to $12.33 million and 48% during the same period of 2005. The increase in gross profit as a percent of revenue is largely attributable to changes in the composition of products sold. Sales of our OEM instruments (third party platforms) provided for higher gross profit in 2006, while gross profit on WAVE sales is down, due to the lower number of instruments sold and the fixed base of costs associated with this area. Sales of specialty consumables (SURVEYOR Nuclease, HPLC separation columns, etc.) were up slightly in 2006 and these products generate higher gross profits than base buffers and enzymes. Gross profit from discovery services is significantly less in 2006 due to the decrease in net sales to a large pharmaceutical customer which produced net sales of $2,188 in 2005 and $8 in 2006, coupled with a much smaller decrease in the cost of goods sold due to the fixed base of cost associated with the discovery services group.

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 remained essentially flat in 2006 compared to 2005, but increased as a percentage of net sales from 47% to 52% as a result of reduced sales. Foreign currency transaction adjustments increased operating expenses by approximately $.08 million compared to the year ended December 31, 2005

Research and Development Expenses.    Research and development expenses primarily include personnel costs, supplies, and facility costs. These costs totaled $2.36 million during the year ended December 31, 2006 compared to $2.20 million during the same period of 2005, an increase of $0.16 million or 7%. As a percentage of net sales, research and development expenses totaled 10% and 9% of net sales during the year ended December 31, 2006 and 2005 respectively. We expect to continue to invest up to 10% of our net sales in research and development activities. Research and development costs are expensed in the year in which they are incurred.

Impairment Charges.    We did not incur any impairment charges during 2006, but incurred $0.43 million of impairment charges during 2005 consisting of a $0.25 million charge associated with certain international patent pursuits that were no longer consistent with our strategic plan and a charge of $0.18 million related to inventory associated with certain OEM instruments.

Other Income (Expense).    Other income during the year ended December 31, 2006 of $0.20 million consisted of interest income of $0.22 million which was partially offset by interest expense of

$0.01 million, and other expense of $0.01 million. Other expense during the year ended December 31, 2005 consisted of interest expense of $1.98 million and a loss on debt extinguishment of $0.54 million which was partially offset by interest income of $0.03 and other income of $0.04 million. Interest expense consisted of the following for the years ended December 31, 2006 and 2005 (dollars in thousands):

We had previously entered into a $7,500,000 line of credit (the “Credit Line”) and a $2,750,000 convertible note (the “Term Note,” and collectively with the Credit Line the “Laurus Loans”) from Laurus Master Fund, Ltd. (“Laurus”). On March 18, 2005, Laurus converted $1.87 million of the outstanding principal balance under the Credit Line into 3,600,000 shares of our common stock at $0.52 per share. In addition, on March 24, 2005, Laurus converted $0.65 million of the outstanding principal balance of the Term Note into 1,250,000 shares of our common stock at $0.52 per share. 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 $1.37 million related to the fair value of incremental shares received by Laurus. Contemporaneously with the closing of a private offering of common stock in November 2005 (the “2005 Private Placement”), we repaid all outstanding principal and accrued interest on the Laurus Loans. 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.

Income Tax Expense.    Income tax expense recorded during the years ended December 31, 2006 and 2005 related to income taxes in states, foreign countries and other local jurisdictions. Due to the our cumulative losses, expected losses in future years and inability to utilize any additional losses as carrybacks, we did not provide for an income tax benefit during the years ended December 31, 2006 or 2005 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. To the extent we begin to generate taxable income in future periods and determine that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time. While the Company has significant net operating loss carryforwards, it is likely that Section 382 (Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses following Ownership Change) of the Internal Revenue Code, and the regulations promulgated thereunder, will significantly limit the amount of net operating loss carryforward that the Company could utilize in any tax year. Our federal net operating loss carryforwards from continuing and discontinued operations of $106.23 million will expire at various dates from 2008 through 2026, if not utilized. We also had state income tax loss carryforwards from continuing and discontinued operations of $43.84 million at December 31, 2006. These carryforwards will also expire at various dates beginning in 2007 if not utilized.

Years Ended December 31, 2005 and 2004

Net Sales. Net sales for the years ended December 31, 2005 and 2004 consisted of the following (dollars in thousands):

WAVE Systems sold totaled 97 during the year ended December 31, 2005 compared to 107 during the same period of 2004. We had an installed base of 1,290 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 increases in sales of bioconsumables used with these instruments. The increase in Discovery Services revenue during 2004 was primarily attributable to the discovery services agreements that we entered into with pharmaceutical companies to support their clinical development of oncology therapeutics.

Costs of Goods Sold.    Cost of goods sold for the years ended December 31, 2005 and 2004 consisted of the following (dollars in thousands):

Overall, our 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 equaled $12.33 million or 48% of total net sales during the year ended December 31, 2005 compared to $13.25 million and 52% during the same period of 2004. The decrease in 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.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses totaled $12.22 million in 2005 compared to $15.96 million in 2004, a decrease of $3.74 million or 23%. As a percentage of revenue, selling, general and administrative expenses totaled 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 conjunction with the

2004 Restructuring Plan. Foreign currency transaction adjustments increased operating expenses by approximately $0.33 million during the years ended December 31, 2005 compared to the same period of 2004 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 $2.20 million during the year ended December 31, 2005 compared to $4.50 million during the same period of 2004, a decrease of $2.30 million or 51%. The decrease related primarily to the 2004 Restructuring Plan.

As a percentage of revenue, research and development expenses totaled 8% and 18% of revenue during the year ended December 31, 2005 and 2004, respectively. Research and development costs are expensed in the year in which they are incurred.

Impairment Charges.    Impairment charges totaled $0.43 million during the year ended December 31, 2005 and consisted of $0.25 million associated with certain international patent pursuits that were no longer consistent with our strategic plan and $0.18 million related to certain inventory associated with third party platforms.

Restructuring Charges.    On November 13, 2004, our Board of Directors approved a restructuring plan designed to refocus and to better align the Company’s cost structure with anticipated revenues. The plan included a workforce reduction and the closure of various facilities and field offices. In order to recognize the various costs associated with workforce reduction and facilities closings, we incurred a charge of $1.23 million during the quarter ending December 31, 2004.

Other Income (Expense).    Other expense during the year ended December 31, 2005 of $2.45 million consisted of interest expense of $1.98 million and a loss on debt extinguishment of $0.54 million, which were partially offset by interest income of $0.03 and other net income of $0.04 million. Other expense during the year ended December 31, 2004 consisted of consisted of interest expense of $2.37 million, loss on debt extinguishment of $2.86 million and other net expense of $0.38 million.

Interest expense consisted of the following for the years ended December 31, 2005 and 2004 (dollars in thousands):

We had previously entered into a $7,500,000 line of credit (the “Credit Line”) and a $2,750,000 convertible note (the “Term Note,” and collectively with the Credit Line the “Laurus Loans”) from Laurus Master Fund, Ltd. (“Laurus”). On March 18, 2005, Laurus converted $1.87 million of the outstanding principal balance under the Credit Line into 3,600,000 shares of our common stock at $0.52 per share. In addition, on March 24, 2005, Laurus converted $0.65 million of the outstanding principal balance of the Term Note into 1,250,000 shares of our common stock at $0.52 per share. 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 $1.37 million related to the fair value of incremental shares received by Laurus. Contemporaneously with the closing of a private offering of common stock in November 2005 (the “2005 Private Placement”), we repaid all outstanding principal and accrued interest on the Laurus Loans. 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 the Note F 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 was 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 represented a premium, which was reflected as a reduction of interest expense over the life of the new debt.

Income Tax Expense.    Income tax expense recorded during the years ended December 31, 2005 and 2004 related to income taxes in states, foreign countries and other local jurisdictions. Due to our cumulative losses, expected losses in future years and inability to utilize any additional losses as 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. To the extent we begin to generate taxable income in future periods and determine that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time.

Results of Discontinued Operations

In the fourth quarter of 2005, we implemented a plan to exit our Nucleic Acids operating segment. In conjunction with the decision to exit this operating segment, the Company recorded impairment charges of $0.43 million and $8.02 million in 2006 and 2005, respectively, consisting of valuation adjustments to reflect the carrying value of the related net assets at estimated fair market value. Accordingly, we now reflect the results of this segment 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 to this segment in determining the results from discontinued operations. Summary results of operations of the former Nucleic Acids operating segment were as follows (dollars in thousands):

On December 22, 2005, the Company’s Directors voted to either 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. In addition, the Company expects to incur additional period costs attributable to closure of the facility that will be recorded in discontinued operations in 2007. In conjunction with the decision to exit this operating segment, the Company recorded an impairment charge of $8,022 in 2005 consisting of valuation adjustments to reflect the carrying value of the related net assets at estimated fair market value.

There was no goodwill associated with the former Nucleic Acids operating segment at December 31, 2005 and 2004. The former Nucleic Acids operating segment recorded charges of $9,865 during 2004, related to the impairment of goodwill. The 2004 charge resulted from an interim period impairment test performed during the second quarter of 2004.

The interim period impairment test became necessary after the Company’s Directors directed management during the second quarter of 2004 to explore strategic alternatives for the former Nucleic Acids operating segment. This process included significant due diligence by management, third-party advisors and prospective independent buyers and other interested parties. Information obtained through this process indicated that it was more likely than not that the assets associated with the Nucleic Acids operating segment were impaired.

The former Nucleic Acids operating segment also recorded a charge of $2,100 during 2004 related to the impairment of property and equipment associated with this operating segment.

On November 13, 2004, the former Nucleic Acids operating segment sold the assets associated with its specialty oligonucleotides manufacturing facility in Boulder, Colorado to a subsidiary of Eyetech Pharmaceuticals, Inc. (“Eyetech”). The sale price was $3,000 in cash plus the assumption of the lease on the Boulder facility and of certain equipment leases with a gross value of $2,377. 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 $2,700. In conjunction with this transaction, the Nucleic Acids operating segment recorded a gain on sale of $1,466 in the fourth quarter of 2004.

The Company implemented restructuring plans in 2004 and 2002 designed to better align its cost structure with anticipated revenues. In conjunction with these plans, the former Nucleic Acids operating segment recorded restructuring charges in 2004 and 2003 of $2,303 and $222, respectively, related primarily to employee severance agreements, office closures, property and equipment and intellectual property. There were accrued expenses associated with these restructuring plans of $191 at December 31, 2005.

The Company accepted common stock from a customer of the former Nucleic Acids operating segment, Geron Corporation (“Geron”) as payment for goods and services. These shares were classified as available-for-sale securities. Net realized gains on these securities during 2005 of $52 and realized losses on these securities of $128 during 2004 were reflected as other expense. Proceeds from the sales of these available for sale securities are reflected within net cash flows from investing activities. During 2005 and 2004, sales to Geron totaled $1,949 and $4,151, respectively, representing 50% and 49%, respectively, of net sales within this operating segment.

Liquidity and Capital Resources

Our working capital positions at December 31, 2006 and 2005 were as follows (in thousands):

We have historically operated at a loss and have not generated sufficient cash from operating activities to cover our operating and other cash expenses. While we have been able to historically finance our operating losses through borrowings or from the issuance of additional equity, we currently have no borrowings and have no plans to issue additional equity securities for this purpose. At March 30, 2007 and December 31, 2006, we had cash and cash equivalents of $7.91 million and $5.87 million, respectively. While we believe that existing sources of liquidity are sufficient to meet expected cash needs through 2007, we will need to increase our revenues or further reduce our operating expenses in order to be assured of meeting our liquidity needs on a long-term basis. On February 20, 2007, we announced a cost reduction plan designed to align our cost structure with anticipated revenues. The plan is expected to yield annualized savings of approximately $1.5 million once all components of the plan are fully implemented. The closing of the Company’s Cramlington, England production facility is the principal component of this plan. We expect to incur aggregate charges estimated at $1.2 to $1.4 million during the first and second quarters of 2007, relating primarily to severance, benefits and facility closure costs. However, we cannot assure you that we will be able to increase our revenues or further reduce our expenses and, accordingly, we may not have sufficient sources of liquidity to continue the operations of the Company indefinitely.

Analysis of Cash Flows

Years Ended December 31, 2006 and 2005

Net Change in Cash and Cash Equivalents.    Cash and cash equivalents decreased $0.87 million during the year ended December 31, 2006 as a result of net cash of $1.21 million being used by operating activities and of $0.20 million being used in investing activities, which was partially offset by net cash provided by financing activities of $0.01 million and changes in foreign currency exchange of $0.54 million.

Cash Flows Used In Operating Activities.    Cash flows used in operating activities totaled $1.21 million during the year ended December 31, 2006 compared to $3.63 million during the same period of 2005. The use in 2006 resulted primarily from our net loss of $3.43 million offset by non-cash charges of $2.55 million. Non-cash charges consisted primarily of depreciation and amortization, impairment charges and non-cash stock based compensation. Working capital and other adjustments decreased cash flows from operating activities by $0.34 million during 2006.

Cash Flows Used In Investing Activities.    Cash flows used in investing activities totaled $0.20 million during the year ended December 31, 2006 compared to $1.65 million of cash flow provided by investing activities during the same period of 2005. The cash used in 2006 was for purchases, offset by

sales, of property and equipment. The principal source of cash flows from investing activities in 2005 was sales of available for sale securities of $2.15 million that were offset by purchases of $0.64 million of property and equipment.

Cash Flows from Financing Activities.    Cash flows from financing activities totaled $0.01 million during the year ended December 31, 2006 as a result of the sale of common stock, through the Employee Stock Purchase Plan. This compares with $7.92 million of cash flow from financing activities during 2005 resulting from the receipt of approximately $13.8 million in net proceeds from the 2005 Private Placement offset by repayment of approximately $5.9 million under the Laurus Loans.

Obligations and Commitments

The following identifies material obligations and commitments as of December 31, 2006:

Off Balance Sheet Arrangements

At December 31, 2006 and 2005, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies

Accounting policies used in the preparation of the consolidated financial statements may involve the use of management judgments and estimates. Certain of our accounting policies are considered critical as they are both important to the portrayal of our 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 Account.    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. We write down slow-moving and obsolete inventory by the difference between the value of the inventory and our estimate of the reduced value based on potential future uses, the likelihood that overstocked inventory will be sold and the expected selling prices of the inventory. If our ability to realize value on slow-moving or obsolete inventory is less favorable than assumed, additional write-downs of the inventory may be required.

Depreciation and Amortization of Long-Lived Assets.    Our long-lived assets consist primarily of equipment, 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 an increase to operating expenses. Property and equipment are carried at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets ranging from 3 to 15 years. We capitalize external and in-house legal costs and filing fees associated with obtaining patents on our new discoveries and amortize 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.    We evaluate goodwill for impairment on an annual basis. We assess 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 our estimate of future undiscounted and discounted cash flows to determine recoverability of these assets. If our assumptions about these assets were to change as a result of events or circumstances, we 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

In July 2006, the FASB issued Interpretation (“FIN”) No. 48, “Uncertainty in Income Taxes.” FIN 48 applies to all tax positions within the scope of Statement 109 and clarifies when and how to recognize tax benefits in the financial statements with a two-step approach of recognition and measurement. FIN 48 will become effective in the first quarter of 2007. Management continues to evaluate the effect that adoption of FIN 48 will have on our consolidated results of operations and financial position.

In September 2006, the SEC issued Staff Accounting Bulletin. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB 108 requires registrants to quantify misstatements using both an income statement and balance sheet approach and then evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial are now considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior year’s financial statements are not restated, the cumulative effect adjustment is recorded in opening accumulated earnings (deficit) as of the beginning of the fiscal year of adoption. SAB 108 is effective for us at the end of 2006. There was no impact to our Consolidated Financial Statements as a result of adoption of this pronouncement.

In September 2006, the FASB issued Statement No. 157,Fair Value Measurement (FAS 157). While this statement does not require new fair value measurements, it provides guidance on applying fair value and expands required disclosures. FAS 157 is effective for us beginning in the first quarter of 2008. We are currently assessing the impact FAS 157 may have on our Consolidated Financial Statements.

In February 2007, the FASB issued Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159). This statement, which is expected to expand fair value measurement, permits entities to choose to measure many financial instruments and certain other items at fair value. FAS 159 is effective for us beginning in the first quarter of 2008. We are currently assessing the impact FAS 159 may have on our Consolidated Financial Statements.

Use of Estimates

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reported period. In addition, estimates and assumptions associated with the determination of the fair value of certain assets and related impairments and the determination of goodwill impairments require considerable judgment by management. Actual results could differ from the estimates and assumptions used in preparing these financial statements.

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.

Item 7A.

Quantitative and Qualitative Disclosure about Market Risk

Interest Rate Risk.    Previously, our principal market risk was interest rate risk on our variable-rate borrowings under the Laurus Loans. During the fourth quarter of 2005, we repaid the entire principal balance of the Laurus Loans with the proceeds from the 2005 Private Placement and have terminated these loans. Accordingly, we no longer have any borrowings which subject us to material interest rate risk.

Foreign Currency Translation Risk.     During the last three fiscal years, our international sales have represented more than 50% 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 owned subsidiaries, Transgenomic Limited, and Cruachem Limited, whose operating currency is British Pounds Sterling and the Euro. Results of operations for the Company’s foreign subsidiaries 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, we feel we do not have a material exposure to foreign currency rate fluctuations at this time.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

of Transgenomic, Inc.

Omaha, Nebraska

We have audited the accompanying consolidated balance sheets of Transgenomic, Inc. and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the 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 audits 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, 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 at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note B to the consolidated financial statements, in 2006 the Company adopted Statement of Financial Accounting Standards No. 123(R),Share-Based Payment.

TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 2006 and 2005

(Dollars in thousands except per share data)

See notes to consolidated financial statements.

TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2006, 2005 and 2004

(Dollars in thousands except per share data)

See notes to consolidated financial statements.

TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years Ended December 31, 2006, 2005 and 2004

(Dollars in thousands except share data)

See notes to consolidated financial statements.

TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2006, 2005 and 2004

(Dollars in thousands)

See notes to consolidated financial statements.

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years Ended December 31, 2006, 2005 and 2004

(Dollars in thousands except per share data)

A.         BUSINESS DESCRIPTION.

Transgenomic, Inc., a Delaware corporation, and its subsidiaries (the “Company”) provide innovative products for the synthesis, purification and analysis of nucleic acids used in the life sciences industry for research focused on molecular genetics and diagnostics. The Company also provides genetic variation analytical services to the medical research, clinical and pharmaceutical markets. Net sales are categorized as bioinstruments, bioconsumables and discovery services.