Historically, we operated a segment (the “Nucleic Acids operating segment”) that developed, manufactured and marketed chemical building blocks for nucleic acid synthesis. In the fourth quarter of 2005, we implemented a plan to exit the Nucleic Acids operating segment and during the three months ended March 31, 2007, we completed the sale of the remaining assets associated with this segment. Accordingly, the assets and results of the Nucleic Acids operating segment are reflected as discontinued operations for all periods presented in this filing.

Although prior to this time we have experienced declining sales and recurring net losses (resulting in an accumulated deficit of $128 million at September 30, 2007)March 31, 2008), managementwe have recently shown increases in sales and have had slight net income in the last two quarters. Management believes existing sources of liquidity, including cash and cash equivalents of $6.5$5.8 million, are sufficient to meet expected cash needs intoduring 2008. Although ourOur business consolidation efforts have helped control our operating costs, however, we will need to increase net sales and/or further reduce operating expenses in order to meet our liquidity needs on a long-term basis. In future periods, there is no assurance that we will be able to increase net sales or further reduce expenses and, accordingly, we may not have sufficient sources of liquidity to continue operations indefinitely. In addition, such cost and expense reductions could have an adverse impact on the new product pipeline and ultimately net sales. We could also pursue additional financing, but ultimately, we must achieve sufficient net sales to consistently generate net income and cash flows from operations.

The consolidated financial statements include the accounts of Transgenomic, Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

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

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2008 and 2007

the reported amounts of net sales and expenses during the reporting 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.

The consolidated balance sheet as of December 31, 20062007 was derived from our audited balance sheet as of that date. The accompanying consolidated financial statements as of and for the three and nine months ended September 30,March 31, 2008 and 2007 and 2006 are unaudited and reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and operating results for the interim periods. These unaudited consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 20062007 contained in our Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results for the entire year.

Cash and cash equivalents include cash and temporary overnight investments with original maturities at acquisition of three months or less.

Accounts receivable are shown net of allowance for doubtful accounts. The following is a summary of activity for the allowance for doubtful accounts during the three and nine months ended September 30, 2007March 31, 2008 and 2006: 

While payment terms are generally 30 days, we have also provided extended payment terms of up to 90 days in certain cases. We review accounts receivable on a quarterly basis and adjust our bad debt reserve accordingly.

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.

Property and fixturesequipment are carried at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the related assets as follows:

Depreciation and amortization during the three months ended September 30,March 31, 2008 and 2007, and 2006, respectively, included $236$0.2 million and $405,$0.2 million, respectively, related to depreciation of property and equipment. Depreciation and amortization during the nine months ended September 30, 2007 and 2006, respectively, included $978 and $1,361 respectively.

Other assets include intellectual property, patents, other intangible assets, and other long-term assets.

Intellectual Property. Initial costs paid to license intellectual property from independent third parties are capitalized and amortized using the straight-line method over the license period. Ongoing royalties related to such licenses are expensed as incurred.

Patents. We capitalize external and in-house legal costs, filing fees and other expenses associated with obtaining patents on new discoveries and amortize these costs using the straight-line method over the shorter of the economic life or the legal life of the patent or its economic life, generally 17 years, beginning on the date the patent is issued.

Other Intangible Assets. Identifiable intangible assets with definite lives are amortized over their estimated useful lives andlives.

All of these assets are treated as long-lived assets for purposes of SFAS No. 144, which provides that long-lived assets will be tested for impairment ason an annual basis. We review the carrying value of our long-lived assets during the fourth quarter of each year to assess whether events or changes in circumstances indicate the carrying amount of the assetthese assets may be impaired.

All stock options awarded to date have exercise prices equal to the market price of our common stock on the date of grant and have ten-year contractual terms. Unvested options as of September 30, 2007March 31, 2008 had vesting periods of three years from date of grant. None of the stock options outstanding at September 30, 2007March 31, 2008 are subject to performance or market-based vesting conditions.

The fair value of the options issued during the quarters ended March 31, 2008 and 2007 was estimated on their respective grant dates using the Black-Scholes option pricing model. The Black-Scholes model was used with the following assumptions: risk-free interest rates of 4.97% to 5.08%, based on the U.S. Treasury yield in effect at the time of grant; dividend yields of zero percent; expected lives of 2 to 10 years, based on historical exercise activity behavior; and volatility of 89.14% and 67.58% for grants issued for the nine months ended September 30, 2007 based on the historical volatility of our stock over a time that is consistent with the expected life of the option. Asoption A small group of September 30, 2007, there was $435senior executives hold the majority of unrecognized compensation expense related to unvestedthe stock options which isand are expected to be recognized over a weighted average period of nearly three years.

Deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax basis of assets and liabilities at each balance sheet date using tax rates expected to be in effect in the year the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent that it is more likely than not that they will not be realized.

Revenue (referred to as “net sales”) 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 under a purchase order. Our sales terms do not provide for the right of return unless the product is damaged or defective. Net sales from certain services associated with the 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. We also enter into various service contracts that cover installed instruments. These contracts cover specific time periods and net sales associated with these contracts are deferred and recognized over the service period. At September 30,March 31, 2008 and 2007, and December 31, 2006, deferred revenue, mainly associated with our service contracts, included in the balance sheet in other accrued expenses, was approximately $1,898$2.0 million and $1,591,$1.7 million, respectively.

Research and development costs are charged to expense when incurred.

Financial statements of subsidiaries outside the U.S. are measured using the local currency as the functional currency. The adjustments to translate those amounts into U.S. dollars are accumulated in a separate account in stockholders’ equity and are included in accumulated other comprehensive income. Foreign currency transaction gains or losses resulting from changes in currency exchange rates are included in the determination of net income. Foreign currency transaction adjustments from continuing operations decreasedincreased net lossincome by $77 and $181$0.2 million during the three and nine months ended September 30, 2007, respectively. For the three and nine months ended September 30, 2006, foreignMarch 31, 2008. Foreign currency transactionstransaction adjustments from continuing operations increased net loss by $98 and decreased net loss by $98, respectively.

Accumulated other comprehensive income at September 30, 2007March 31, 2008 and December 31, 20062007 consisted of foreign currency translation adjustments, net of applicable tax of zero.tax. We deem our foreign investments to be permanent in nature and do not provide for taxes on currency translation adjustments arising from converting investments in a foreign currency to U.S. dollars.

Basic earnings per share is calculated based on the weighted average number of common shares outstanding during each period. Diluted earnings per share includeincludes shares issuable upon exercise of outstanding stock options, warrants or conversion rights that have exercise or conversion prices below the market value of our common stock. Options,At March 31, 2008, there were outstanding options, warrants and conversion rights pertaining to 12,201,141 and 13,778,84112,223,879 shares of our common stock have beenof which options to acquire 33,334 shares were included in the calculation of diluted earnings per share. At March 31, 2007, there were outstanding options, warrants and conversion rights pertaining to 13,729,241 shares of our common stock all of which were excluded from the computation of diluted earnings per share at September 30, 2007 and 2006, respectively, because the effect would be anti-dilutive due to the net loss from continuing operations in those periods. As a result, none of our outstanding options, warrants or conversion rights affect the calculation of diluted earnings per share.