PART I

FORWARD-LOOKING STATEMENTS

FORWARD-LOOKING STATEMENTS

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

Item 1.    Business.Business

Overview

We provide innovative products and services for the synthesis, purification and analysis of nucleic acids. Our operations fall into two principal business units, BioSystems and Nucleic Acids. Our BioSystems products include our WAVE^® automated instrument systems, WAVE associated consumables,consumable products and other related consumable products. Our Nucleic Acids products include chemical building blocks for nucleic acid synthesis and synthesized nucleic acids. OurBoth business units have service offerings includeas well, including genetic variation discovery and analysis services, novel chemistry development services and custom synthesis of nucleic acids. Our business strategy is to align our productproducts and service offeringsservices with the evolutionadvancements in the field of genetic advancementsgenetics and to become a major supplier of products and services to researchers, medical institutions, diagnostic and pharmaceutical companies. Specifically, our strategy is toto:

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Establish the WAVE systemSystem as the industry standard in the genetic research market, thereby expanding the installed base of systems and related consumable sales,sales; and



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Position ourselves as a unique partner to biopharmaceutical and pharmaceutical companies in the early stages of their efforts to develop genomic-based diagnostics and therapeutics thereby allowing us to participate in future successes of products derived from the expanding knowledge of genomics.

Our technologies center around three core competencies: separation chemistries, enzymology, and nucleic acid chemistries.

Separations Chemistries

        Our separation chemistries competency consists of expertise in developing novel chemical compounds tailored to interact with samples of interest. Specifically, this interaction involves binding of the total sample to the compound followed by a selective release of individual components of the sample. This release is induced by the introduction of other factors, such as chemical reagents, temperature changes, and pressure changes. The separation compound is coated on the surface of microscopic polymer beads and packed in a column. The interaction and separation occurs within the tube as the sample is pumped through it. We currently haveemploy novel chemistries for separating nucleic acids, proteins, peptides, amino acids and carbohydrates.

One of our significant separation technologies is currently embodied in the WAVE System. The WAVE System is a versatile instrument that can be used for variation detection, size-based double-strand DNA separation and analysis, single-strand DNA separation and analysis and DNA purification. Because of this versatility, the WAVE System can essentially replace the use of traditional gel electrophoresis in the molecular biology laboratory. Our patented technology uses a process known as high performance liquid chromatography to separate DNA material so that genetic variation may be identified and analyzed. In this process, DNA is injected into a special tube or column containing microscopic polymer beads. These

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micro-beads have special surface chemistries that cause the DNA molecules to attach to the surface of the beads. A chemical reagent is then pumped through the column under carefully controlled pressure and temperature conditions causing the DNA molecules to be selectively released from the beads so that they can be separated and measured. Our proprietary software controls the entire process and produces the results of the operation in an easy-to-read chart format. Once the DNA sample is loaded into the instrument and necessary data is entered into the software, the process requires virtually no additional input from the researcher. By using our patented DNASep®, OLIGOSep® and RNASep® columns and specifically formulated reagents that we have developed for various applications, the researcher is able to achieve a consistent high-quality result. Our WAVE system may be designed in the future to meet the needs of the emerging molecular diagnostics market.

        Additionally, theThe WAVE System requires the use of various consumable products that we manufacture and sell separately. As more WAVE Systems are sold, we expect that these consumable products will become an increasingly significant source of revenue for us. The principal consumable products used with the WAVE System are the DNASep, OLIGOSep and RNASep columns and the chemical reagents that are used to carry the DNA samples through the WAVE System. Other consumables include filters and other replacement parts of the WAVE System.

Enzymology

Our second core competency is expertise in developing novel enzymes. Enzymes are proteins that act as catalysts for biochemical reactions. One such reactionSeveral of these reactions are useful in genomics is the cleavage of DNA into defined fragments at specific points, accomplished by the use of restriction enzymes. Another example is the formation of DNA or RNA from precursor substances in the presence of pre-existing DNA or RNA acting as a template. Enzymes that catalyze this reaction are called polymerases.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. One of our current enzymology offerings is called Optimase. Optimase polymerase is a novel enzyme unique to Transgenomic that was developed specifically to meetThese products can also expand the needs of customers with post polymerase chain reaction (PCR) applications such as the WAVE system. Although this product may be used for any PCR application it was specifically developed to be used with a WAVE system. Optimase, used in conjunction with our WAVE optimized consumables, provides superior testing results and extends the life of our DNASep, OligoSep or RNASep columns. This product is expected to further expand our salessale of consumable products to WAVE systemSystem users and may also be sold for other PCR applications.

In September 2003 we introduced our SURVEYORNucleic Acid Chemistries^™ product line of mutation detection kits. The key component of SURVEYOR Mutation Detection Kits is an enzyme that cleaves DNA at points where any type of DNA sequence variation exists, a significant improvement compared to related enzymes in its class. The resulting DNA fragments can then be analyzed by the Transgenomic 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. We have recently begun commercial sales of SURVEYOR.

Our third core competency is nucleic acid chemistries, stems in part from our 2001 acquisition of Annovis, Inc.chemistries. Our Synthetic Nucleic Acidsynthetic nucleic acid products consist of chemical building blocks ("phosphoramidites"of nucleic acids (known as “phosphoramidites”), fluorescent markers and dyes, associated reagents, oligonucleotides and oligomimetics.synthesized segments of nucleic acids (known as “oligonucleotides” and “oligomimetics”). These products are currently being sold toused by research organizations, diagnostic companies and pharmaceutical companies. The majority of our synthetic nucleic acid revenues are currently generated through the sale of phosphoramiditeWe produce these products that are produced in our Glasgow, Scotland facility. We are in the process of completingIn 2003 we began production at a new productioncGMP compliant facility in Boulder, Colorado that will beColorado. This facility is able to further process phosphoramidite products into synthesized oligonucleotides in largelarger quantities. This facility will also provide process development, enhancement and unique chemistry development services. We expect demand for phosphoramidites and synthesized oligonucleotides to increase over the next several years as biopharmaceutical and pharmaceutical companies in the early stages of their efforts to develop genomic-based diagnostics and therapeutics experience product successes. Finally, our nucleic acid chemistry capabilities also include expertise in the ability to produce related specialty chemicals, such as molecular tags, dyes, quenchers, linkers, and solvents used to modify nucleic acids for subsequent detection or manipulation.

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The Company's internet address iswww.transgenomic.com. The Company makes available free of charge through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d)Company’s operations are managed based upon the nature of the Exchange Act as soon as reasonably practicable after such documentsproducts and services provided. Accordingly, the Company operates in two reportable segments, BioSystems and Nucleic Acids. Operations for these segments are electronically filedevaluated based upon specific identification of revenues and expenses associated with the Securitiesbusiness activities resulting in a segment operating income. Segment revenues and Exchange Commission.loss/income from operations are included in Note L to the Company’s consolidated financial statements contained in Item 8 of this report.

Industry Background

Genomics-Based Research, Diagnostics and Therapeutics

The human body is composed of billions of cells each containing deoxyribonucleic acid, or DNA, which encodes the basic instructions for cellular function. The complete set of DNA is called the genome, or genetic code. The human genome is composed of 23 pairs of chromosomes that are further divided into approximately 30,000, or more, smaller regions called genes. Genes are used in the cell as the template for the production of proteins, and it is these proteins that direct cell function that are ultimately reflected in the individual traits of the person. Any variation in the DNA sequence of a particular gene may result in a change in the cell function controlled by that gene. These changes, known as genetic variations, are often the cause of disease or make an individual more susceptible to disease.

Genomics is the systematic and comprehensive analysis of the sequence, structure and function of the genes that comprise the genome, the objective of which is identifying and understanding the role of genes in human physiology and disease. This information will only be developed through the intense study of genetic variation. Accordingly, genomics researchers are now attempting to understand variations in this DNA sequence information and how it correlates to disease in order to develop new therapeutics and diagnostic tools.

Synthetic Nucleic Acids

Synthetic nucleic acid molecules—commonly referred to as oligonucleotides—are necessary consumable reagents for numerous DNA-based analytical methods, diagnostic methods, and therapeutic products.

Genomics-based Diagnostics

Once a relationship is established between a particular genetic variation(s) and a disease it becomes possible to look for the specific genetic variation(s) or other biomarkers as a way of diagnosing a person'sperson’s susceptibility to the disease or the actual presence of the disease.

Genomics-basedNucleic Acid-based Therapeutics

 Target Identification—It has

Most drugs developed to date have been estimatedsmall molecules that act by inhibiting the human genome sequence could provide 5,000-10,000 new potential target molecules on whichaction of protein targets, typically enzymes or receptors that are known to base drug discovery efforts, representing a 10 to 20-fold increase over the approximately 500 targets identified during the entire history of drug development to date.

Target Validation—Target validation is the process of establishing proof that a particular drug target isbe involved in a disease disease. Drug discovery involves the isolation and/or biological processsynthesis of interestlarge numbers of candidate chemical compounds, followed by high-throughput screening of these candidates for the ability to inhibit the protein target of interest. Drug candidates that pass initial screening

are then subjected to additional rounds of screening, preclinical testing in animal models, and furthermore,Phase I – Phase III clinical trials. Experimental drugs that experimental modulation of the target (which would ultimately be accomplished by a drug) has an impact on that process.

Clinical Trials—After a lead drug candidate has been identified, and itshave demonstrated safety and efficacy at the end of this path are then candidates for potential marketing approval by regulatory agencies. Since the advent of recombinant DNA technology, proteins themselves have been increasingly exploited as therapeutic agents. More recently still, it has been demonstrated that nucleic acids—DNA and/or RNA—can also be utilized in animal models, testing must be performed on human subjects. Genetic variation among patients can impacta therapeutic context. The mechanisms by which they act are novel, setting the stage for new paradigms in drug efficacy as well as the likelihood of adverse drug reactions. It has been suggested that study of these effects should be incorporated into the clinical trial process. The relatively new segment of genomics called pharmacogenetics studies the impact genetic variation has on the safety and efficacy of drugs.discovery/development.

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Business Strategy

Our business strategy is to align our product and service offerings with the evolution of genetic advancements and to become a major supplier of products and services to researchers, medical institutions, diagnostic and pharmaceutical companies. Genetic advancements have beendeveloped and continue to develop over time. The movement alongin the field of genomics, continuum and related market opportunities, has shifted from gene discovery to the analysis of variations in gene sequences. From these variations researchers are beginning to link the impacts of variations in the gene sequences to associated disorders and diseasesdiseases. It is hoped that furtherthis knowledge will lead to the creation of diagnostic tests for these disorders and appropriatediseases and the development of therapeutic treatments and drugs.

 Key elements of our strategy are as follows:

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Establish the WAVE System as the Industry Standard.    We have focused our marketing efforts on large well-known government, academic and commercial research institutions to establish the WAVE System as the industry standard for variation analysis. We believe we are the first to bring high performance DNASep micro-bead technology to the market and have sold instruments to key genomics researchers to gain validation of our technology, which has resulted in the publication of over 500 articles in numerous scientific journals discussing the WAVE technology. Our current installed base includes several hundred customers with a total of nearly 1,000 installed systems. We intend to leverage the documented success of our customers to continue to introduce our technology to new users and new markets.



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Penetrate New Markets.    Our WAVE System may be used for purposes other than genetic variation discovery research. These other potential uses represent additional market opportunities that we intend to pursue. For example, a potential new market for the WAVE System will be the genetic screening and diagnostics market. Additional market opportunities exist in the fields of pathogen identification, bioterrorism and plant genetics. We continue to develop new applications and further improvements for the WAVE and other complementary technologies.



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Position ourselves as a unique partner to biopharmaceutical and pharmaceutical companies in the early stages of their efforts to develop genomic-based diagnostics and therapeutics.    Our partnering strategy is to seek out those companies who show the potential to have consistent success in the relatively new area of developing commercially viable genomic-based diagnostic and therapeutic products. We have begun to seek out partners with whom we will develop and manufacture novel chemistries. In positioning ourselves to partner with such companies we have attracted world-class nucleic acid chemistry expertise and are in the process of completing and qualifying a cGMP (Good Manufacturing Process) oligonucleotide manufacturing facility in Boulder, Colorado. This partnering strategy may result in varying demand for the products and services we seek to provide depending largely on the success of the biopharmaceutical and pharmaceutical companies involved in developing such products.



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Become the Principal Supplier of Specialty Synthetic Nucleic Acids.    Our Synthetic Nucleic Acid products are used in large quantities by a variety of commercial entities. In conjunction with aligning our new products and solutions with the genomics continuum our strategy also includes vertical expansion of our synthetic nucleic acid solution components whereby we intend to produce more of the components of the phosphoramidite chain starting from the raw material (nucleosides), to intermediates (trityls), to phosphoramidites, to the end oligonucleotide product.

        In support of our business strategy the following key milestones were achieved during 2002:

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BioSystems



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Launched WAVE MD platform,



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Launched Mutationdiscovery.com™,

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Launched Optimase polymerase,




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Nucleic Acids



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Expanded production capacity at two sites,



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Initiated cGMP oligonucleotide/oligomimetic manufacturing project,




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Corporate



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Developed and implemented a corporate restructuring to better align the Company's expense structure with current business prospects.

Research and Development

We maintain an active program of research and development and expect to continue to spend significant amounts on research and development in 2003.2004. Our research and development activities include the improvement of the DNA separation media used in our columns,WAVE System, the refinement of the hardware and software components of the WAVE System, the creation of unique enzymes and WAVE optimizedWAVE-optimized enzymes, for PCR and the improvement of chemical and biochemical reaction techniques for synthetic nucleic acids. We consult with several leading scientists from around the world as part of our ongoingOur research and development efforts. These advisors assist usexpenses were $9.3 million, $12.2 million and $9.4 million in formulating our research, development,2003, 2002 and commercialization strategies.2001, respectively.

 Our WAVE system related research and development work is focused on developing additional functionality in the WAVE System that will enable us to expand the number of applications thereby making the system an essential tool in genetic research. We are also developing improved methods and procedures to enable researchers to use the WAVE System to screen biological samples for genetic markers known to be disease related. We are working to make the screening process faster and more automated through the development of new software and improved separation media and instrumentation.

        Our Synthetic Nucleic Acid related research is focused on process and chemistry improvements in order to achieve greater quality and yields in the manufacture of chemical building blocks and the synthesis of oligonucleotides. We are also involved in the development of new synthetic nucleic acid chemistries for various applications in research, diagnostic and therapeutic markets.

Sales and Marketing

We currently sell our products in major markets, specificallyincluding the U.S., the U.K. and most countries in Western Europe, with a direct sales and support staff. For the rest of the world, we sell our products through dealers and distributors located in those local markets. As of December 31, 2002,2003, we had 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., Europe and Japan. See Note L, "Operating Segment and Geographical Information," to our consolidated financial statements for a summary of our net sales by geographic area and product group.Europe.

 Our marketing efforts utilize a variety of promotional channels including print advertisements, scientific conferences, trade shows and Internet browser ads. The primary targets of our marketing efforts are life sciences researchers and medical geneticists in academic and commercial research institutions, biopharma and pharmaceutical companies.

Customers

We have sold our products to several hundred customers in over 30 countries. Customers include numerous leading academic and medical institutions in the U.S. and abroad. In addition, our customers

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also include a number of large, established U.S. and foreign pharmaceutical, biotech and commercial companies.

        No single customer During 2003, two customers within our Nucleic Acids business unit, Geron Corporation and Invitrogen Corporation, each accounted for more than 10% of our sales in 2002. During 2001, one customer, Applied Biosystems, accounted for approximately 14%over 10 percent of our total revenues. Sales to Applied Biosystems included WAVE systems, WAVE optimized consumable products and Synthetic Nucleic Acid products. No single customer accounted for more than 10% of our sales in 2000.revenues from that business unit.

Manufacturing

We manufacture bioconsumable products including our separation columns, liquid reagents, polymeraseenzymes and nucleic acid products. 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 Synthetic Nucleic Acid products are manufactured in Glasgow, Scotland and Boulder, Colorado. In 2002 we began a project to upgrade and expand our production capabilities in Glasgow. This project included the upgrading of equipment and processes at the current production facility and the purchase of a new facility that will permit significant capacity expansion, equipment upgrades and process improvements in the future. Also in 2002, we leased a production facility in Boulder, Colorado. This facility is currently being developed and qualified as a cGMP (Good Manufacturing Practices) facility mainly for the synthesis of oligonucleotides. Such qualification is required for facilities that will produce Active Pharmaceutical Ingredients (API's). The Boulder facility began non-GMP production operations in the first quarter of 2003 and is expected to begin cGMP production in the second quarter of 2003.

Backlog

We manufacture our consumable products and assemble our system units based upon forecasts of near-term demand and receipts of firm orders from customers. Systems are configured to customer specifications and are

generally shipped shortly after receipt of the order. Customers may reschedule orders with little or no penalty. For these reasons, our systems backlog at any given time is not particularly meaningful because it is not necessarily indicative of future sales levels. We had order backlogs at December 31, 2002,2003, totaling approximately $3.0$2.6 million. In addition to our order backlog, we have deferred revenue recorded on our balance sheet totaling approximately $1.2$1.8 million. This amount is made up mainly of deferred revenue associated with service contracts on our WAVE instruments that cover a certain period of time. Such deferred revenue is generally recognized over the term of the service contract period.contract.

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 have successfully prosecuted or licensed in numerous patents protecting our core technologies, and as a result we presently own rights to more than 8060 issued patents and over 60 pending applications in both the US and abroad. Our DNA separation technologies and methods embodied in our BioSystems business unit products are protected by patents and licensed technologies. These patents, including licensed technologies, have remaining lives of between 9 to 18 years. Intellectual property related to our Nucleic Acid business unit is mainly licensed—in technology. We will continue to file patent applications and seek new licenses as we develop new products and technologies. We presently have no indication that our products infringe on the intellectual property rights of others, but it is possible we may be required to defend ourselves against such claims, whether or not these have merit. We also protect our trade secrets by entering into confidentiality agreements with third parties and require employees and consultants also sign confidentiality agreements, including assignment of patents and copyrights made in the course of employment. Despite such efforts it is possible that we will have to sue to enforce these agreements and the outcome of any such lawsuit is uncertain.

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Competition

Competitors for our Biosystems segment include several companies including Varian, Waters, Agilent, Applied Biosystems, Beckman Coulter, Amersham Biosciences and Invitrogen. These companies provide various products and services that compete either directly with our systems, bioconsumables and services, or indirectly through alternative technologies and/or methods. Competitors for our nucleic acid segment vary depending on the product. In the standard chemical building blocks market, we compete with Applied Biosystems, Proligo Degussa and Pierce Nucleic Acid Technologies. The competitors for our pharmaceutical grade oligonucleotide synthesis products and services include primarily Proligo Degussa, Dow Chemical and Avecia.

Employees

As of December 31, 2002,2003, we had 326244 full-time employees. The following sets forth the number of persons employed in the principal areas of our operation:

We supplement our workforce through the use of independent contractors and consultants. As of December 31, 2002,2003, we have engaged independent contractors or consultants who provide services to us approximately equivalent to 54 full time employees.

General Information

We were incorporated in Delaware on March 6, 1997. Our principal office is located at 12325 Emmet Street, Omaha, Nebraska 68164 (telephone: 402-452-5400). Our internet address iswww.transgenomic.com. We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports available free of charge through our website as soon as reasonably practicable after we file these documents with the Securities and Exchange Commission. The Company began a restructuring process during the fourth quarterinformation contained in our website is not part of 2002 that resulted in the elimination of a significant number of job positions. A large number of employees that had been notified of termination had not yet reached their termination date and thus are included in the 12/31/02 employee counts shown above. Additionally, further job eliminations were to occur during the first quarter of 2003. The total employee count following these further reductions is expected to be approximately 270 to 280.this Report on Form 10-K.

Risks Related to Our Business

We may not have adequate financial resources available to execute our business plan.

We have historically experienced operating losses from operations and negative cash flows. These results were mostly due to researchAs of December 31, 2003, we had approximately $1.2 million in cash and development expensescash equivalents and sales and marketing expenses related to the development and marketingan accumulated deficit of our products. We could continue to incur losses for the foreseeable future and may never be profitable.$72.7 million. To date, we have financed our operations and capital expenditures primarily from the proceeds of a $77.3 million public offeringand private placements of common stock. In MarchAdditionally, in December 2003 and February 2004, we entered into loan agreements with Laurus Master Fund, Ltd. for a loan commitment agreement with a financial institution for up to a $5.0$7.5 million secured line of credit.credit and a $2.75 million convertible note, respectively. In February 2004, Laurus issued us a letter which waived the borrowing base limitation on our line of credit, thereby making the full $7.5 million facility available to us regardless of collateral. Laurus has committed to keeping the waiver open through the end of 2004. We willexpect to continue to need substantial amounts of cash for researchto fund our operations and developmentcapital expenditures in the future. Based upon our current projections, we expect to meet our future cash needs from existing cash, additional cash generated from our working capital, funds available to us under our $7.5 million credit facility and the net proceeds of the convertible note. These projections may or may not be realized based upon actual operating results and capital project requirements. Thus, our existing cash balances, cash generated by our working capital, available borrowings under our secured line of credit and net proceeds of the convertible note may be insufficient to expandsatisfy our sales and manufacturing infrastructure. Weliquidity requirements. Accordingly, we may need to raise the additional capital in the future through bankcapital. However, we cannot assure you that additional financing or strategic investments. Additional financing may notwill be available to us when we need it or if available, we cannot assure that we will be able to obtain such financing on terms favorable to our stockholders or us.acceptable terms. If we raise additional capital by issuing common stock or other equity securities, the issuance of suchthese securities would result in ownership dilution to our existing stockholders. If we borrow additional money, we will incur additional interest costs and may become subject to covenants that restrict our operations and capital expenditures. If we are not able to obtain additional capital as needed, we may need to take further steps to reduce our operating costs, and may not be able to execute parts or all of our business plan.

We may not have adequate organizational resources availablea history of operating losses and expect to execute our business plan.incur losses in the future.

 During

We have experienced losses from operations since inception of our operations. Our operating losses for each of the fourth quarter oflast three fiscal years were $22.6 million, $21.7 million and $9.7 million, in 2003, 2002 and 2001, respectively. These losses have been due principally to the first quarterhigh levels of 2003, we restructured the Company, which resulted in a net reduction in staffresearch and facilities,development expenses and the abandonment of certain intellectual property. While we feelsales and marketing expenses that we have retainedincurred in order to develop and redeployed existing resourcesmarket our products, restructuring charges and secured additional resources necessarygoodwill impairment charges. In addition, markets for our products have developed more slowly than expected in some cases and may continue to successfully conductdo so. As a result, we expect to incur operating losses in the future and we may never be profitable.

Markets for our business,products and services may develop slowly.

There are many factors that affect the market demand for our products and services that we cannot assure youcontrol. This is especially true in our Nucleic Acid segment where the demand for our products depends to a large degree on the success that the net reduction will not impair our abilitycustomers and potential customers have in developing useful pharmaceutical products based on genetic intervention. A central strategy for our Nucleic Acid segment is to achieve our planned revenue levels.

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Our business strategy includes positioning ourselves as a unique partnersell synthetic nucleic acid products to biopharmaceutical and pharmaceutical companies that are seeking to develop commercially viable genomic-based diagnostic and therapeutic products. We have invested a significant amount of capital into acquiring and developing manufacturing facilities and other assets to allow us to pursue this market. However, this is a new field of commercial development, and many of these biopharmaceutical and pharmaceutical companies are in the early stages of their efforts to develop genomic-based diagnostics and therapeutics.therapeutics and have encountered difficulties in these efforts. As a result, the demand for our synthetic nucleic acid products is difficult to forecast and may develop slowly or sporadically. In addition, we cannot assure you that these companies will not develop internally the chemistries and manufacturing capabilities to produce the products they could buy from us. Demand for our WAVE System is similarly affected by the needs and budgetary resources of research institutions, universities, hospitals and others who use the WAVE System for genetic-variation research. The WAVE System represents a significant expenditure by these types of customers and often requires a long sales cycle. If revenues from the sales of our products and services continue at current levels, we

may need to raise additional working capital or take steps to further reduce operating expenses. We cannot assure you that sales will increase or that we will be able to raise additional working capital or reduce operating expenses.

Customer clinical trials may be delayed or discontinued.

A significant percentage of our Nucleic Acid business unit revenues are generated by sales to customers involved in drug development. Our products are generally used by these customers in the manufacture of drugs candidates in varying stages clinical trials. If these clinical trials are delayed or cancelled this could have a significant impact on our revenues generated by the Nucleic Acid business unit.

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

During the last three fiscal years, our international sales have represented approximately 50-65% of our net sales. As a result, a major portion of our revenues and expenses are subject to risks associated with international sales and operations. These risks include:

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

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

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

During the fourth quarter of 2002 and the first half of 2003, we took steps to reduce our operating costs that resulted in a significant reduction in our number of employees, including our research and development staff and our sales and marketing personnel. In addition, we may lose other key management, scientific, technical, sales and manufacturing personnel from time to time. It may be very difficult to replace personnel if they are needed in the future, and the loss of key personnel could harm our business and operating results. We cannot assure you that our employee reductions will not impair our ability to continue to develop new products and refine existing products in order to remain competitive. In addition, these reductions could prevent us from successfully execute this strategy. Additionally,marketing our products and developing our customer base.

Our markets are very competitive.

We compete with many other companies in both our Biosystems segment and Nucleic Acids segment. Competitors for our Biosystems segment include several companies, such as Varian, Waters, Agilent, Applied

Biosystems, Beckman Coulter, Amersham Biosciences and Invitrogen. These companies provide various products and services that compete either directly with our WAVE system, bioconsumables and services, or indirectly through alternative technologies and/or methods. Competitors for our Nucleic Acid segment vary depending on the product. In the standard chemical building blocks market, we compete with Applied Biosystems, Proligo Degussa and Pierce Nucleic Acid Technologies. The competitors for our pharmaceutical-grade oligonucleotide synthesis products and services include primarily Proligo Degussa, Dow Chemical and Avecia. Many of these competing companies have greater resources than we do or may enjoy other competitive advantages. This may allow them to more effectively market their products to our customers or potential customers, to develop products that make our products obsolete or to produce and sell products less expensively than us. As a result of these competitive factors, demand for and pricing of our products and services could be negatively affected.

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

Over the past two years our stock has traded at prices as high as $10.77 per share in the first quarter of 2002 to as low as $0.93 per share in the second quarter of 2003. This volatility in the price of our stock is attributable to a number of factors, not all of which relate to our operating results and financial position. Nevertheless, continued volatility in the market price for our stock should be expected and we cannot assure you that the companiesprice of our stock will increase in the future. Fluctuations or further declines in the price of our stock may affect your ability to sell shares of our stock and our ability to raise capital through future equity financing.

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

Patent law relating to the scope of claims in the technology fields in which we seek to partner withoperate is still evolving. The degree of future protection for our proprietary rights is uncertain. Furthermore, we cannot be certain that others will not decideindependently develop similar or alternative products or technology, duplicate any of our products, or, if patents are issued to us, design around the patented products developed by us. Our patents or licenses could be challenged by litigation and, if the outcome of such litigation were adverse to us, our competitors could be free to use our technology. We may not be able to obtain additional patents for our technology, or if we are able to do so, patents may not provide us with substantial protection or be commercially beneficial. In addition, we could incur substantial costs in litigation if we are required to defend ourselves in patent suits brought by third parties or if we initiate such suits.

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

We rely upon trade secret protection, copyright 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 novel chemistriesnew products that we need to remain competitive.

The patent underlying our nonexclusive license to manufacture standard nucleic acid building blocks will expire in the first quarter of 2005. The expiration of this patent could result in additional manufacturers entering

the market for these products. Some of these manufacturers may have lower cost structures or other competitive advantages which may reduce our market share and/or our operating margins related to these products.

The protection of intellectual property in foreign countries is uncertain.

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

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

There are a significant number of U.S. and foreign patents and patent applications submitted for themselves. Lastly, we cannot assure that these companies will have consistent successtechnologies in, this relatively newor related to, our area of developingbusiness. 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 viable genomic-based diagnostic and therapeutic products. In fact, the biopharmaceutical and pharmaceutical companies involved have encountered difficulty in accomplishing this andreasonable 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 have seen varying demand for the products and services we seek to provide to them.use may adversely affect our results of operations.

 In positioning ourselves to partner with such companies we must:

•

Attract and retain world-class nucleic acid chemistry expertise,



•

Develop and maintain world-class

Our research and development facilities,



•

Qualify and maintain cGMPmanufacturing activities involve the controlled use of hazardous materials and chemicals. We are subject to federal, state and local 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



•

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



•

Establish long-term partner relationships with various companies.

WeIf our outstanding options and warrants are exercised, or our outstanding debt is converted into common stock, it will need to effectively manage our growth if we are to successfully implement our strategy.result in dilution.

 The scope

As of December 31, 2003, we had outstanding approximately 28.1 million shares of common stock. We also had obligations to issue approximately 6.3 million shares of common stock under outstanding stock options and warrants. Additionally, we may issue shares of common stock upon conversion of all or part of our business operations hasnew line of credit and will continuenew convertible note. The issuance of such additional shares of common stock may be dilutive to changeour current shareholders and evolve. Such changes in our business andcould negatively impact the growth that may accompany them may place a strain on our management and operations. Our ability to manage our growth will depend on the abilitymarket price of our officers and key employees to continue to implement and improve our operational, management information and financial control systems and to expand, train and manage our work force both in the U.S. and abroad. Our inability to manage our growth effectively could affect our ability to pursue business opportunities and expand our business.common stock.

Item 2.    Properties.

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

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

        As a part of our restructuring plans developed in the fourth quarter of 2002 our office space requirements have been reduced. As a result, some of our locations will be closed or the amount of space

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leased will be reduced. Our restructuring plans included the closing or reduction of leased office space in Omaha, Nebraska, Crewe, England, San Diego, California and Wayne, Pennsylvania.

Item 3.    Legal Proceedings.

We are not a party, nor are any of our assets or properties subject, to any material legal proceedings.

Item 4.    Submission of Matters to a Vote of Security Holders.

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.

Item 4a.4A.    Executive Officers.

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

Our current officers and their ages as of December 31, 20022003 are listed below followed by a brief biography.

Collin J. D'Silva.D’Silva.    Mr. D'SilvaD’Silva has served as our Chairman of the Board and Chief Executive Officer since 1997 and is also a Director. Mr. D'Silva,D’Silva, a co-founder of Transgenomic, has worked for Transgenomic and its predecessors since 1988. Prior to that time, Mr. D'SilvaD’Silva was employed by AT&T from 1980. 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'SilvaD’Silva holds a B.S. degree and a M.Eng. degree in industrial engineering from Iowa State University and an M.B.A.MBA from Creighton University.

        William P. Rasmussen.Michael J. Draper.    Mr. RasmussenDraper joined us on October 1, 1998Transgenomic, Inc. in April 2000 and currently serves as our Chief Financial Officer.Officer and was previously the Controller. Prior to joining us,Transgenomic, Mr. RasmussenDraper was Chief Financial Officera business consultant from 1999 to 2000 providing accounting, business and systems consulting to corporations. From 1997 to 1999, he was Vice President of Accounting and Finance at I-MarkMidland Systems, from 1996 until it was purchased in 1997. I-MarkInc. (MSI Systems designed integratedIntegrators). MSI provided computer votinghardware and networking solutions and was a successor corporation of ADD Consulting Inc., which provided computer staffing professionals to numerous industries. Mr. Rasmussen served as Chief Financial Officer of ADD Consulting Inc. from 1994 until joining I-Mark Systems in 1996. Mr. Rasmussen owned a travel management company from 1986 to 1998, and he provided consulting services to numerous software and telecommunication companiescustomers throughout the Midwestern United States. Mr. Draper also spent 8 years in public accounting with the firm of Deloitte & Touche LLP from 19841989 to 1994.1997. Mr. Rasmussen's previous experience also includes serving as Controller and Principal Accounting Officer for Applied Communications, Inc. from 1979 to 1984. Applied Communications, Inc., now known as Transaction Systems Architects, Inc., is a software provider for transaction processing systems. Mr. RasmussenDraper holds a B.S. degree in Accounting and Business Administration from the University of Nebraska.

John L. Allbery.    Mr. Allbery joined us in June 2001, and currently serves as an Executive Vice President. Prior to joining us, Mr. Allbery was a private business consultant based in Budapest, Hungary from 2000 to 2001. From 1999 to 2000 Mr. Allbery served as the Chief Financial Officer of The Virtus Group, a private

business venture in Budapest, Hungary. Mr. Allbery also spent approximately 20 years in public accounting. Prior to leaving public accounting, Mr. Allbery was a Partner with Deloitte & Touche

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LLP. Mr. Allbery holds a B.A. degree in Accounting from Doane College and a MBA in Taxation from Golden Gate University.

Keith A. Johnson.    Mr. Johnson joined us in 20012002 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'sJohnson’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, and New Jersey and Nebraska and is admitted to practice before the USPTO.

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 companies involved in manufacturing, steel distribution and rebar fabrication for 15 years. 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.

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Part II

Item 5.    Market for Registrant'sRegistrant’s Common Equity and Related Stockholder Matters.

Our common stock is listed for trading on the NASDAQ National Market under the symbol TBIO. The following table sets forth the high and low prices for our common stock during each of the quarters of 20012002 and 2002.2003.

At March 24, 2003,16, 2004, there were 23,532,04929,044,514 shares of our common stock outstanding and approximately 3,3003,500 holders of record. The outstanding shares consist of 24,026,653 shares issued less 494,604 shares of treasury stock.

We have never declared or paid any cash dividends on our capital 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'sboard’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.

Item 6.    Selected Financial Data.

The statement of operations data for the years ended December 31, 2003, 2002 2001 and 20002001 and the balance sheet data as of December 31, 20022003 and 20012002 are derived from our historical consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K, which have been audited by Deloitte & Touche LLP, our independent auditors. The statement of operations data for the years ended December 31, 19992000 and 19981999 and the balance sheet data as of December 31, 2001, 2000 1999 and 19981999 are derived from our audited historical consolidated financial statements that are not included in this Annual Report on Form 10-K. In May 2001, we acquired Annovis, Inc., a specialty chemicals company that develops, manufactures and markets a wide variety of nucleic acid-based products and services for the life science industry, for a total purchase price of approximately $16.9 million. Annovis'sAnnovis’s results of operations have been included in the accompanying financial statements beginning on May 1, 2001. Additionally, our financial statements include the results from our non-life sciences product line which was sold effective April 1, 2000.

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

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

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

Overview

We provide innovative products and services for the synthesis, purification and analysis of nucleic acids. OurThe Company’s operations are managed based upon the nature of the products and services includeprovided. Accordingly, the Company has determined that it operates in two segments, BioSystems and Nucleic Acids. Operations for these segments are evaluated based upon specific identification of revenues and expenses associated with the business activities resulting in a segment operating income. Expenses that cannot be directly identified to an operating activity or are considered corporate overhead are not allocated to the segments in arriving at operating income for the segment.

The BioSystems operating segment generates revenue from the sale of automated instrument systems and associated consumables,consumable products and services. This segment’s products are based upon separations chemistries and enzymology. Specifically, this segment’s main products are the WAVE System, related bioconsumables and research services. Since the WAVE System product introduction in 1997, we have sold over 1,000 instruments to customers in over 30 countries.

The Nucleic Acids operating segment generates revenue from the sale of products and services based upon nucleic acid chemicalchemistries, separations chemistries and enzymology. Specifically, this segment’s main products are nucleic acid building blocks nucleic acid synthesis products,or phosphoramidites, oligonucleotides, fluorescent markers, dyes and associated reagents and novel chemistry development for nucleic acids,and process development services and genetic variation discovery services.

Our technologies center around three core competencies: separation chemistries, enzymology, and nucleic acid chemistries. We develop, assemble, manufacture and market our products and services to the life sciences industry to be used in research focused on molecular genetics of humans and other organisms. Such research could lead to development of new diagnostics and therapeutics. Our products can be used to analyze DNA or RNA at the molecular level, amplify, separate, and isolate nucleic acid fragments of particular interest and synthesize conventional or chemically-modified nucleic acid molecules. These capabilities are central to research seeking to discover and understand variations in the genetic code, the relationship of these variations to disease and, ultimately, to develop diagnostics and therapeutics based on this understanding. Our business plan is to participate in the value chain associated with these activities by providing key technology, tools, consumables, and biochemical reagents and services to those entities engaged in basic biomedical research and the development of diagnostics and therapeutic agents.

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

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

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

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

We have incurred significant losses resulting principally from costs incurred in research and development and selling, general and administrative costs associated with our operations. At December 31, 2002,2003, we had an accumulated deficit of $49.8$72.7 million. We expect to continue to incur substantial research and development and selling, general and administrative costs.

Executive Summary

The following is a summary of significant items or events that have had an effect on the Company’s financial position, results of operations, and liquidity:

Results of Operations

Changes in Results of Operations

Years Ended December 31, 2003 and 2002

Net Sales.    Net sales decreased in 2003 due to a significant decline in demand for our Nucleic Acids products. Sales in our Nucleic Acid 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. We look for demand for these products to rebound slightly in 2004 as other customer products move through the clinical trial phases and as the anticipated FDA approval of certain DNA based drug candidates increases the potential for commercial production of these drugs. 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. Part of our business strategy has been to position ourselves as a unique partner to biopharmaceutical and pharmaceutical companies in the early stages of their efforts to develop genomic-based diagnostics and therapeutics. As part of this strategy we are focusing our sales efforts on large consumers of our Synthetic Nucleic Acid products who are willing to commit to long-term supply agreements. While we expect to see increased sales of these products based upon this strategy, we also may see varying demand depending on the success of the biopharmaceutical and pharmaceutical companies diagnostic and therapeutic products on which we are targeting our sales efforts. As a result we may see large variations in revenue flows for these products.

Sales in our BioSystems operating segment increased in 2003. Revenues from sales of WAVE systems and related services were relatively flat with 2002. However, bioconsumable product sales strength resulted from increased WAVE related consumable usage as the installed base of WAVE Systems has increased and as researchers begin to use them more extensively in place of other methods of DNA analysis. Also contributing to the increase were revenues generated by new product sales including our Optimase product line that was launched in 2002 and began to see increased usage in 2003. Sales of WAVE systems declined slightly from 2002 to 2003 offset by an increase in related services revenues. The slight decline in systems sales is mainly due to continued low sales volumes to our North American customer base. Increased services revenue is attributable to our focus on providing genetic variation discovery and analysis services to our pharmaceutical base of customers. We believe that our genetic variation discovery and analysis services provide us a significant opportunity to expand revenues in the future. In December 2003, we announced a discovery services agreement with Novartis Pharmaceuticals Corp. supporting the clinical development of oncology therapeutics and believe this provides a good model of the opportunity for our services offering.

Cost of Goods Sold.    Cost of goods sold increased despite the decline in our revenues. This increase was anticipated and is attributable mainly to excess manufacturing capacity in our Nucleic Acids business unit. The BioSystems business unit cost of goods sold as a percentage of sales declined year over year but remained within historical ranges at approximately 43%. We expect that our Biosystems margins will fluctuate within historical ranges based upon the sales mix of systems, consumables and services. Currently our Nucleic Acid products are sold at lower margins compared to our Biosystems products. The margins in our Nucleic Acids business unit have been negatively impacted by higher manufacturing costs and excess capacity due largely to our plant expansion efforts in Glasgow, Scotland and Boulder, Colorado. In 2004 we anticipate that our cost of goods sold for our Nucleic Acid products will remain under pressure due to continued excess capacity. Overall we anticipate that our cost of goods sold as a percentage of sales will be consistent with 2003 or slightly lower as we are hopeful that demand for our Nucleic Acid products will rebound slightly. Margin improvement will depend largely on the return of product demand thereby more fully utilizing our manufacturing capacity and spreading fixed costs across a larger revenue base.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses decreased significantly as a result of our restructuring activities and focus on expense control. Nearly half of the total decrease was in personnel and personnel related expenses as we have 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. While we believe that further reductions in selling, general and administrative expenses are possible in 2004, we do not expect to see the same level of decreases experienced from 2002 to 2003.

Research and Development Expenses.    Research and development expenses decreased significantly as a result of our restructuring activities and focus on expense control. Over 60% of the total decrease was in personnel and personnel related expenses as we have 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 $1.2 million of development costs. While we believe that further reductions in research and development expenses are possible in 2004, we do not expect to see the same level of decreases experience from 2002 to 2003. Research and development expenses consist of salaries and related personnel costs of researchers and software developers, material costs for prototypes and test units, legal expenses relating to intellectual property research and application development activities, testing and enhancement of our products, and amortization of intellectual property. We expense our research and development costs in the year in which they are incurred with the exception of certain capitalized software development costs.

Restructuring Charges.    During the fourth quarter of 2002 management formulated and executed a significant portion of a restructuring plan. The plan was developed to reduce expenses thereby better aligning the Company’s expense structure with current business prospects. The plan included employee terminations, office

closures, termination of collaborations and write-offs of abandoned intellectual property. We continued to execute the plan during the first half of 2003 resulting in the additional charges recorded in 2003. These charges consisted of mainly employee severance costs and the write-off of a note receivable related to the abandonment of a product development collaboration. The note receivable write-off was a non-cash charge of $350,000. Management does not expect to incur further restructuring charges in 2004.

Goodwill Impairment Charge.    Statement of Financial Accounting Standard (SFAS) No. 142,Goodwill and Other Intangible Assets, establishes guidelines for accounting for goodwill and other intangible assets and provides that goodwill and other intangible assets with indefinite lives will not be amortized, but will be evaluated for impairment annually. The Company engaged an external valuation firm to assist with the completion of its annual impairment test during the fourth quarter of 2003. As a result of this test we recorded a non-cash goodwill impairment charge of $4.8 million related to our nucleic acids segment.

Income Taxes.    The Company’s tax expense relates to its operations in certain foreign countries and certain states. No tax benefits are being recorded due to our cumulative losses in recent years, expected losses in future years and the uncertainty as to whether we will be able to utilize any additional losses as carrybacks. We will continue to assess the recoverability of deferred tax assets and the related valuation allowance. We expect to continue to incur losses and expect to continue to provide valuation allowances against deferred tax assets. To the extent we begin to generate income in future years and it is determined that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized. Our deferred tax assets as of December 31, 2003 were $30.6 million and were offset by a valuation allowance of $30.6 million. Our deferred tax assets as of December 31, 2002 were $23.2 million and were offset by a valuation allowance of $23.2 million. As of December 31, 2003, we had federal net operating loss carryforwards of approximately $78.5 million. Our net operating loss carryforwards will expire at various dates from 2008 through 2023, if not utilized. We also had state income tax loss carryforwards of $28.7 million at December 31, 2003. These carryforwards will also expire at various dates beginning in 2008 if not utilized.

Years Ended December 31, 2002 and 2001

Net Sales.    Net sales decreased in 2002 due to weakness in demand for our Biosystems business unit products. Sales in our BioSystems business unit decreased as a decline in sales of WAVE Systems was offset by an increase in Bioconsumable product sales. Sales of WAVE systems declined mainly due to lower sales volumes to our commercial and industrial customer base and our North American customer base. Systems sold to our commercial and industrial customers accounted for approximately 6% of unit sales in 2002 as compared to approximately 34% in 2001. Systems sold in North America accounted for approximately 25% of unit sales in 2002 as compared to approximately 40% in 2001. Sales of WAVE related consumable products increased as the installed base of WAVE Systems has increased and as researchers begin to use them more extensively in place of other methods of DNA analysis. Sales in our Nucleic Acid operating segment increased in 2002 due to the timing of our acquisition of Annovis, Inc. in May 2001.

Cost of Goods Sold.    Cost of goods sold increased in 2002 due mainly to the mix of products sold. BioSystems sales margins improved year over year mainly due to higher average selling prices per system resulting from greater sales of our higher margin high throughput WAVE system. The average sales price per instrument increased approximately 10% in 2002. The higher margins on our BioSystems products were offset by lower margins in our nucleic acid operating segment. Currently our nucleic acid products, which have become a larger percentage of our total revenues, are sold at lower margins compared to our BioSystems products. The margins in our Nucleic Acids operating segment are lower due to bulk sales of nucleic acid building block products and higher manufacturing costs due largely to our plant expansion efforts in Glasgow, Scotland and Boulder, Colorado.

Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased as a result of additional personnel and personnel-related expenses, bad debt expense and the write-off of a portion of notes receivable. These increases were offset by a reduction in goodwill amortization and foreign currency

exchange rate gains. Combined these items accounted for over 90% of the total increase. Direct personnel expenses increased due to our expanded employee base during 2002. Bad debt expense increased as we felt it was appropriate to increase the allowance for bad debt given our increased levels of accounts receivable. The decrease in goodwill amortization is the result of our adoption of Statement of Financial Accounting Standards (SFAS) No. 142,Goodwill and Other Intangible Assets.

Research and Development Expenses.    Research and development expenses increased in 2002 due to increased personnel and personnel related expenses resulting from an expanded employee base during 2002, depreciation, amortization and supplies offset by increased amounts of capitalized software expenses related to the WAVE system operating software. During 2002 we capitalized approximately $1.2 million of software development costs as compared to approximately $700,000 in the prior year. Research and development expenses consist of salaries and related personnel costs of researchers and software developers, material costs for prototypes and test units, legal expenses relating to intellectual property research and application development activities, testing and enhancement of our products, and amortization of intellectual property. We expense our research and development costs in the year in which they are incurred with the exception of certain capitalized software development costs.

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

Other Income (Expense).    Other income and expense, which consists mainly of net interest income and expense, decreased to income of $437,000 in 2002 from income of $2.4 million in 2001. Interest income for the year was $626,000 as compared to $2.5 million in 2001. Interest expense for the year was $62,000 as compared to $58,000 in 2001. The decrease in interest income is a result of declining interest rates on investments and reductions in our short-term investment balances.

Liquidity and Capital Resources

Overview

We have historically experienced net losses and negative cash flows. As a result, we had an accumulated deficit of $72.7 million as of December 31, 2003. As of December 31, 2003 and 2002, we had approximately $1.2 million and $9.7 million, respectively, in cash and cash equivalents. In addition, as of December 31, 2003 and 2002, we had no short-term investments and $3.6 million in short-term investments, respectively, for total cash and short-term investments of approximately $1.2 million and $13.3 million, respectively.

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

We expect to devote substantial capital resources to continue our research and development efforts, to support our marketing and sales and customer support activities, and for other general corporate activities. Our capital requirements for operations depend on a number of factors, including sales levels, the level of our research and development activities, market acceptance of our products and services, the resources we devote to developing and supporting our products and services and normal capital expenditures. The restructuring plan developed in 2002 has reduced our operating expenses and thereby reduced the cash needed to fund our operations. Additionally, our capital budget includes expenditures for the completion of our facility expansion projects in Glasgow, Scotland, and Boulder, Colorado, and for general facility and equipment improvements. Additional expansion projects for the Glasgow and Boulder production facilities may be incurred over the next 2 to 3 years as business demand dictates. During 2003, our major capital projects were substantially completed and we expect our capital expenditures to decrease significantly in 2004. Our original capital expenditures budget for 2003 was approximately $8.4 million while our actual cash utilized on capital expenditures for the year was $6.4 million. Currently, we project capital expenditures for 2004 to be in the range of $1.7 million to $2.5 million, depending largely upon demand for our nucleic acid products.

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

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

term of the agreement is three years carrying an interest rate of 2.0% over the prime rate or a minimum of 6.0%. Funds available under the line are determined by a borrowing base equal to 90% of eligible accounts receivable balances plus up to $1.0 million related to inventory balances. This line of credit is secured by most of our assets. Payment of interest and principal can, under certain circumstances, be made with shares of our common stock at a fixed conversion price of $2.20 per share. In January and February 2004, Laurus exercised its conversion rights on the line of credit and converted $2.0 million of amounts outstanding on the line into approximately 910,000 shares of common stock of the Company. As of December 31, 2003, we had approximately $3.0 million outstanding on this line of credit. In February 2004, Laurus waived the borrowing base limitation on our line, thereby making the full $7.5 million facility available to us regardless of the available collateral. This waiver will expire on December 19, 2004. This waiver, and the resulting access to the full amount of our line of credit, is a positive development in terms of access to liquidity for the Company.

As a result of our cost control measures and reduced capital expenditures, we expect our cash usage to decrease during 2004. Based upon our current projections, we expect to meet our cash needs for 2004 from existing cash, additional cash generated from our working capital, additional funds available to us under our $7.5 million credit facility and the proceeds of the $2.75 million convertible note entered into in February 2004, net of debt repayment costs. These projections assume continued revenue strength from our Biosystems business unit. We believe growth will result from increased consumable product offerings and continued strength in demand for our instruments. These projections also assume that revenues from our Nucleic Acid business unit have reached a base level in the third quarter of 2003 and will begin to increase in the future. Much of the anticipated increase in the Nucleic Acid business unit revenues will come from new customers and additional business from existing customers of our Boulder, Colorado facility that began production in 2003. More specifically, our current financial and cash flow projections indicate that we expect to use approximately $2.5 million in cash to fund further operating losses and an additional $1.7 million to $2.5 million for capital expenditures. The majority of the capital expenditures will be associated with our Nucleic Acids business unit. These projections indicate a cash need of $4.2 million to $5.0 million for the year. Our cash balance at December 31, 2003 of $1.2 million, plus the net proceeds from our new convertible note of approximately $750,000 received in February 2004, additional advances available on our line of credit and the conversion by Laurus of $2.0 million of amounts outstanding on the line into approximately 910,000 shares of common stock of the Company are sufficient to meet this projected cash need. As of December 31, 2003, additional advances available on our line of credit were $1.7 million based upon eligible collateral as of that date. Based upon the waiver received in February 2004, an additional $4.5 million was available when calculated as the total line of credit available of $7.5 million less $3.0 million outstanding at December 31, 2003. These projections may or may not be realized based upon actual operating results and capital project requirements. Thus, during or after this period, if our existing cash balances, cash generated by our working capital, and available borrowings under credit agreements are insufficient to satisfy our liquidity requirements, we may need to sell additional equity or debt securities, or obtain additional credit arrangements. We are monitoring our liquidity position and are prepared to take appropriate measures, as needed, to address liquidity. Such measures may include, but are not limited to, further expense reductions, an expansion of our line of credit, asset sales and the placement of equity or debt. We cannot assure you that any financing arrangement will be available in amounts or on terms acceptable to us. Our failure to raise additional capital, if needed, would harm our financial condition, results of operations and our business.

Analysis of Cash Flows

During 2003 our major cash expenditures were the funding of our operations and capital projects. Cash and investments decreased by a total of approximately $12.1 million in 2003 as compared to approximately $30.2 million in 2002. In 2003 approximately $13.2 million was used to fund our operations and $6.4 million used for capital projects offset by $3.0 million provided by advances on our line of credit and $4.3 million provided by the sale of common stock. Major capital projects included facility build-out, expansion and improvement at our two nucleic acid production facilities in Boulder, Colorado and Glasgow, Scotland. The Boulder facility project is designed to be a cGMP (Good Manufacturing Practices) facility for the synthesis of oligonucleotides. This facility began non-GMP production operations during the first quarter of 2003 and cGMP production in the

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

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

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

Net cash provided by financing activities was $7.3 million in 2003 and $1.7 million for 2002. The financing cash inflows in 2003 were the result of proceeds from the sale of common stock and advances on our line of credit. Financing cash inflows in 2002 were the result of the sale of common stock and proceeds from long-term debt offset by the purchase of treasury stock.

Obligations and Commitments

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

Off Balance Sheet Arrangements

At December 31, 2003 and 2002, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies

Accounting policies used in the preparation of the consolidated financial statements may involve the use of management judgments and estimates. Certain of the Company'sCompany’s accounting policies are considered critical as they are both important to the portrayal of the Company'sCompany’s financial statements and they require significant or

complex judgments on the part of management. Our judgments and estimates are based on experience and assumptions that we believe are reasonable under the circumstances. Further, we evaluate our judgments and estimates from time to time as circumstances change. Actual financial results based on judgment or estimates may vary under different assumptions or circumstances. The following are certain critical accounting policies that may involve the use of judgment or estimates.

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

•

The age of the accounts receivable,



•

Customer credit history,



•

Customer financial information,



•

Reasons for non-payment, and



•

Our knowledge of the customer.

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

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

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

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

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

Results of Operations

Years Ended December 31, 2002 and 2001

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

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

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

        Selling, General and Administrative Expenses.    Selling, general and administrative expenses increased 12% to $24.1 million in 2002 from $21.5 million in 2001. This increase is the result of additional personnel and personnel-related expenses, bad debt expense and the write-off of a portion of notes receivable. These increases were offset by a reduction in goodwill amortization and foreign currency exchange rate gains. Combined these items accounted for over 90% of the total increase. Direct personnel expenses increased due to our expanded employee base during 2002. Bad debt expense increased as we felt it was appropriate to increase the allowance for bad debt given our increased levels of accounts receivable. The decrease in goodwill amortization is the result of our adoption of Statement of Financial Accounting Standards (SFAS) No. 142,Goodwill and Other Intangible Assets. Total selling, general and administrative expenses represented 64% of net sales in 2002 versus 56% of net sales in 2001. During the fourth quarter of 2002 management formulated a restructuring plan for the Company and executed a significant portion of the plan. The plan included employee terminations, office closures, the termination of collaborations and write-offs of intellectual property. It is expected that, as a result of the restructuring, our total operating expenses will be initially decreased by 20% to 25% from 2002 levels.

        Research and Development Expenses.    Research and development expenses increased 30% to $12.2 million in 2002 from $9.4 million in 2001. Research and development expenses consist of salaries and related personnel costs of researchers and software developers, material costs for prototypes and test units, legal expenses relating to intellectual property research and application development activities, testing and enhancement of our products, and amortization of intellectual property. We expense our research and development costs in the year in which they are incurred with the exception of certain capitalized software development costs. The increase in these expenses is attributable to increased personnel and personnel related expenses resulting from an expanded employee base during 2002, depreciation, amortization and supplies offset by increased amounts of capitalized software expenses related to the WAVE system operating software. Combined these items accounted for over 90% of the total increase. Total research and

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

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

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

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

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

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Years Ended December 31, 2001 and 2000

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

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

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

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

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

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

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

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

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

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

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

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

        In fiscal year 2003, current financial and cash flow projections indicate that we expect to use approximately $14.0 million in cash to fund further operating losses and our capital expenditures budget of approximately $8.4 million. The current capital expenditures budget mainly relates to the completion of the current projects in Boulder and Glasgow during the first half of 2003. We expect to meet this total cash need from existing cash as of December 31, 2002 of $13.3 million, additional cash generated from operations during 2003 and funds available to us under our new $5.0 million credit facility expected to be available during the second quarter of 2003. Current financial and cash flow projections indicate that operating cash is expected to turn positive during the fourth quarter of 2003. These projections may or may not be realized based upon actual operating results and project requirements, thus, during or after this period, if our existing cash and short-term investments, cash generated by operations and available borrowings under credit agreements is insufficient to satisfy our liquidity requirement, we may need to sell additional equity or debt securities, or obtain additional credit arrangements. We are currently pursuing additional financing of up to $5.0 million beyond the committed line of credit. We feel that such additional financing will be secured in 2003. However, we cannot assure you that any financing arrangement will be available in amounts or on terms acceptable to us.

Impact of Inflation

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

Recent Account Pronouncements

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

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

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

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

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

Foreign Currency Rate Fluctuations

 Historically,

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

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

 The primary objective of our investment activities is to preserve principal while at the same time maximizing the income

In 2003, we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the market value of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the market value of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. The average duration of all of our investments in 2002 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. Therefore, no quantitative tabular disclosure is presented. We recently committed toobtained a secured line of credit that carries a variable interest rate. This line of credit will exposeexposes us to interest rate riskrisk. If the prime lending rate in 2003.the United States were to increase we would experience higher interest costs. Based upon our total available credit of $7.5 million, a 1% increase in the prime rate would increase our annual interest expense by approximately $75,000. We no longer have short-term investments in debt securities that subject us to the market risks described in our 2002 Annual Report on Form 10-K.

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Item 8.    Financial Statements and Supplementary Data.

INDEPENDENT AUDITORS'AUDITORS’ REPORT

Board of Directors

Transgenomic, Inc.

Omaha, Nebraska

We have audited the accompanying consolidated balance sheets of Transgenomic, Inc. and subsidiaries (the Company) as of December 31, 20022003 and 20012002 and the related consolidated statements of operations, stockholders'stockholders’ equity (deficit) and cash flows for each of the three years in the period ended December 31, 2002.2003. These financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Transgenomic, Inc. and subsidiaries as of December 31, 20022003 and 2001,2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 20022003 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note R, during the first quarter of 2004, the Company obtained a waiver of the borrowing base limit on its existing line of credit and entered into a convertible note agreement. As discussed in Note A, in 2002 the Company changed its method of accounting for goodwill and other intangible assets in connection with the adoption of Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible AssetsAssets.. Also, as discussed in Note Q, on March 31, 2003, the Company received a commitment letter for a new revolving credit agreement.

/s/ DELOITTE & TOUCHE LLP

Deloitte & Touche LLP

Omaha, Nebraska
February 4, 2003 (March 31, 2003 as to the second paragraph of Note Q)

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TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 20022003 and 2001

2002

(In thousands except share and per share data)

See notes to consolidated financial statements.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2003, 2002 2001 and 2000

2001

(inIn thousands except share and per share data)