SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2004March 31, 2005

Or

For the transition period fromto            to

Commission file number: 000-30975

TRANSGENOMIC, INC.

(Exact name of registrant as specified in its charter)

(402) 452-5400

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934,    Yes  ¨    No  x

As of November 15, 2004,May 13, 2005, the number of shares of common stock outstanding was 29,070,651.34,234,922.

TRANSGENOMIC INC.

INDEX

PART II. FINANCIAL INFORMATION

Item 1. Financial Statements

Transgenomic, Inc. and SubsidiariesUNAUDITED CONSOLIDATED BALANCE SHEETS

Consolidated Balance Sheets (Unaudited)

(InDollars in thousands except share and per share data)

The accompanyingSee notes are an integral part of theseto consolidated financial statements.

Transgenomic, Inc. and SubsidiariesUNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

Consolidated Statements of Operations (Unaudited)

(InDollars in thousands except share and per share data)

The accompanyingSee notes are an integral part of theseto consolidated financial statements.

Transgenomic, Inc. and SubsidiariesUNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

Consolidated Statement of Cash Flows (Unaudited)

(In thousands)

(Dollars in thousands except per share data)

The accompanyingSee notes are an integral part of theseto consolidated financial statements.

Transgenomic, Inc. and SubsidiariesNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Notes to the Consolidated Financial Statements (Unaudited)

(InDollars in thousands except share and per share data)

A. CONSOLIDATED FINANCIAL STATEMENTS

The accompanying unaudited consolidated financial statements of Transgenomic, Inc. and Subsidiaries (the “Company”) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. In the opinion of management of the Company, all adjustments (consisting of only normal and recurring accruals)items) have been made to present fairly the financial positions, the results of operations and cash flows for the periods presented.

The results of operations for the ninethree months ended September 30,March 31, 2005 and 2004 and 2003 are not necessarily indicative of the results to be expected for the full year.

Although the Company believes that the disclosures are adequate to make the information presented not misleading, these financial statements should be read in conjunction with the consolidated financial statements for the period ended December 31, 2003,2004, that are included in the Company’s Annual Reportannual report on Form 10-K.10-K, as amended.

The Company has experienced recurring net losses and had an accumulated deficit of $109,993 at March 31, 2005. Based on the Company’s 2005 operating plan, management believes its existing sources of liquidity will be sufficient to meet its cash needs during 2005. If necessary, the Company’s management believes they can manage costs and expenses at reduced levels to conserve working capital. The need for any such cost and expense reductions during 2005 would likely delay implementation of the Company’s business plan. Additionally, management may pursue additional financing alternatives. Ultimately, the Company must achieve sufficient revenue levels to support its cost structure.

Principles of Consolidation.

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

Cash and Cash Equivalents.

For purposes of reporting cash flows, cash and cash equivalents include cash and temporary investments with original maturities at acquisition of three months or less.

Accounts Receivable.

Accounts receivable are shown net of allowance for doubtful accounts. The following is a summary of activity for the allowance for doubtful accounts during each of the three months ended March 31, 2005 and 2004.

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. The Company also enters into various service contracts that cover installed WAVE Systems.systems. These contracts cover specific time periods and revenue associated with these contracts is deferred and recognized over the service period. At March 31, 2005 and December 31, 2004, deferred revenue, mainly associated with the Company’s service contracts, included on the Company’s balance sheet was approximately $1,765 and $1,478, respectively.

During the first quarter ofthree months ended March 31, 2004, the Company recognized approximately $196,000$196 of product sales under bill-and-hold arrangements. Under these arrangements, the customer had accepted title and risk of ownership

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in thousands except per share data)

to the product, but had requested that the Company store the product on behalf of the customer, in a rented freezer, until the second quarter ofthree months ended June 30, 2004.

During There were no sales recognized during the second quarter of 2004, the Company recognized approximately $450,000 of product salesthree months ended March 31, 2005 under the bill-and-hold arrangement. Under these arrangements, the customer had accepted title and risk of ownership to the product, but had requested that the Company store the product on behalf of the customer, in a rented freezer, until the third quarter of 2004. As of September 30, 2004, all products under these arrangements had been shipped to the respective customers.arrangements.

Stock Based Compensation.

The Company accounts for its employee stock option grants under the provisions of Accounting Principles Board Opinion No. 25 (“APB”),Accounting for Stock Issued to Employees, which utilizes the intrinsic value method. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair market value of the Company’s common stock at the date of grant over the stock option exercise price. Stock option grants to nonemployeesnon-employees are accounted for using the fair value method of accounting in accordance with Statement of Financial Accounting Standards (SFAS)(“SFAS”) No. 123,Accounting for Stock-Based Compensation, using the Black-Scholes model.

Transgenomic, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Unaudited)

(In thousands except share and per share data)

The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123Accounting for Stock-Based Compensation, to stock based employee compensation.

B. INVESTMENTSTranslation of Foreign Currency.

AsFinancial statements of September 30, 2004 and December 31, 2003,subsidiaries outside the Company had no available-for-sale securities.

In January and March 2004,U.S. are measured using the Company enteredlocal currency as the functional currency. The adjustments to translate those amounts into addendums to an existing supply agreement with Geron Corporation. The addendums allowed Geron to pay for products being manufactured by the Company under the addendum with Geron common stock. These sharesU.S. dollars are being accounted for as available for sale securities. As a result in January 2004, Geron issued 85,885 shares of common stock, valued at $959,000, to the Company as a prepayment for products. On February 12, 2004 the Company sold these shares for $932,000 resultingaccumulated in a loss of $27,000, which is reflectedseparate account in stockholders’ equity and are included in accumulated other comprehensive income. Foreign currency transaction gains or losses resulting from changes in currency exchange rates are included in the current earningsdetermination of net income. Foreign currency transaction adjustments decreased net loss approximately $200 and cash flow from operations.

In March 2004, Geron issued 33,662 shares of common stock, valued at $289,000, to the Company as a prepayment$120 for products. In April 2004, Geron issued 140,872 shares of common stock, valued at $1,288,000, to the Company as prepayment and payment for products. On July 1, 2004 the company sold these shares for $1,361,328 resulting in a loss of $215,672, which is reflected in the current earnings and cash flow from operations.

In July, 2004, Geron issued 75,247 shares of common stock, valued at $601,371, to the Company as payment and prepayment for products. On July 28, 2004 and July 29, 2004, the Company sold these shares for $474,212 resulting in a loss of $127,159, which is reflected in the current earnings and cash flow from operations.

Included in accounts receivables at September 30, 2004 are amounts due from Geron totaling $1.3 million. In October 2004 these Geron receivables were exchanged for 208,131 shares of Geron common stock. During November 2004, the Company sold these shares for $1.5 million resulting in a gain of $173,000 that will be recognized during the three months ending Decemberended March 31, 2004.2005 and 2004, respectively.

C. INVENTORIESEarnings Per Share.

At September 30, 2004,Basic earnings per share are calculated based on the weighted-average number of common shares outstanding during each period. Diluted earnings per share include shares issuable upon exercise of outstanding stock options and December 31, 2003, inventories consistedwarrants or conversion of the following:convertible notes, where dilutive.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Transgenomic, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Unaudited)

(InDollars in thousands except share and per share data)

As of September 30,Recently Issued Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R,Share-Based Payment. SFAS No.123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using APB No. 25 and generally requires that such transactions be accounted for using a fair-value-based method. The Company had approximately $5.0 millionexpects to adopt this standard on January 1, 2006. The Company is currently assessing the final impact of chemical building block inventory.this standard on its financial position, results of operations or cash flows. This assessment includes evaluating option valuation methodologies and assumptions as well as potential changes to compensation strategies.

On November 24, 2004, the FASB issued SFAS No. 151,Inventory Costs – an amendment of ARB No. 43. SFAS No. 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs be excluded from the cost of inventory and expensed when incurred. It also requires that allocation of fixed production overhead be based on the normal capacity of the production facilities. SFAS No. 151 will be effective at the beginning of 2006. The Company is currently assessing the final impact of this standard on its financial position, results of operations or cash flows.

Use of Estimates.

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

B. INVENTORIES

Inventories consisted of the following at March 31, 2005 and December 31, 2004:

The Nucleic Acids operating segment inventory at March 31, 2005 and December 31, 2004 consisted primarily includesof phosphoramadites and the raw materials to produce phosphoramadites. Based on an analysisphosphoramadites which are used and produced at the Company’s facility in Glasgow, Scotland. As of these chemical building blocks as of September 30, 2004 and sales forecast for phosphoramidites,March 31, 2005, the Company has classified $2.7 milliona portion of this inventory as a long-term other asset under “Intangibles and Other Assets”. The remaining chemical building block inventory of $2.3 million is expected to be sold within twelve months and, accordingly, continues to be classified as current assets.based on its existing sales forecasts for these products.

The Company periodically evaluates its inventory of chemical building blocks to determine whether they continue to meet quality and other specifications and over what time period such products are expected to be sold. Product that does not meet quality and other specifications can generally be re-worked to enhance purity. CostCosts to purify such product and related yield losses will beare expensed as incurred.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in thousands except per share data)

C. GOODWILL

At March 31, 2005 and December 31, 2004, goodwill by operating segment consisted of the following:

D. INTANGIBLE AND OTHER ASSETS

At September 30, 2004,March 31, 2005 and December 31, 2003,2004, finite lived intangible assets and other assets consisted of the following:

Amortization expense for intangible assets was $242,121approximately $249 and $205,000$243 during the three months ended September 30, 2004, and 2003, respectively. The Company expects amortization expense for intangible assets to be approximately $345,000 for the remainder of 2004, $1,022,000 in fiscal 2005, $367,000 in fiscal 2006, $377,000 in fiscal 2007, $77,000 in fiscal 2008, $104,000 in fiscal 2009 and $104,000 in fiscal 2010.

E. GOODWILL

At September 30, 2004, and December 31, 2003, goodwill by operating segment consisted of the following:

Transgenomic, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Unaudited)

(In thousands except share and per share data)

During the three months ended March 31, 2005 and 2004, respectively. Amortization expense for intangible assets is expected to be approximately $763 for the remainder of 2005, $342 in 2006, $330 in 2007, $62 in 2008, $133 in 2009, $133 in 2010 and $26 in 2011

E. DEBT

At March 31, 2005 and December 31, 2004, debt consisted of the following:

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in thousands except per share data)

On March 18, 2005, Laurus agreed to extend the borrowing base waiver on the Credit Line until March 31, 2006. In connection with this extension, the Company agreed to allow Laurus to convert $1,879 of the outstanding principal balance under the Credit Line into 3,600,000 shares of its common stock at $0.52 per share. In addition, on March 24, 2005 the Company agreed to allow Laurus to convert $650 of the outstanding principal balance of the Term Note into 1,250,000 shares of common stock at $0.52 per share. Laurus agreed to apply this Term Note conversion against substantially all remaining 2005 scheduled principal payments on such loan. The closing market price of the Company’s Boardcommon stock the day before each of Directors directed managementthese conversions was $0.58 per share. No other provisions of our Credit Line or Term Note (collectively, the “Laurus Loans”) were modified, including the $1.00 conversion price for remaining debt. In conjunction with these conversions we accelerated amortization of $409 of related debt premiums and discounts and recorded a charge of $1,365 related to explore strategic alternativesfair value of incremental shares received by Laurus.

Interest expense consisted of the following:

Principal repayments under the Term Note are scheduled as follows: $0 for the Nucleic Acids operating segment. The ongoing process has included significant due diligence by management, its advisorsremainder of 2005, $875 in 2006, and prospective independent buyers and other interested parties.

Based upon information obtained through this process during the three months ended June 30, 2004, management determined that it was more likely than not that the assets of the Nucleic Acids business were impaired. Accordingly, the Company engaged an external valuation firm to assist with the completion of a mid-year impairment test. As a result, the Company recorded a non-cash charge of $11,964,387 related to its Nucleic Acids segment during the three months ended June 30, 2004. The charge consisted of $9,864,387 related to the impairment of goodwill and $2,100,000 related to the impairment of property and equipment.$800 in 2007.

F. STOCKHOLDERS’ EQUITY AND STOCK OPTIONS

Other Comprehensive Income.Results of operations for the Company’s foreign subsidiary are translated using the average exchange rates during the period. Assets and liabilities are translated at the exchange rate in effect on the balance sheet dates. These translation adjustments, along with unrealized gains and losses on available-for-sale securities, are the Company’s only components of other comprehensive income.

Stock Options.During the nine months ended September 30, 2004, the Company granted 360,000 options at an exercise price of between $1.32 to $2.57 per share. The following table summarizes activity under the 1997 Stock Option Plan during the nine months ended September 30, 2004.

The weighted average fair value of options granted during the first nine months of fiscal 2004 was $1.34 per share. The fair value of each stock option granted is estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for options granted in the first nine months of fiscal 2004: no common stock dividends; risk-free interest rates of 4.14% to 4.79%; 85% volatility; and an expected option life of 3 years. At September 30, 2004, the weighted average remaining contractual life of options outstanding was 5.6 years.

G. COMMITMENTS AND CONTINGENCIES

The Company has has been named as a defendant in a lawsuit filed in Spain by a prospective distributor who claims that the Company breached a promise to grant the plaintiff a distributorship for certain of the Company’s products in a specific geographic area in Europe. The plaintiff is seeking monetary relief of approximately $500,000.$500. The Company believes the lawsuit is without merit and intends to vigorously defend this matter.

Transgenomic, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Unaudited)

(In thousands except share and per share data)

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

The Company leases certain equipment, vehicles and operating facilities. The Company’s leases related to its operating facilities currently expire on various dates through 2010. At March 31, 2005, the future minimum lease payments required under non-cancellable lease provisions are approximately $1,092 for the remainder of 2005, $1,384 in 2006, $441 in 2007, $187 in 2008, $191 in 2009, and $181 in 2010. Rent expense related to all operating leases for the three months ended March 31, 2005 and 2004 was approximately $237 and $585, respectively.

H.At March 31, 2005, the Company had firm commitments totaling $477 to a vendor to purchase components used in WAVE Systems.

G. INCOME TAXES

The Company’sIncome tax expense (benefit) relatesrecorded during the three months ended March 31, 2005 and 2004 related to its operationsincome taxes in certainstates, foreign countries and certain states. The tax benefit recorded during the nine months ended September 30, 2004 relates toother local jurisdictions offset by refunds receivedreceived.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in the United Kingdom. thousands except per share data)

Due to the Company’s cumulative losses, expected losses in future years and inability to utilize any additional losses as carrybacks, the Company has not provided for an income tax benefit during the ninethree months ended September 30,March 31, 2005 or 2004 based on management’s determination that it was more likely than not that such benefits would not be realized. The Company will continue to assess the recoverability of deferred tax assets and the related valuation allowance. To the extent the Company begins to generate taxable income in future periods and it determines that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time. As of September 30, 2004,March 31, 2005 and December 31, 2003,2004, the Company’s deferred tax assets were offset by a valuation allowance of approximately $41.4 million$39,417 and $30.6 million,$38,287, respectively.

H. STOCKHOLDERS’ EQUITY

During three months ended March 31, 2005, the Company issued 4,900,000 shares of common stock in conjunction with conversions under the Laurus Loans.

I. STOCK OPTIONS

During the three months ended March 31, 2005, the Company granted 172,500 options at an exercise price of $1.09 per share. The following table summarizes activity under the 1997 Stock Option Plan during the three months ended March 31, 2005.

The weighted average fair value of options granted during the three months ended March 31, 2005 was $0.59 per share. The fair value of each stock option granted is estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for options granted three months ended March 31, 2005: no common stock dividends; risk-free interest rates of 4.14% to 4.79%; 85% volatility; and an expected option life of 3 years. At March 31, 2005, the weighted average remaining contractual life of options outstanding was 5.2 years.

The following table summarizes information about options outstanding as of March 31, 2005:

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Dollars in thousands except per share data)

J. OPERATING SEGMENT AND GEOGRAPHIC INFORMATION

The Company’s operations are managed 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 (loss).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 (loss) for the segment. Generally, decisions regarding asset allocation, financing, taxes or other items impacting the Company’s balance sheet are made at the corporate level and, accordingly, operating segment balance sheet information is not typically reviewed by operating segment.decision makers.

The BioSystems operating segment generates revenue from the sale of automated instrument systems and associated consumable products and services. This segment’s 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,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 segment’s main products are nucleic acid building blocks or phosphoramidites, oligonucleotides,“phosphoramidites,” fluorescent markers, dyes and associated reagents and novel chemistry and process development services.

The following is information fortable sets forth net sales and loss from operating income (loss) by segment.

During the three months ended March 31, 2005, sales to Novartis Pharmaceuticals, Inc. totaled $717 and represented 10% of net sales within the BioSystems Operating segment and 10% of total consolidated net sales.

Transgenomic, Inc. and SubsidiariesNOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Notes to the Consolidated Financial Statements (Unaudited)

(InDollars in thousands except share and per share data)

J. LINE OF CREDIT AND LONG-TERM DEBT

During the three months ended March 31, 2004, sales to Geron Corporation (“Geron”) totaled $722 and represented 32% of net sales within our Nucleic Acids operating segment and 8% of total consolidated net sales. In December 2003, the Company entered into a $7.5 million linefirst quarter of credit (the ”Credit Line”) with Laurus Master Fund, Ltd. (“Laurus”). The term of the Credit Line is three years carrying an interest rate of 2.0% over the prime rate or a minimum of 6.0%. Funds available under the Credit 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. The Credit Line is secured by most of the Company’s assets. Prior to amendments to the Credit Line discussed below, payment of interest and principal could, under certain circumstances, be made with shares of the Company’s common stock at a fixed conversion price of $2.20 per share. Conversion of this debt to common stock may be made at the election of Laurus or the Company. The Company could elect to convert only if its shares trade at a price exceeding $2.42 per share for ten consecutive trading days, and such conversion is further subject to trading volume limitations and a limitation on the total beneficial ownership by Laurus of the Company’s common stock. Upon entering into the Credit Line, the Company issued warrants to Laurus to acquire 550,000 shares of the Company’s common stock at an exercise price exceeding the average trading price of the Company’s common stock over the ten trading days prior to the date of the warrant. As of September 30, 2004, the Company had approximately $7.1 million outstanding on the Credit Line.

In February 2004, the Company entered into a separate $2.75 million convertible noteaddendums to an existing supply agreement with Laurus (the ”Term Note”).Geron. The Term Note carries an interest rate of 2.0% over the prime rate or a minimum of 6.0% and has a term of 3 years. Prioraddendums allowed Geron to amendments to the Term Note discussed below, the principal and interest on the Term Note could be converted into common stock ofpay for products being manufactured by the Company atunder the addendum with Geron common stock. The following is a fixed conversion pricesummary of $2.61 per share. Upon entering the Term Note,Geron shares received and sold by the Company issued warrants to Laurus to acquire 125,000 shares of its common stock. Borrowings underduring the Term Note were primarily used to retire the mortgage debt on the Company’s Glasgow facility. Remaining borrowings of approximately $750,000 were used to complete the build-out of the Glasgow facility, complete the consolidation the Company’s Glasgow operations into the new facilitythree months ended March 31, 2005 and provide funds for operations.2004.

Certain features of the Credit Line and Term Note (collectively, the “Laurus Loans”) require the Company

Subsequent to separately account for the value of certain amounts related to the warrantsMarch 31, 2005, Geron issued and the conversion feature of the Laurus Loans. Specifically, Emerging Issues Task Force (“EITF”) No. 00-27,Application of Issue No. 98-5 to Certain Convertible Instruments, requires the Company to separately value the warrants issued and the “beneficial conversion premium” related to the Laurus Loans. Any borrowings under the Credit Line may result in additional beneficial conversion premiums. The values of the warrants and the beneficial conversion premium have been recorded on the balance sheet101,801 shares valued at $608 as a debt discount and an increaseprepayment for products that are expected to additional paidbe completed in capital. The debt discount recorded for these items will be amortized as expense to the income statement over the termssecond half of the Laurus Loans or as the warrants are exercised or the debt is converted into common stock thereby increasing the effective interest rate on the Laurus Loans. In January and February 2004, Laurus exercised its conversion rights on the Credit Line and converted $2.0 million of amounts outstanding on the Credit Line into approximately 910,0002005. These shares of common stock of the Company. In connection with this conversion, the Company accelerated the amortization of approximately $539,000 of the beneficial conversion premium.

In February 2004, Laurus waived the borrowing base limitation on the Credit Line, thereby making the full $7.5 million facility available to the Company regardless of the available collateral. On August 31, 2004, Laurus agreed to extend the borrowing base waiver on the Credit Line through March 19, 2005. In addition, Laurus

Transgenomic, Inc. and Subsidiaries

Notes to the Consolidated Financial Statements (Unaudited)

(In thousands except share and per share data)

deferred certain payments due under the Term Note and reduced the interest rate on both of the Laurus Loans to 0% for any day the closing sale price of the Company’s common stock is at or above $1.75 per share. In return, the Company lowered the conversion price on each of the Laurus Loans to $1.00 per share and issued a warrant to Laurus covering an additional 400,000 common shares at an exercise price of $1.25 per share. The closing price of the Company’s common stock on August 31, 2004 was $1.20 per share.

The August 31, 2004 Laurus modifications were treated as extinguishments for financial reporting purposes since the change in present value of expected cash flows between the original and modified agreements is greater than 10%. As such, the Company recorded a loss on extinguishment of debt of $2.9 million at August 31, 2004 reflecting the difference between (i) the recorded amount of debt, net of related discounts, of $7.4 million and (ii) the fair value of the new debt instrument of $10.3 million plus the fair value of the new warrants of $120,000. The difference between the fair value of the new debt of $10.3 million and the face value of the debt of $8.6 million represents a premium, which will be reflected as a reduction of interest expense over the life of the new debt.

Prospectively, draws on the Credit Line may result in beneficial conversion charges to the extent the price of the Company’s common stock exceeds the conversion price on the day of the draw. Such beneficial charges will be amortized as expense to the income statementsold during the period the draw remains outstanding or up to the point the debt is converted into common stock thereby increasing the effective interest rate on the Credit Line.

The following table details the componentssecond quarter of the Company’s Credit Line, Term Loan and other debt as2005 for $617 resulting in a gain of September 30, 2004 and December 31, 2003.$9.

K. CORPORATE RESTRUCTURING PLAN

The Company has historically experienced net losses and negative cash flows from operations. As a result, during the fourth quarter of fiscal 2002, management formulated a restructuring plan designed to reduce expenses thereby better aligning the Company’s expense structure with current business prospects. The plan included employee terminations, office closures, and termination of collaborations and write-offs of abandoned intellectual property. A significant portion of the plan was executed in the fourth quarter of 2002 resulting in the recording of $3.3 million in restructuring charges. The Company had accrued expenses and other liabilities associated with theits 2004 restructuring activitiesplan of approximately $3,365$931 and $227,000$1,909 at September 30, 2004,March 31, 2005 and December 31, 2003,2004, respectively. The accrued expensesbalance at September 30, 2004, were relatedMarch 31, 2005 relates primarily to lease payments associated with office closures.

Transgenomic, Inc.future rents on closed facilities (net of projected sublease rents) of which $602 is expected to be paid during the remainder of 2005 and Subsidiaries

Notes to the Consolidated Financial Statements (Unaudited)

(In thousands except share$329 in 2006 and per share data)thereafter.

L. SUBSEQUENT EVENTSRESTATEMENTS OF CONSOLIDATED STATEMENTS OF CASH FLOWS

Sale of Specialty Oligonucleotides Facility. On November 11, 2004,Subsequent to the Company sold the assets associated with its specialty oligonucleotides manufacturing facility in Boulder, Colorado to a subsidiary of Eyetech Pharmaceuticals, Inc. (“Eyetech”). The sale price was $3.0 million in cash plus the assumptionissuance of the lease onCompany’s financial statements for the Boulder facility and certain equipment leases with a gross value of $2.3 million. Substantially all of the 27 employees at the Boulder facility became Eyetech employees. Net proceeds from the sale (after transaction expenses and fees paid to the Company’s investment advisors) equaled approximately $2.7 million, subject to a holdback of $300,000 that will be held in escrow for 90 days for liabilities for representations and warranties and to pay the costs of moving certain acquired assets to the Boulder facility. The net proceeds will be used primarily for general working capital purposes and to repay a portion of the Credit Line. The sale will be recognized during the quarter endingyear ended December 31, 2004, and is not expected to a significant effect on earnings duringthe Company’s management determined that quarter.it had incorrectly included the amortization of software development costs within net cash flows from investing activities rather than within net cash flows from operating activities.

Restructuring Plan. On November 13, 2004, the Board of Directors approvedAs a restructuring plan designed to refocus the Company on its BioSystems business segment and to alignresult, the Company’s cost structure with anticipated revenues. The plan (which is incrementalunaudited consolidated statement of cash flows for the three months ended March 31, 2004 have been restated from the amounts previously reported to the sale of the Boulder facility previously summarized) includes a workforce reduction of approximately 60 positions and the closure of two domestic research and development facilities associated withcorrect these errors. This restatement had no impact on the Company’s nucleic acids operation segment and two European field offices.consolidated balance sheets or consolidated statements of operations. The majorityimpact of workforce reductions will be completed bythis restatement on the endconsolidated statements of November 2004. The plancash flows is expected to yield annualized savings of $6.0 to $8.0 million once the cost reductions are fully implementedas follows: (dollars in the first quarter 2005. In conjunction with the plan, the Company expects to incur a charge of between $1.5 million to $1.8 million during the quarter ending December 31, 2004, related primarily to severance, benefits and facility closures.thousands):

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be readanalysis gives effect to the restatement of our statements of cash flows for the quarter ended March 31, 2004, as discussed in conjunction with ourNote L to the accompanying unaudited consolidated financial statements and notes included elsewhere in this filing.statements.

Overview

We provide innovative products and services for the synthesis, purification and analysis of nucleic acids. We develop, assemble,Our operations fall into two principal business units, BioSystems and Nucleic Acids. Our BioSystems products include our WAVE^® automated instrument systems, WAVE associated consumable products and other related consumable products. Our Nucleic Acids products consist principally of chemical building blocks for nucleic acid synthesis. Both business units have service offerings as well, including genetic variation discovery and analysis services and custom synthesis of specialty nucleic acids.

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

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

Our third core competency is nucleic acid chemistries. Our synthetic nucleic acid products consist of chemical building blocks of nucleic acids (known as phosphoramidites). We also manufacture related specialty chemicals such as fluorescent markers and molecular tags, dyes, quenchers, linkers, and solvents used to analyze DNAmodify nucleic acids for subsequent detection or RNA atmanipulation. These products are used by research organizations, diagnostic companies and pharmaceutical companies. These products are produced primarily in our Glasgow, Scotland facility. Prior to November 11, 2004, we had also manufactured synthesized segments of nucleic acids (known as oligonucleotides) in a facility in Boulder, Colorado. On November 11, 2004, we sold the 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 chainassets associated with this facility to a subsidiary of Eyetech Pharmaceuticals, Inc. As a result of this sale, we no longer manufacture and sell these activities by providing key technology, tools, consumables, biochemical reagents and services to those entities engaged in basic biomedical research and the development of diagnostics and therapeutic agents.specialized oligonucleotides.

The Company’sOur operations are managed based upon the nature of the products and services provided. Accordingly, the Company has determined that it operateswe operate in two reportable segments, BioSystems and Nucleic Acids. Operations for these segments are evaluated based upon specific identification of revenues and expenses associated with the business activities resulting in a segment operating income. Expenses that cannot be directly identified to an operating activityincome or are considered corporate overhead are not allocatedloss. See the Notes to the segmentsaccompanying consolidated financial statements for detailed segment information.

To respond to changes in arriving at operating income for the segment.

Theoverall business climate and our liquidity position, we instituted significant changes during the fourth quarter of 2004 designed to, among other things, better align our cost structure with projected revenues, focus on opportunities in our BioSystems operating segment, generates revenue fromand minimize the saleadverse financial effect of automated instrument systems and associated 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.

Theour Nucleic Acids operating segment has been engaged insegment. Specifically, during the manufacturefourth quarter of nucleic acid building blocks or phosphoramidites, oligonucleotides, fluorescent markers, dyes and associated reagents and novel chemistry and process development services. This operating segment has historically operated at a loss and the Company has been exploring strategic alternatives regarding this operating segment during 2004. On November 11, 2004, we sold the assets associated with our specialty oligonucleotide manufacturing facility in Boulder, Colorado and implemented a restructuring plan (the “2004 Restructuring Plan”). While the primarily goals of these changes were to provide the foundation for a subsidiary of Eyetech Pharmaceuticals, Inc. As a result,self-sustaining, growth-oriented company with positive cash flows and earnings, there can be no assurance that we no longer manufacture and sell oligonucleotides.can achieve these goals.

Executive Summary and Operating Strategy

An increasing installed base and strong performance from Discovery Services, fueled 8% revenue growth in our BioSystms operating segment during the first quarter of 2005 compared to the same period of 2004. Revenues from our Nucleic Acids operating segment did not meet our expectations during the quarter; however, amendments recently executed with Geron Corporation (“Geron”) and other customers provide significant backlog for the remainder of 2005.

Expenses for the first quarter of 2005 reflect the benefits we expected to receive from the sale of our Boulder, Colorado facility and the 2004 Restructuring Plan. Our loss from operations of $1.23 million (including depreciation and amortization expense of $1.05 million) and cash flows used by operations of $0.21 million ranked among the best quarters since our initial public offering in 2000, and demonstrated significant progress toward our goal of generating positive operating and net cash flows. Foreign currency charges totaling $0.20 million during the quarter were not expected and adversely affected our loss from operations and cash flows from operations. We have incurred significant losses resulting principallyspent $0.94 million during the quarter to fund our 2004 Restructuring Plan, which also adversely affected cash flow from operations. These restructuring costs incurred in researchwere expected and developmenthad been previously accrued. We are assessing strategies to effectively manage our foreign exchange risk (which could be significant) and selling, general and administrativedo not expect cash paid for restructuring costs associated with our operations. At September 30, 2004, we had an accumulated deficit of $100.2 million. to recur at these levels.

Our liquidity and working capital positions deterioratedimproved during the first quarter predominatelyof 2005 due principally to operating losses. These operating losses were funded primarily by borrowingsconversions of borrowing under our credit facility and reductions in accounts receivables.

While we expect to continue to incur substantial research and development and selling, general and administrative costs, we have implemented an operating strategy which is designed to refocus on the BioSystems segment of our business and to align our cost structure with projected revenues. We have initiated the following steps to accomplish this objective.

Strategic Alternatives For Our Nucleic Acids Operating Segment. Our Nucleic Acids operating segment has historically operated at a loss and produced negative cash flow. While we believe the long-term prospects for this business segment are favorable, the projected levels of near-term revenues from this segment are not expected to generate either positive cash flows or profits from operations. After considering, among other factors, the historical financial results of this division and the near-term outlook for the nucleic acids industry, our

Board of Directors directed management to explore strategic alternatives for this operating segment, including the possible sale of one or both of the facilities in Glasgow, Scotland and Boulder, Colorado. On November 11, 2004, the Company sold the assets associated with its specialty oligonucleotide manufacturing facility in Boulder, Colorado to a subsidiary of Eyetech Pharmaceuticals, Inc.line (“Eyetech”). The sale price was $3.0 million in cash plus the assumption of the lease on the Boulder facility and certain equipment leases with a gross value of $2.3 million. Substantially all of the 27 employees at the Boulder facility became Eyetech employees. Net proceeds from the sale (after transaction expenses and fees paid to our investment advisors) equaled approximately $2.7 million, subject to a holdback of $300,000 that will be held in escrow for 90 days for liabilities for representations and warranties and to pay the costs of moving certain acquired assets to the Boulder facility. The net proceeds will be used primarily for general working capital purposes and to repay portion of our credit line. We have also taken steps to downsize our remaining nucleic acids facility in Glasgow, Scotland as part of the restructuring plan described below.

Restructuring Plan. On November 13, 2004, the Board of Directors approved a restructuring plan designed to refocus the Company on its BioSystems business segment and to align the Company’s cost structure with anticipated revenues. The plan (which is incremental to the sale of the Boulder facility previously summarized) includes a workforce reduction of approximately 60 positions and the closure of two domestic research and development facilities associated with our nucleic acids operating segment and two European field offices. The majority of workforce reductions will be completed by the end of November 2004. The plan is expected to yield annualized savings of $6.0 to $8.0 million once the cost reductions are fully implemented in the first quarter 2005. In conjunction with the plan, the Company expects to incur a charge of between $1.5 million to $1.8 million during the quarter ending December 31, 2004 related primarily to severance, benefits and facility closures. Additionally, we have adopted processes to improve the collection of accounts receivables, especially with respect to sales in European markets which historically have longer payment cycles. Finally, we have taken steps to more appropriately align the timing of our inventory acquisitions with anticipated sales.

Together, the sale of our oligonucleotide manufacturing facility and the November 13, 2004 restructuring plan, is expected to result in $10.0 to $12.0 million in annual cost savings.

Revisions to Credit Facilities. We have entered into a $7.5 million line of credit (the ”Credit Line”) and a separate $2.75 million convertibleterm note with Laurus (the ”Term(“Term Note”) (collectively, the “Laurus Loans”) with Laurus Master Fund, Ltd. (“Laurus”) (collectively, the “Laurus Loans”). In February 2004, Laurus waived the borrowing base limitation on the Credit Line, thereby making the full $7.5totaling $2 million facility available to the Company regardlessinto common stock. The accounting effects of the available collateral. On August 31, 2004, Laurus agreed to extend the borrowing base waiver on the Credit Line through March 19, 2005. In addition, Laurus has deferred certain payments due under the Term Noteconversions and reduced the interest rate on both of the Laurus Loans to 0% for any day the closing sale price of the Company’s common stock is at or above $1.75 per share). In return, we lowered the conversion price on each of the Laurus Loans to $1.00 per share and issued a warrant to Laurus covering an additional 400,000 common shares at an exercise price of $1.25 per share. The closing price of the Company’s common stock on August 31, 2004 was $1.20 per share.

The revisionsmodifications to the Laurus Loans agreements, alonghad an adverse effect on our reported results. Interest expense during the quarter totaled $1.66 million, representing an effective annual interest yield approaching 100%. However, interest actually paid or accrued on this debt totaled only $0.17 million. The remainder of the expense related primarily to net amortization of discounts and premiums plus non-cash charges associated with the anticipated liquidity benefits resulting fromaforementioned conversion of Laurus Loans into shares of our common stock. We continue to evaluate alternatives to simplifying our capital structure and enhancing the saletransparency of the Boulder facility and implementation of the restructuring plan are expected to significantly improve our liquidity position. However, there can be no assurance that these initiatives alone will be sufficient to allow the Company to operate without additional capital.reported results.

Results of Operations Three Months Ending September 30, 2004 and 2003