D. OTHER ASSETSimpairment or disposal of long-lived assets and supersedes SFAS No. 121, and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30,Reporting the Results of Operations, for a disposal of a segment of a business. The Company periodically reviews the carrying value of its long-lived assets to assess recoverability and impairment. The Company recorded no impairments during the three and six months ended June 30, 2007 or 2006.

Finite livedOther assets include intellectual property, patents, other intangible assets, and other assets consistedlong-term assets.

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

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

Amortization expense forOther Intangible Assets. Identifiable intangible assets was $10with definite lives are amortized over their estimated useful lives and $222 duringtested for impairment as events or changes in circumstances indicate the three months ended September 30, 2006 and 2005, respectively, and $160 and $717 for the nine months ended September 30, 2006 and 2005, respectively. Amortization expense for intangible assets is expected to be approximately $11 for the remainder of 2006, $40 in eachcarrying amount of the next four yearsasset may be impaired.

Other Long-Term Assets. Other long-term assets consist primarily of demonstration inventory that has been at customer or prospective customer sites for greater than one year and $37 in 2011.security deposits on leased facilities. Long-term demonstration inventory is stated at the lower of cost or market.

E. DEBTStock Based Compensation.

The Company had no debt at September 30, 2006 or December 31, 2005.

In December 2003, the Company entered into a $7,500 line of credit (the “Credit Line”) with Laurus Master Fund, Ltd. (“Laurus”). The term of the Credit Line was three years carrying an interest rate of 2.0% over the prime rate or a minimum of 6.0%. The Credit Line was secured by most of the Company’s assets. In February 2004, the Company entered into a separate $2,750 convertible note with Laurus (the “Term Note”). The Term Note carried an interest rate of 2.0% over the prime rate or a minimum of 6.0%. The Company issued warrants covering 1,136,484 common shares of the Company in conjunction with the Credit Line and Term Note (collectively, the “Laurus Loans”). Principal and interest on the Laurus Loans could be converted into commonAll stock of the Company at a fixed conversion price of $1.00 per share.

Certain features of the Laurus Loans required the Companyoptions awarded to separately account for the value of certain amounts relateddate have exercise prices equal to the warrants 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, required the Company to separately value the warrants issued and the “beneficial conversion premium” related to the Laurus Loans. The values of the warrants and the beneficial conversion premium were recorded on the balance sheet as a debt discount and an increase to additional paid in capital. The debt discount recorded for these items was amortized as expense to the income statement over the terms of the Laurus Loans or as the debt was converted into common stock thereby increasing the effective interest rate on the Laurus Loans.

On March 18, 2005, the Company agreed to allow Laurus to convert $1,872 of the outstanding principal balance under the Credit Line into 3,600,000 shares of its common stock. 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. The closing market price of the Company’s common stock on the day before eachdate of these conversions was $0.58 per share. No other provisionsgrant and have ten-year contractual terms. Unvested options as of June 30, 2007 had vesting periods of three years from date of grant. None of the Credit Linestock options outstanding at June 30, 2007 are subject to performance or Term Note were modified, including the $1.00 conversion price for remaining debt. In

TRANSGENOMIC, INC. AND SUBSIDIARIESmarket-based vesting conditions.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Nine Months Ended September 30, 2006 and 2005

(Dollars in thousands except per share data)

conjunction with these conversionsThe Company adopted Financial Accounting Standards Board (FASB) Statement No. 123(R),Share-Based Payment (“FAS 123(R)”), on January 1, 2006. FAS 123(R) requires the Company accelerated amortization of $0.41 million of related debt premiumsto measure and discountsrecognize compensation expense for all stock-based awards made to employees and recorded a charge to interestdirectors, including stock options. Compensation expense of $1.37 million related tois based on the calculated fair value of incremental shares received by Laurus.

Interest expense consistedthe awards as measured at the grant date and is expensed ratably over the service period of the following:

Contemporaneously withawards (generally the closing of a private placement of the Company’s common stock on October 31, 2005 (the “2005 Private Placement”), the Company repaid all outstanding principal and accrued interest on the Laurus Loans which have been cancelled and are no longer available to the Company.

F. COMMITMENTS AND CONTINGENCIESvesting period).

The Company is subject to a number of claims of various amounts, which arise out of the normal course of business. In the opinion of management, the disposition of pending claims will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

During the three months ended September 30, 2006, the Company was notified by one of its OEM instrument suppliers (the “Supplier”) that its primary creditor filed a petition against the Supplier requesting the appointment of a receiver. The Supplier, its shareholders and creditors, and the court-appointed receiver are evaluating alternatives, including the sale or liquidation of the Supplier. The Company has sold 16 of the Supplier’s instruments over the past three years resulting in net sales of $2,988. The Company continues to provide warranties and support for 11 of these instruments (six of which are in their initial 12-month warranty period), with such obligations expiring at various times through 2010. While agreements between the Company and the Supplier provide for the Supplier’s technologies (engineering designs, etc.) to be escrowed for the Company’s benefit, there are no assurances that the Company can continue to support these OEM customers without proprietary bioconsumables, component parts and technical assistance currently provided by the Supplier. The Company continues to coordinate with management of the Supplier, evaluate alternatives and evaluate the impact, if any, on the Company’s financial position, results of operations or cash flows.

The Company leases certain equipment, vehicles and operating facilities under non-cancellable operating leases that expire on various dates through 2014. The future minimum lease payments required under these leases are approximately $335 for the remainder of 2006, $732 in 2007, $409 in 2008, $381 in 2009, $257 in 2010 and $93 thereafter. Rent expense for continuing operations related to all operating leases for the three months ended September 30, 2006 and 2005 was approximately $260 and $238, respectively, and for the nine months ended September 30, 2006 and 2005 was $774 and $730, respectively.

At September 30, 2006 and December 31, 2005, firm commitments to vendors to purchase components used in WAVE^® systems and instruments manufactured by others totaled $1,161 and $879, respectively. The Company expects to satisfy these purchase commitments during 2006 and 2007.

G. INCOME TAXES

Income tax expense during relates to income taxes in states, foreign countries and other local jurisdictions offset by refunds received. While the Company has significant net operating loss carryforwards, it is likely that Section 382

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Nine Months Ended September 30, 2006 and 2005

(Dollars in thousands except per share data)

(Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change) of the Internal Revenue Code, and the regulations promulgated there under, will significantly limit the amount of net operating loss carry forward that the Company could utilize in any tax year. As of September 30, 2006 and December 31, 2005, deferred tax assets totaled $43,450 and $42,561, respectively, that were fully offset by valuation allowances.

H. EMPLOYEE BENEFIT PLAN

The Company maintains an employee 401(k) retirement savings plan that allows for voluntary contributions into designated investment funds by eligible employees. The Company matches the employees’ contributions at the rate of 50% on the first 6% of contributions. The Company may, at the discretion of its Board of Directors, make additional contributions on behalf of the Plan’s participants. Company contributions to the 401(k) plan were $40 and $45 for the three months ended September 30, 2006 and 2005, respectively, and $123 and $135 for the nine months ended September 30, 2006 and 2005, respectively.

I. STOCKHOLDERS’ EQUITY

Common Stock.

During the three and nine months ended September 30, 2006, the Company issued zero and 7,551 shares of common stock, respectively, under the Transgenomic, Inc. 2001 Employee Stock Purchase Plan. During the three and nine months ended September 30, 2005, the Company issued, 5,055 and 15,462 shares of common stock, respectively, under the Transgenomic, Inc. 2001 Employee Stock Purchase Plan. No additional stock will be issued under this plan as it was terminated in December 2005.

During the three and nine months ended September 30, 2005, the Company issued 4,900,000 shares of common stock in conjunction with conversions under the Laurus Loans as follows:

Common Stock Warrants.

No common stock warrants were issued during the nine months ended September 30, 2006 or 2005. At September 30, 2006, the Company had 8,062,577 common stock warrants outstanding.

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Nine Months Ended September 30, 2006 and 2005

(Dollars in thousands except per share data)

J. STOCK OPTIONS

During the three months and nine months ended September 30, 2006, the Company issued 225,000 options at exercise prices of $0.68 and 15,000 options at exercise prices $1.09. The following table summarizes activity under the Company’s 2006 Equity Incentive Plan (formerly, the 1997 Stock Option Plan) during the nine months ended September 30, 2006:

On December 28, 2005, the Company’s Directors approved a plan to accelerate the vesting of all outstanding stock options. Aside from the acceleration of the vesting date, the terms and the conditions of the stock option award agreements governing the underlying stock option grants remained unchanged. As a result of this plan, options to purchase approximately 1,081,845 shares became immediately exercisable. All such options were out-of-the-money and, accordingly, the accelerated vesting resulted in no compensation expense since there was no intrinsic value associated with these fixed awards at the date of modification. Accelerating the vesting of these options allowed the Company to avoid recognition of compensation expense associated with these options in future periods.

During the threesix months ended SeptemberJune 30, 2007 and 2006, the Company recorded compensation expense of $3$46 and $0, respectively, within the general administrative expense related to 240,000 new option grantsthe vesting of 685,000 and $149 related to modifications to an extension of the post-termination exercisable period for 450,0000 options, from 90 days after termination to the remaining contractual term of the original option grants (the “Modified Options”).respectively during these periods. The fair value of the Modified Options wereoptions was estimated on the modificationtheir respective grant dates using the Black-Scholes option pricing model. The Black-Scholes model was used with the following assumptions: risk-free interest rates of 4.71% to 4.93%; dividend yields of zero percent; expected lives of 2 to 9 years and volatility of 89.14%. At September 30, 2006, there was $105 of unrecognized compensation expense related unvested stock options, which is expected to be recognized over a weighted-average period of nearly 5.0 years.5.08%, based on the U.S.

The following table summarizes information about options outstanding as of September 30, 2006:

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

NineSix Months Ended SeptemberJune 30, 20062007 and 20052006

(Dollars in thousands except per share data)data and as noted)

Treasury yield in effect at the time of grant; dividend yields of zero percent; expected lives of 2 to 10 years, based on historical exercise activity behavior; and volatility of 89.14% and 79.10% for grants issued for the three months ended March 31, 2007 and June 30, 2007, respectively, based on the historical volatility of our stock over a time that is consistent with the expected life of the option. As of June 30, 2007, there was $272 of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of nearly three years.

Income Taxes.

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

Revenue Recognition.

Revenue (referred to as “net sales”) on the sales of products is recognized in accordance with the terms of the sales arrangement. Such recognition is based on receipt of an unconditional customer order and transfer of title and risk of ownership to the customer, typically upon shipment of the product under a purchase order. The Company’s sales terms do not provide for the right of return unless the product is damaged or defective. Net sales from certain services associated with the Company’s 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 instruments. These contracts cover specific time periods and net sales associated with these contracts are deferred and recognized over the service period. At June 30, 2007 and December 31, 2006, deferred revenue mainly associated with the Company’s service contracts, included in the Company’s balance sheet in other accrued expenses, was approximately $2,047 and $1,591, respectively.

Research and Development.

Research and development costs are charged to expense when incurred.

Translation of Foreign Currency.

Financial statements of subsidiaries outside the U.S. are measured using the local currency as the functional currency. The adjustments to translate those amounts into U.S. dollars are accumulated in a separate account in stockholders’ equity and are included in accumulated other comprehensive income. Foreign currency transaction gains or losses resulting from changes in currency exchange rates are included in the determination of net income. Foreign currency transaction adjustments from continuing operations increased/decreased net income (loss) by $69 and $99 during the three and six months ended June 30, 2007, respectively, and reduced net loss by $72 and $180 during the three and six months ended June 30, 2006, respectively.

Comprehensive Income.

Accumulated other comprehensive income at June 30, 2007 and December 31, 2006 consisted of foreign currency translation adjustments, net of applicable tax of zero. The Company deems its foreign investments to be permanent in nature and does not provide for taxes on currency translation adjustments arising from converting its investments in a foreign currency to U.S. dollars.

Earnings Per Share.

Basic earnings per share is 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, warrants or conversion rights that have exercise or conversion prices below the market value of the Company’s common stock. Options, warrants and conversion rights pertaining to 12,175,141 and 13,538,841 shares of the Company’s common stock have been excluded from the computation of diluted earnings per share at June 30, 2007 and 2006, respectively, because the exercise or conversion price of these instruments exceeded the market price of the Company’s common stock on those dates.

TRANSGENOMIC, INC. AND SUBSIDIARIES

K. OPERATING SEGMENTNOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

(Dollars in thousands except per share data and as noted)

Recently Issued Accounting Pronouncements

In July 2006, the FASB issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes(“FIN 48”). FIN 48 applies to all tax positions within the scope of Statement 109 and clarifies when and how to recognize tax benefits in the financial statements with a two-step approach of recognition and measurement. The Company adopted FIN 48 on January 1, 2007. Under FIN 48, tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is more likely than not to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.

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

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

In the fourth quarter of 2005, the Company implemented a plan to exit its Nucleic Acids operating segment. Accordingly, the Company now reflects the results related to this operating segment as discontinued operations for all periods presented. Expenses that are not directly identified to the Nucleic Acids operating segment or that are considered corporate overhead have not been allocated in arriving at the loss from discontinued operations. Summary results of operations of the former Nucleic Acids operating segment were as follows:

Assets associated with the Nucleic Acids segment consisted principally of the Company’s facility in Glasgow, Scotland. During the six months ended June 30, 2007, the Company completed the sale of the Glasgow facility and the associated equipment for $2.9 million, net of selling expenses, which resulted in a gain of $0.1 million. The gain is reflected in the operating expenses of discontinued operations during the period.

TRANSGENOMIC, INC. AND GEOGRAPHIC INFORMATIONSUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

(Dollars in thousands except per share data and as noted)

The assets and liabilities of the former Nucleic Acids operating segment were as follows:

Liabilities are related to expenses to be paid during 2007 for final closing costs of the Glasgow facility.

The Company recorded restructuring charges totaling $624,000 and $624,000 for the three and six months ended June 30, 2007. The restructuring charges were comprised of severance totaling $364,000 and facility closure costs totaling $260,000. Restructuring charges related to three events: A restructuring plan completed in the second quarter of 2007, which resulted from the termination of 4 employees in Omaha, Nebraska; facility closure activities to close the Cramlington, England production facility and consolidate production in the Omaha, Nebraska facility; and facility closure activities to close an administrative office outside Paris, France, with those functions performed elsewhere in the organization.

Inventories consisted of the following:

Finite lived intangible assets and other assets consisted of the following:

Amortization expense for intangible assets was $24 and $133 during the three months ended June 30, 2007 and 2006, respectively, and $46 and $150 during the six months ended June 30, 2007 and 2006, respectively. Amortization expense for intangible assets is expected to be approximately $46 for the remainder of 2007, $86 in 2008, $75 in 2009, $50 in 2010, $38 in 2011, and $32 in 2012 and 2013.

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

(Dollars in thousands except per share data and as noted)

The Company is subject to a number of claims of various amounts, which arise out of the normal course of business. In the opinion of management, the disposition of pending claims will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

The Company leases certain equipment, vehicles and operating facilities under non-cancellable operating leases that expire on various dates through 2014. The future minimum lease payments required under these leases are approximately $541 for the remainder of 2007, $863 in 2008, $770 in 2009, $657 in 2010, $500 in 2011, $226 in 2012, and $98 thereafter. Rent expense for continuing operations related all to operating leases for the three months ended June 30, 2007 and 2006 was approximately $246 and $303, respectively, and for the six months ended June 30, 2007 and 2006 was approximately $527 and $596, respectively.

At June 30, 2007, firm commitments to vendors to purchase components used in WAVE Systems and instruments manufactured by others totaled $1,254. The Company expects to satisfy these purchase commitments during 2007.

In July 2006, the FASB issued Interpretation No. 48,Accounting for Uncertainty in Income Taxes(“FIN 48”). FIN 48 applies to all tax positions within the scope of Statement 109 and clarifies when and how to recognize tax benefits in the financial statements with a two-step approach of recognition and measurement. The Company adopted FIN 48 on January 1, 2007. Under FIN 48, tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is more than likely not to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.

Upon adoption of FIN 48 on January 1, 2007, the Company recognized a $129 increase in the liability for unrecognized tax benefits. This increase in the liability was offset by an increase to the January 1, 2007 balance in the accumulated deficit. The gross amount of unrecognized tax benefits as of the date of adoption was $129, all of which would affect the effective tax rate if recognized. Included in this amount is an aggregate of $72 of interest and penalties. The Company’s policy is to recognize interest and penalties directly related to income taxes as part of income tax expense.

The Company files income tax returns in the U.S. federal jurisdiction, various U.S. state jurisdictions and various foreign jurisdictions. The Company has statutes of limitation open for Federal income tax returns related to tax years 2004 through 2006. The Company has state income tax returns subject to examination primarily for tax years 2003 through 2006. Open tax years related to foreign jurisdictions remain subject to examination. The Company’s primary foreign jurisdiction is the United Kingdom which has open tax years for 2005 through 2006. The Company is not currently under examination in any jurisdiction.

During the three and six months ended June 30, 2007, there were no material changes to the liability for uncertain tax positions.

The Company maintains an employee 401(k) retirement savings plan that allows for voluntary contributions into designated investment funds by eligible employees. The Company matches the employees’ contributions at the rate of 50% on the first 6% of contributions. The Company may, at the discretion of its Board of Directors, make additional contributions on behalf of the Plan’s participants. Company contributions to the 401(k) plan were $39 and $41 for the three months ended June 30, 2007 and 2006, respectively, and $81 and $83 for the six months ended June 30, 2007 and 2006, respectively.

Common Stock Warrants.

No common stock warrants were issued during the three and six months ended June 30, 2007 or 2006. At June 30, 2007, the Company had 8,062,577 common stock warrants outstanding.

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

(Dollars in thousands except per share data and as noted)