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Precipio (PRPO)

Filed: 30 Mar 03, 7:00pm

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-K

(Mark One)

ýANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                            to                            

Commission File Number 000-30975


TRANSGENOMIC, INC.
(Exact Name of Registrant as Specified in its Charter)

Delaware 91-1789357
(State or Other Jurisdiction of
Incorporation or Organization)
 (IRS Employer
Identification Number)
12325 Emmet Street
Omaha, NE 68164
 68164
(Address of Principal Executive Offices) (Zip Code)

(402) 452-5400
(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
 Name of Each Exchange On Which Registered
None N/A

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share
(Title of Class)


        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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /x/    No / /

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K / /

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes / /    No /x/

        The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant based on the last reported closing price per share of Common Stock as reported on The Nasdaq National Market on the last business day of the registrant's most recently completed second fiscal quarter was approximately $34,400,000.

        As of March 24, 2003, the registrant had 23,532,049 shares of Common Stock outstanding that consist of 24,026,653 shares issued less 494,604 shares of treasury stock.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the 2002 Proxy Statement relating to the Registrant's May 21, 2003 Annual Stockholders Meeting are incorporated by reference into Part III.





TRANSGENOMIC, INC.
Index to Form 10-K for the Fiscal Year Ended December 31, 2002

PART I     
 Item 1. Business 3
 Item 2. Properties 10
 Item 3. Legal Proceedings 11
 Item 4. Submission of Matters to a Vote of Security Holders 11
 Item 4a. Executive Officers 11

PART II

 

 

 

 

 
 Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 13
 Item 6. Selected Financial Data 13
 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 23
 Item 8. Financial Statements and Supplementary Data  
   Independent Auditors' Report 24
   Consolidated Balance Sheets as of December 31, 2002 and 2001 25
   Consolidated Statements of Operations for the Years Ended December 31, 2002, 2001 and 2000 26
   Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended December 31, 2002, 2001 and 2000 27
   Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000 28
   Notes to the Consolidated Financial Statements for the Years Ended December 31, 2002, 2001 and 2000 29
 Item 9. Changes in and Disagreement with Accountants on Accounting And Financial Disclosure 47

PART III

 

 

 

 

 
 Item 10. Directors and Executive Officers of the Registrant 47
 Item 11. Executive Compensation 47
 Item 12. Security Ownership of Certain Beneficial Owners and Management 47
 Item 13. Certain Relationships and Related Transactions 47
 Item 14. Controls and Procedures 47

PART IV

 

 

 

 

 
 Item 15. Exhibits, Financial Statement Schedules and Reports of Form 8-K 47

SIGNATURES

 

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        This Form 10-K references the following trademarks which are the property of Transgenomic: DNASEP®, GUARD-DISC®, WAVE®, WAVEMAKER®, TRANSFORMING THE WORLD®, TRANSGENOMIC®, TRANSGENOMIC and DESIGN® and TRANSGENOMIC GLOBE LOGO®; OLIGOSEP™, OPTIMASE™, RNASEP™, WAVE OPTIMIZED™, WAVE-MD™, WAVE NAVIGATOR™, THE POWER OF DISCOVERY™, and MutuationDiscovery.com™. All other trademarks or trade names referred to in this Form 10-K are the property of their respective owners.

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PART I


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" 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 Related to Our Business" and other factors identified by cautionary language used elsewhere in this annual report on Form 10-K.

Item 1.    Business.

Overview

        We provide innovative products and services for the synthesis, purification and analysis of nucleic acids. Our products include automated instrument systems, associated consumables, chemical building blocks for nucleic acid synthesis and synthesized nucleic acids. Our service offerings include genetic variation discovery services, novel chemistry development services and custom synthesis of nucleic acids. 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. Specifically, our strategy is to

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

    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 have 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, the 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 reaction 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. 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 meet 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 sales of consumable products to WAVE system users and may also be sold for other PCR applications.

    Nucleic Acid Chemistries

        Our third core competency, nucleic acid chemistries, stems in part from our 2001 acquisition of Annovis, Inc. Our Synthetic Nucleic Acid products consist of chemical building blocks ("phosphoramidites"), fluorescent markers and dyes, associated reagents, oligonucleotides and oligomimetics. These products are currently being sold to research organizations, diagnostic companies and pharmaceutical companies. The majority of our synthetic nucleic acid revenues are currently generated through the sale of phosphoramidite products that are produced in our Glasgow, Scotland facility. We are in the process of completing a new production facility in Boulder, Colorado that will be able to further process phosphoramidite products into synthesized oligonucleotides in large 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) of the Exchange Act as soon as reasonably practicable after such documents are electronically filed with the Securities and Exchange Commission.

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's susceptibility to the disease or the actual presence of the disease.

Genomics-based Therapeutics

        Target Identification—It has been estimated that the human genome sequence could provide 5,000-10,000 new potential target molecules on which 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 is involved in a disease or biological process of interest and, furthermore, 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 its safety and efficacy has been demonstrated in animal models, testing must be performed on human subjects. Genetic variation among patients can impact 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.

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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 been and continue to develop over time. The movement along the genomics continuum and related market opportunities has shifted from gene discovery to analysis of variations in gene sequences. From these variations researchers are beginning to link the impacts to associated disorders and diseases that further lead to the creation of diagnostic tests and appropriate therapeutic treatments and drugs.

        Key elements of our strategy are as follows:

    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.

    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.

    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.

    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:

    BioSystems

    Launched WAVE MD platform,

    Launched Mutationdiscovery.com™,

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      Launched Optimase polymerase,

    Nucleic Acids

    Expanded production capacity at two sites,

    Initiated cGMP oligonucleotide/oligomimetic manufacturing project,

    Corporate

    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. Our research and development activities include the improvement of the DNA separation media used in our columns, the refinement of the hardware and software components of the WAVE System, the creation of unique enzymes and WAVE 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 ongoing research and development efforts. These advisors assist us in formulating our research, development, and commercialization strategies.

        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, specifically 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, 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.

        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 accounted for more than 10% of our sales in 2002. During 2001, one customer, Applied Biosystems, accounted for approximately 14% 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.

Manufacturing

        We manufacture bioconsumable products including our separation columns, liquid reagents, polymerase 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, totaling approximately $3.0 million. In addition to our order backlog, we have deferred revenue recorded on our balance sheet totaling approximately $1.2 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 recognized over the service contract period.

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 80 issued patents and over 60 pending applications in both the US and abroad. 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 and Pierce Nucleic Acid Technologies. The competitors for our pharmaceutical grade oligonucleotide synthesis products and services include primarily Proligo and Avecia.

Employees

        As of December 31, 2002, we had 326 full-time employees. The following sets forth the number of persons employed in the principal areas of our operation:

Manufacturing 108
Sales, Marketing and Administration 158
Research and Development 60

        We supplement our workforce through the use of independent contractors and consultants. As of December 31, 2002, we have engaged independent contractors or consultants who provide services to us approximately equivalent to 5 full time employees.

        The Company began a restructuring process during the fourth quarter 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.

Risks Related to Our Business

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

        We have historically experienced losses from operations and negative cash flows. These results were mostly due to research and development expenses and sales and marketing expenses related to the development and marketing of our products. We could continue to incur losses for the foreseeable future and may never be profitable. To date, we have financed our operations and capital expenditures primarily from the proceeds of a $77.3 million public offering of common stock. In March 2003, we entered into a loan commitment agreement with a financial institution for up to a $5.0 million secured line of credit. We will continue to need substantial amounts of cash for research and development and to expand our sales and manufacturing infrastructure. We may need to raise the additional capital in the future through bank financing or strategic investments. Additional financing may not 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. If we raise additional capital by issuing equity securities, the issuance of such securities would result in ownership dilution to our stockholders.

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

        During the fourth quarter of 2002 and the first quarter of 2003, we restructured the Company, which resulted in a net reduction in staff and facilities, and the abandonment of certain intellectual property. While we feel we have retained and redeployed existing resources and secured additional resources necessary to successfully conduct our business, we cannot assure you that the net reduction will not impair our ability to achieve our planned revenue levels.

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Our business strategy includes positioning ourselves as a unique partner to biopharmaceutical and pharmaceutical companies in the early stages of their efforts to develop genomic-based diagnostics and therapeutics.

        We cannot assure you that we will be able to successfully execute this strategy. Additionally, we cannot assure you that the companies we seek to partner with will not decide to develop novel chemistries and manufacturing capabilities for themselves. Lastly, we cannot assure that these companies will have consistent success in this relatively new area of developing commercially viable genomic-based diagnostic and therapeutic products. In fact, the biopharmaceutical and pharmaceutical companies involved have encountered difficulty in accomplishing this and we have seen varying demand for the products and services we seek to provide to them.

        In positioning ourselves to partner with such companies we must:

    Attract and retain world-class nucleic acid chemistry expertise,

    Develop and maintain world-class research and development facilities,

    Qualify and maintain cGMP manufacturing facilities,

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

    Establish long-term partner relationships with various companies.

We will need to effectively manage our growth if we are to successfully implement our strategy.

        The scope of our business operations has and will continue to change and evolve. Such changes in our business and 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 ability 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.

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. The following table summarizes information related to property occupied in these locations.

Location

 Square Footage
 Annual Rent
 Lease Term
Expires

Omaha, Nebraska 55,243 $422,260 2007
San Jose, California 14,360 $246,000 2005
Boulder, Colorado 33,673 $336,732 2007
Glasgow, Scotland 14,500 £95,000 2007
Glasgow, Scotland 45,000  N/A Owned Property

        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.    Executive Officers.

        Our executive officers are elected annually by the Board of Directors at the first meeting following the annual stockholder's meeting. Other officers are elected 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, 2002 are listed below followed by a brief biography.

Name

 Age
 Position
Collin J. D'Silva 44 Chairman of the Board, Chief Executive Officer and Director
William P. Rasmussen 50 Chief Financial Officer
John L. Allbery 43 Executive Vice President
Keith A. Johnson 43 Vice President, General Counsel
Mitchell L. Murphy 45 Vice President, Secretary and Treasurer

        Collin J. D'Silva.    Mr. D'Silva has served as our Chairman of the Board and Chief Executive Officer since 1997 and is also a Director. Mr. D'Silva, a co-founder of Transgenomic, has worked for Transgenomic and its predecessors since 1988. Prior to that time, Mr. D'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'Silva holds a B.S. degree and a M.Eng. degree in industrial engineering from Iowa State University and an M.B.A. from Creighton University.

        William P. Rasmussen.    Mr. Rasmussen joined us on October 1, 1998 and currently serves as our Chief Financial Officer. Prior to joining us, Mr. Rasmussen was Chief Financial Officer at I-Mark Systems from 1996 until it was purchased in 1997. I-Mark Systems designed integrated computer voting 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 companies from 1984 to 1994. 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. Rasmussen holds a B.S. degree in 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 2001 as Vice President, General Counsel. Mr. Johnson has a B.A. in Biochemistry from Kalamazoo College, an M.B.A. in International Business and Marketing from Michigan State, and a law degree from the University of San Diego. Before joining Transgenomic Mr. Johnson was Director of Intellectual Property, Technology Development and Licensing at Integra LifeSciences in Plainsboro, NJ, from 1999 to 2001. Mr. Johnson's previous experience also includes Senior Licensing Manager, Rutgers University, from 1998 to 1999 and Technology Licensing Officer, Washington State University, from 1995 to 1998. Mr. Johnson is a member of the state bars of California, Washington and New Jersey 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.

12



Part II

Item 5.    Market for Registrant'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 2001 and 2002.

Year Ended December 31, 2001

 High
 Low
First Quarter $10.98 $5.19
Second Quarter $15.00 $5.50
Third Quarter $12.85 $6.01
Fourth Quarter $12.60 $5.45

Year Ended December 31, 2002

 

 

 

 

 

 
First Quarter $10.77 $7.00
Second Quarter $9.00 $2.10
Third Quarter $4.52 $2.39
Fourth Quarter $3.80 $2.15

        At March 24, 2003, there were 23,532,049 shares of our common stock outstanding and approximately 3,300 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'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, 2002, 2001 and 2000 and the balance sheet data as of December 31, 2002 and 2001 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, 1999 and 1998 and the balance sheet data as of December 31, 2000, 1999 and 1998 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'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 Discussion and

13



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

 
 Year Ended December 31,
 
 
 2002
 2001
 2000
 1999
 1998
 
 
 In thousands, except per share data

 
Statement of Operations Data:                
Net sales $37,554 $38,467 $25,883 $23,035 $18,935 
Cost of good sold  19,569  17,198  12,800  12,090  9,590 
  
 
 
 
 
 
Gross profit  17,985  21,269  13,083  10,945  9,345 

Selling, general and administrative

 

 

24,068

 

 

21,497

 

 

14,047

 

 

11,532

 

 

8,160

 
Research and development  12,201  9,372  7,652  6,297  3,159 
Stock based compensation expense  131  139  861     
Restructuring Charges  3,282         
Gain on sale of product line      (784)    
  
 
 
 
 
 
Operating expenses  39,682  31,008  21,776  17,829  11,319 

Loss before income taxes

 

 

(21,260

)

 

(7,377

)

 

(8,481

)

 

(8,082

)

 

(2,506

)

Net loss

 

$

(21,365

)

$

(7,401

)

$

(8,661

)

$

(9,827

)

$

(1,576

)
  
 
 
 
 
 

Basic and diluted net loss per share

 

$

(0.91

)

$

(0.33

)

$

(0.52

)

$

(0.76

)

$

(0.13

)

Basic and diluted weighted average shares outstanding

 

 

23,583

 

 

22,560

 

 

16,630

 

 

13,000

 

 

12,279

 
 
   
As of December 31,

 
 2002
 2001
 2000
 1999
 1998
 
 In thousands

Balance Sheet Data:               
Total assets $74,035 $89,286 $77,863 $19,964 $14,736
Long-term debt, less current portion  1,499      12,538  695
Total stockholders' equity (deficit) $61,515 $82,104 $73,966 $(2,099)$6,649

Item 7.    Management'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. Our products and services include automated instrument systems, associated consumables, nucleic acid chemical building blocks, nucleic acid synthesis products, novel chemistry development for nucleic acids, 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 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, we had an accumulated deficit of $49.8 million. We expect to continue to incur substantial research and development and selling, general and administrative costs.

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's accounting policies are considered critical as they are both important to the portrayal of the Company'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.

15


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

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

            Depreciation and Amortization of Long-Lived Assets.    The Company'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's estimate of future undiscounted and discounted cash flows to determine recoverability of these assets. If management'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

    16


    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

    17



    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.

    18



    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

    19



    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

    20


    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

    21



    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

    22



    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, approximately 50% of our net sales have been to customers in the United States. While we do sell products in many foreign countries, most of these sales are completed by our wholly-owned subsidiaries, Transgenomic, LTD., or Cruachem, LTD., and are made in their operating currency British pounds sterling, or the Euro. Results of operations for the Company'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, 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 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 to a secured line of credit that carries a variable interest rate. This line of credit will expose us to interest rate risk in 2003.

    23



    Item 8.    Financial Statements and Supplementary Data.


    INDEPENDENT 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, 2002 and 2001 and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

            We conducted our audits in accordance with 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, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.

            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 Assets. 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)

    24



    TRANSGENOMIC, INC. AND SUBSIDIARIES

    CONSOLIDATED BALANCE SHEETS

    As of December 31, 2002 and 2001

    (In thousands except share and per share data)

     
     2002
     2001
     
    ASSETS 
    CURRENT ASSETS:       
     Cash and cash equivalents $9,735 $19,613 
     Short term investments  3,612  23,913 
     Accounts receivable, net  11,058  11,248 
     Inventories  12,448  5,829 
     Prepaid expenses and other current assets  2,274  2,273 
      
     
     
      Total current assets  39,127  62,876 
    PROPERTY AND EQUIPMENT:       
     Land and Buildings  2,020   
     Equipment  16,852  10,459 
     Furniture and fixtures  5,849  3,004 
      
     
     
        24,721  13,463 
     Less—accumulated depreciation  9,069  5,278 
      
     
     
       15,652  8,185 
    DEMONSTRATION INVENTORY  181  250 
    GOODWILL  15,275  14,274 
    OTHER ASSETS  3,800  3,701 
      
     
     
      $74,035 $89,286 
      
     
     

    LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

     

    CURRENT LIABILITIES:

     

     

     

     

     

     

     
     Accounts payable $4,917 $2,664 
     Accrued compensation  1,113  1,212 
     Current portion of long-term debt  63   
     Other accrued expenses  4,928  3,306 
      
     
     
      Total current liabilities  11,021  7,182 
     Long-term debt  1,499   
      
     
     
      Total liabilities  12,520  7,182 

    COMMITMENTS AND CONTINGENCIES (Note F)

     

     

     

     

     

     

     

    STOCKHOLDERS' EQUITY:

     

     

     

     

     

     

     
     Preferred stock, $.01 par value, 15,000,000 shares authorized, none outstanding     
     Common stock, $.01 par value, 60,000,000 shares authorized, 24,006,649 and 23,867,907 shares issued in 2002 and 2001, respectively  240  239 
     Additional paid-in capital  113,934  113,260 
     Unearned compensation  (78) (158)
     Accumulated other comprehensive income (loss)  378  (81)
     Accumulated deficit  (49,771) (28,406)
      
     
     
        64,703  84,854 
     Less: Treasury Stock, at cost, 494,604 and 261,904 shares in 2002 and 2001, respectively  (3,188) (2,750)
      
     
     
      Total stockholders' equity  61,515  82,104 
      
     
     
      $74,035 $89,286 
      
     
     

    See notes to consolidated financial statements.

    25



    TRANSGENOMIC, INC. AND SUBSIDIARIES

    CONSOLIDATED STATEMENTS OF OPERATIONS

    Years Ended December 31, 2002, 2001 and 2000

    (in thousands except share and per share data)

     
     2002
     2001
     2000
     
    NET SALES $37,554 $38,467 $25,883 
    COST OF GOODS SOLD  19,569  17,198  12,800 
      
     
     
     
     Gross profit  17,985  21,269  13,083 
    OPERATING EXPENSES:          
     Selling, General and administrative  24,068  21,497  14,047 
     Research and development  12,201  9,372  7,652 
     Stock based compensation expense  131  139  861 
     Restructuring Charges (Note Q)  3,282     
     Gain on sale of product line      (784)
      
     
     
     
        39,682  31,008  21,776 

    LOSS FROM OPERATIONS

     

     

    (21,697

    )

     

    (9,739

    )

     

    (8,693

    )
    OTHER INCOME (EXPENSE):          
     Interest income  626  2,450  2,005 
     Interest expense  (62) (58) (1,779)
     Other—net  (127) (30) (14)
      
     
     
     
       437  2,362  212 

    LOSS BEFORE INCOME TAXES

     

     

    (21,260

    )

     

    (7,377

    )

     

    (8,481

    )
    INCOME TAX EXPENSE (BENEFIT):          
     Current  105  24   
     Deferred      180 
      
     
     
     
       105  24  180 
      
     
     
     
    NET LOSS $(21,365)$(7,401)$(8,661)
      
     
     
     

    BASIC AND DILUTED LOSS PER SHARE

     

    $

    (0.91

    )

    $

    (0.33

    )

    $

    (0.52

    )

    BASIC AND DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING

     

     

    23,582,687

     

     

    22,560,057

     

     

    16,629,555

     

    See notes to consolidated financial statements.

    26



    TRANSGENOMIC, INC. AND SUBSIDIARIES

    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

    Years Ended December 31, 2002, 2001 and 2000

    (in thousands except share data)

     
     Common Stock
      
      
      
      
      
      
     
     
     Outstanding
    Shares

     Par
    Value

     Additional
    Paid in
    Capital

     Unearned
    Compensation

     Accumulated
    Deficit

     Accumulated Other
    Comprehensive
    Income (Loss)

     Treasury
    Stock

     Total
     
    Balance, January 1, 2000 13,000,000 $130 $10,232 $(113)$(12,344)$(4)$ $(2,099)
     Net loss             (8,661) (8,661)    (8,661)
     Other comprehensive (loss):                        
     Foreign currency translation adjustment                (5)    (5)
     Unrealized gain on available for sale securities                13     13 
                    
           
     Comprehensive loss                (8,653)      
     Sale of common shares 25,000     250              250 
     Initial public offering (net of expenses) 5,152,000  52  69,644              69,696 
     Conversion of Notes Payable and accrued interest 2,750,906  28  13,909              13,937 
     Issuance and exercise of stock options or warrants 544,910  5  3,930  (508)          3,427 
     Amortization of unearned compensation          158           158 
     Purchase of treasury stock (261,904)                (2,750) (2,750)
      
     
     
     
     
     
     
     
     
    Balance, December 31, 2000 21,210,912  215  97,965  (463) (21,005) 4  (2,750) 73,966 
     Net loss             (7,401) (7,401)    (7,401)
     Other comprehensive income (loss):                        
     Foreign currency translation adjustment                (107)    (107)
     Unrealized gain on available for sale securities                22     22 
                    
           
     Comprehensive loss                (7,486)      
     Issuance of shares for acquisition 1,889,523  19  13,065              13,084 
     Issuance and exercise of stock options or warrants 505,568  5  2,396              2,401 
     Deferred compensation       (166) 204           38 
     Amortization of unearned compensation          101           101 
      
     
     
     
     
     
     
     
     
    Balance, December 31, 2001 23,606,003  239  113,260  (158) (28,406) (81) (2,750) 82,104 
     Net loss             (21,365) (21,365)    (21,365)
     Other comprehensive income (loss):                        
     Foreign currency translation adjustment                493     493 
     Unrealized gain on available for sale securities                (34)    (34)
                    
           
     Comprehensive loss                (20,906)      
     Issuance and exercise of stock options or warrants 81,900  1  460  (51)          410 
     Issuance of shares for employee stock purchase plan 56,842     214              214 
     Amortization of unearned compensation          131           131 
     Purchase of treasury stock (232,700)                (438) (438)
      
     
     
     
     
     
     
     
     
    Balance, December 31, 2002 23,512,045 $240 $113,934 $(78)$(49,771)$378 $(3,188)$61,515 
      
     
     
     
     
     
     
     
     

    See notes to consolidated financial statements.

    27



    TRANSGENOMIC INC. AND SUBSIDIARIES

    CONSOLIDATED STATEMENTS OF CASH FLOWS

    Years Ended December 31, 2002, 2001 and 2000

    (In thousands)

     
     2002
     2001
     2000
     
    CASH FLOWS FROM OPERATING ACTIVITIES:          
     Net loss $(21,365)$(7,401)$(8,661)
     Adjustments to reconcile net loss to net cash flows from operating activities:          
      Depreciation and amortization  3,993  3,680  1,807 
      Non-cash restructuring charges  1,698     
      Gain on sale of product line      (784)
      Accrued interest and redemption premium      1,415 
      Other  131  130  1,146 
     Changes in operating assets and liabilities, net of acquisitions:          
      Accounts receivable  794  (4,677) 1,444 
      Inventories  (5,767) (1,910) (223)
      Prepaid expenses and other current assets  527  (1,169) (357)
      Accounts payable  2,249  (378) (796)
      Accrued expenses  (204) 608  261 
      
     
     
     
      Net cash flows from operating activities  (17,944) (11,117) (4,748)
    CASH FLOWS FROM INVESTING ACTIVITIES:          
     Purchase of property and equipment  (11,468) (5,706) (3,109)
     Proceeds from asset sales    15  5,657 
     Increase in other assets  (2,871) (1,351) (980)
     Proceeds from the maturities and sale of available for sale securities  39,355  52,739   
     Purchases of available for sale securities  (19,088) (52,902) (23,728)
     Purchase of business, net of cash acquired    (2,189)  
      
     
     
     
      Net cash flows from investing activities  5,928  (9,394) (22,160)
    CASH FLOWS FROM FINANCING ACTIVITIES:          
     Issuance of common stock, net of expenses  624  2,401  72,670 
     Purchase of treasury stock  (438)   (2,750)
     Proceeds from long-term debt  1,559    204 
     Net change in note payable—bank      (4,340)
     Payments on long-term debt      (901)
     Repayment of acquired business debt    (458)  
      
     
     
     
      Net cash flows from financing activities  1,745  1,943  64,883 
    EFFECT OF FOREIGN CURRENCY EXCHANGE RATE CHANGES ON CASH  393  (12) 65 
      
     
     
     
    NET CHANGE IN CASH AND CASH EQUIVALENTS  (9,878) (18,580) 38,040 
    CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR  19,613  38,193  153 
      
     
     
     
    CASH AND CASH EQUIVALENTS AT END OF YEAR $9,735 $19,613 $38,193 
      
     
     
     

    See notes to consolidated financial statements.

    28



    TRANSGENOMIC, INC. AND SUBSIDIARIES

    NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

    Years Ended December 31, 2002, 2001 and 2000

    (Tabular amounts in thousands except share and per share data)

    A.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    Business Description.

            Transgenomic, Inc., a Delaware corporation, and its subsidiaries (the "Company") provide innovative products and services for the synthesis, purification and analysis of nucleic acids. The Company's products and services include automated instrument systems, associated consumables, nucleic acid chemical building blocks, nucleic acid synthesis products, novel chemistry development for nucleic acids, process development services and genetic variation discovery services. The Company develops, assembles, manufactures and markets it's 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. The Company's business plan is to participate in the value chain associated with 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.

            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. The BioSystems operating segment generates revenue from the sale of automated instrument systems and associated consumable products and services. The Nucleic Acids operating segment generates revenue from the sale of nucleic acid-based products and services.

            The Company markets and sells these products primarily through a direct sales and support group in North America and Europe and through a network of distributors in the Pacific Rim and other international markets. These sales efforts are directed from the Company headquarters in Omaha, Nebraska and through a series of sales and support offices strategically located throughout the United States, Europe and Japan.

    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.

    Short Term Investments.

            The Company classifies all of its short-term investments with maturities at acquisition of greater than three months as available for sale securities. Such short term investments consist primarily of United States government and federal agency securities, corporate commercial paper and corporate debt which are stated at market value, with unrealized gains and losses on such securities reflected, net of tax, as other comprehensive income in stockholders' equity. Realized gains and losses on short term investments are

    29



    included in earnings and are derived using the specific identification method for determining the cost of securities. It is the Company's intent to maintain a liquid portfolio to take advantage of investment opportunities; therefore, all securities are considered to be available for sale and are classified as current assets.

    Accounts Receivable.

            Accounts receivable are shown net of allowance for doubtful accounts of $450,000 and $213,000 in 2002 and 2001, respectively. Payment terms generally are 30 or 60 days. The Company has also provided extended payment terms of up to 90 days to some of its customers.

    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.

    Property and Equipment.

            Property and equipment are carried at cost. Depreciation and amortization are computed by the straight-line and accelerated methods over the estimated useful lives of the related assets as follows:

    Buildings 15 years
    Furniture and fixtures 5 to 7 years
    Production equipment 5 to 7 years
    Computer equipment 3 to 5 years
    Research and development equipment 3 to 5 years
    Demonstration equipment 3 to 5 years

    Goodwill.

            Effective January 1, 2002, the Company 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.

    Impairment of Long-Lived Assets.

            The Company assesses the recoverability of long-lived assets held for use, including certain intangible assets and goodwill, whenever events or changes in circumstances indicate that the carrying amount of an

    30



    asset may not be recoverable. In such cases, if the sum of the expected cash flows (undiscounted and without interest) resulting from the use of the asset is less than the carrying amount, an impairment loss is recognized based on the difference between the carrying amount and the fair value of the assets.

    Other Assets.

            Other assets include patents, intellectual property, goodwill and capitalized software development costs. 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 of between 5 and 10 years.

    Software Development Costs.

            The Company capitalizes software development costs for products offered for sale in accordance with Statement of Financial Accounting Standard No. 86,Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. This Standard allows for the capitalization of certain development costs once a software product has reached technological feasibility. Capitalized costs are included in Other Assets, net of amortization. Such capitalized costs are amortized over the estimated useful life of the software product, generally 3 to 5 years, beginning when a product is released for sale.

            The Company capitalizes internal use software development costs in accordance with Statement of Position No. 98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Capitalized internal use software development costs are amortized on an accelerated basis over three years. For the years ended December 31, 2002 and 2001, capitalized internal software costs included in property, plant and equipment, net of accumulated amortization, totaled $461,000 and $1,000,000, respectively.

    Stock Based Compensation.

            The Company accounts for its employee stock option grants under the provisions of Accounting Principles Board Opinion No. 25,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 deemed fair market value of the Company's common stock at the date of grant over the stock option exercise price. Stock option grants to nonemployees are accounted for using the fair value method of accounting in accordance with Statement of Financial Accounting Standards (SFAS) No. 123,Accounting for Stock-Based Compensation using the Black-Scholes model.

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            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. 123,Accounting for Stock-Based Compensation, to stock based employee compensation.

     
     2002
     2001
     2000
     
    Net Loss:          
     As reported $(21,365)$(7,401)$(8,661)
     Pro forma  (23,274) (10,110) (10,205)
    Basic and diluted loss per share:          
     As reported  (0.91) (0.33) (0.52)
     Pro forma  (0.99) (0.45) (0.61)

    Unearned Compensation.

            Unearned compensation represents the unamortized difference between the option exercise price and the deemed fair market value of the Company's common stock at the option grant date, for options issued under the Company's Stock Option Plan (Note I). The unearned compensation is charged to operations over the vesting period of the respective options.

    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 unlikely they will be realized.

    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. These contracts cover specific time periods and revenue associated with these contracts is deferred and recognized over the service period. At December 31, 2002 and 2001 deferred revenue, mainly associated with our service contracts, included on the Company's balance sheet was approximately $1.2 million.

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    Research and Development.

            Research and development costs are charged to expense when incurred with the exception of certain software development costs that are capitalized.

    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 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 decreased net loss approximately $1.0 million in 2002. Foreign currency transaction adjustments in 2001 and 2000 were not significant.

    Comprehensive Income.

            Comprehensive income for all periods presented consists of net income, foreign currency translation adjustments and unrealized gains or losses on available for sale investments. 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. There were no reclassification adjustments to be reported in the periods presented.

    Fair Value of Financial Instruments.

            The carrying amount of the Company's cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair value because of the short maturity of those instruments. The Company derives the fair value of its short-term investments based on quoted market prices. The carrying value of long-term debt approximates fair value based upon existing interest rates available to the Company for similar debt.

    Earnings Per Share.

            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 warrants or conversion of convertible notes, where dilutive. Potentially dilutive securities have been excluded from the computation of diluted earnings per share as they have an antidilutive effect due to the Company's net loss.

    Recently Issued Accounting Pronouncements.

            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 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.

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            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.

    Use of Estimates.

            The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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.

    Reclassifications.

            Certain reclassifications may have been made to the 2000 and 2001 financial statements to conform to the 2002 presentation.

    B.    SHORT TERM INVESTMENTS

            The amortized cost of available-for-sale securities and their approximate fair values were as follows:

     
     Amortized
    Cost

     Gross Unrealized
    Gains

     Gross Unrealized
    Losses

     Fair
    Value

    December 31, 2002            
    Corporate Debt $3,611 $1 $ $3,612
      
     
     
     
    Total securities available-for-sale $3,611 $1 $ $3,612
      
     
     
     
    December 31, 2001            
    Commercial Paper $8,782 $10 $ $8,792
    U.S. Government Agencies  5,774      5,774
    Corporate Debt  9,322  25    9,347
      
     
     
     
    Total securities available-for-sale $23,878 $35 $ $23,913
      
     
     
     

            Maturities of short-term investments are due within one year.

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    C.    INVENTORIES

            At December 31, 2002 and 2001, inventories consist of the following:

     
     2002
     2001
     
    Finished goods $6,400 $2,335 
    Raw materials and work in process  5,904  3,248 
    Demonstration inventory  325  496 
      
     
     
       12,629  6,079 
    Less long-term demonstration inventory  (181) (250)
      
     
     
      $12,448 $5,829 
      
     
     

    D.    OTHER ASSETS

            At December 31, 2002 and 2001, finite lived intangible assets and other assets consist of the following:

     
     2002
     2001
     
     Cost
     Accumulated
    Reserve

     Net Book
    Value

     Cost
     Accumulated
    Reserve

     Net Book
    Value

    Capitalized software $2,132 $24 $2,108 $728 $ $728
    Intellectual property  545  90  455  275  38  237
    Patents  883  150  733  1,514  78  1,436
    Other  504    504  1,545  245  1,300
      
     
     
     
     
     
    Total $4,064 $264 $3,800 $4,062 $361 $3,701
      
     
     
     
     
     

            Amortization expense for intangible assets was $150,000 during 2002. The Company expects amortization expense for intangible assets to be approximately $900,000 in fiscal 2003, $900,000 in fiscal 2004, $850,000 in fiscal 2005, and $200,000 in fiscal 2006 and 2007.

    E.    GOODWILL

            At December 31, 2002 and 2001, goodwill by operating segment consisted of the following:

     
     Biosystems
    operating
    segment

     Nucleic Acids
    operating
    segment

     Total
    Net balance December 31, 2001 $638 $13,636 $14,274
    Finalization of purchase price allocations    1,001  1,001
      
     
     
    Net balance December 31, 2002 $638 $14,637 $15,275
      
     
     

            Annual testing of goodwill for impairment was completed in the fourth quarter, after the annual forecasting process. The Company has determined that no impairment existed at the time of the annual test. The fair value of operating segments was estimated using a discounted cash flow model.

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            A reconciliation of previously reported net loss and loss per share to the amounts adjusted for the exclusion of goodwill amortization follows:

     
     Fiscal Years Ended December 31,
     
     
     2002
     2001
     2000
     
    Reported Net Loss $(21,365)$(7,401)$(8,661)
    ADD: Goodwill Amortization    889  127 
      
     
     
     
    Adjusted Net Loss $(21,365)$(6,512)$(8,534)
      
     
     
     

    Loss Per Share:

     

     

     

     

     

     

     

     

     

     
    As Reported $(0.91)$(0.33)$(0.52)
    Adjusted $(0.91)$(0.29)$(0.51)

    F.    COMMITMENTS AND CONTINGENCIES

            The Company leases certain equipment, vehicles and operating facilities. The Company's leases related to its operating facilities currently expire on various dates through 2007. At December 31, 2002, the future minimum lease payments required under non-cancellable lease provisions are approximately $2.9 million in 2003; $2.6 million in 2004; $2.2 million in 2005; $1.4 million in 2006; $700,000 in 2007; and no rental payments for the year 2008. Rent expense related to all operating leases for the years ended December 31, 2002, 2001 and 2000 was approximately $2.3 million, $1.7 million and $1.0 million, respectively.

            During 2002, Cruachem Ltd., wholly owned subsidiary of the Company, entered into a long-term mortgage loan with The Royal Bank of Scotland. The principal amount of the loan was £1.0 million, or approximately $1.5 million. Principal and interest are payable in quarterly installments. The loan carries a 15 year term and a fixed annual interest rate of 6.77%. Security for this loan is the Company's 45,000 square foot manufacturing facility located in Glasgow, Scotland. The loan carries certain financial and non-financial covenants that must be met by Cruachem Ltd. that includes a minimum net cash flow requirement. The net book value of the facility was approximately $1.9 million at December 31, 2002.

            The Company is not a party to any material legal proceedings.

    G.    INCOME TAXES

            Loss before income taxes consists of the following:

     
     Years ended December 31,
     
     
     2002
     2001
     2000
     
    United States $(19,640)$(7,448)$(8,231)
    International  (1,620) 71  (250)
      
     
     
     
      $(21,260)$(7,377)$(8,481)
      
     
     
     

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            The income tax provision consists of the following:

     
     Years ended December 31,
     
     2002
     2001
     2000
    CURRENT TAX EXPENSE (BENEFIT)         
     United States Federal $105 $24 $
    DEFERRED TAX EXPENSE (BENEFIT)         
     United States Federal      180
      
     
     
    Total Income Tax Provision $105 $24 $180
      
     
     

            The Company's provision for income taxes for the years ended December 31, 2002, 2001 and 2000 differs from the amounts determined by applying the statutory Federal income tax rate to loss before income taxes for the following reasons:

     
     2002
     2001
     2000
     
    Benefit at Federal Rate $(7,228)$(2,508)$(2,884)
    Increase (decrease) resulting from:          
    State income taxes—net of federal benefit  (518) (154) (119)
    Foreign subsidiary tax rate difference  224  (17) 30 
    Research and development tax credit  (188) (98) (69)
    Other—net  137  345  85 
    Valuation allowance  7,678  2,456  3,137 
      
     
     
     
    Total income tax expense (benefit) $105 $24 $180 
      
     
     
     

            The Company's deferred income tax asset at December 31, 2002 and 2001 is comprised of the following temporary differences:

     
     2002
     2001
     
    Net operating loss carryforward $23,099 $14,634 
    Allowance for doubtful accounts  58  45 
    Fixed asset depreciation  104  98 
    Accrued vacation  116  107 
    Other  (194) (16)
      
     
     
       23,183  14,868 
    Less valuation allowance  (23,183) (14,868)
      
     
     
      $ $ 
      
     
     

            At December 31, 2002, the Company has unused federal tax net operating loss carryforwards of approximately $1.8 million which expire in 2008, $3.7 million which expire in 2009, $3.0 million which expire in 2010, $0.9 million which expire in 2011, $3.4 million which expire in 2012, $1.8 million which expire in 2018, $8.2 million which expire in 2019, $9.7 million which expire in 2020, $8.2 million which

    37



    expire in 2021 and $19.6 million which will expire in 2022. Approximately $11.8 million of the Company's total federal net operating loss carryforwards were obtained in the acquisition of Annovis, Inc. and may be subject to certain restrictions. Additionally, at December 31, 2002, the Company has unused state tax net operating loss carryforwards of approximately $22.2 million and unused general business credits earned primarily through increased research expenditures of approximately $0.9 million. These credits expire at various times between 2008 and 2021. A valuation allowance has been provided in 2001 and 2000 for the remaining deferred tax assets, due to the Company's cumulative losses in recent years, expected losses in future years and an inability to utilize any additional losses as carrybacks. 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 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 at such time.

    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 were $507,000, $357,000 and $220,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

    I.    STOCKHOLDERS' EQUITY

    Common Stock Warrants.

            The Company issued 2,000,000 shares of the Company's common stock, mainly through placement agents, in a private placement during 1997 and 1998. The Company also issued warrants to the Placement Agents with an exercise price of $5.00 per share (subject to certain cashless exercise rights) that have terms of five years expiring in 2003. Total shares eligible to be purchased through these warrants were 49,613 and 49,613 at December 31, 2002, and 2001, respectively. During 2002 the Company entered into an operating lease agreement with GE Capital. The agreement included the issuance of 13,762 warrants with an exercise price of $3.27 per share and a term of five years expiring in 2007. All warrants issued to GE Capital remain outstanding at December 31, 2002.

    Preferred Stock.

            The Company's Board of Directors is authorized to issue up to 15,000,000 shares of preferred stock in one or more series, from time to time, with such designations, powers, preferences and rights and such qualifications, limitations and restrictions as may be provided in a resolution or resolutions adopted by the Board of Directors. The authority of the Board of Directors includes, but is not limited to, the determination or fixing of the following with respect to shares of such class or any series thereof: (i) the number of shares; (ii) the dividend rate, whether dividends shall be cumulative and, if so, from which date; (iii) whether shares are to be redeemable and, if so, the terms and amount of any sinking fund providing

    38



    for the purchase or redemption of such shares; (iv) whether shares shall be convertible and, if so, the terms and provisions thereof; (v) what restrictions are to apply, if any, on the issue or reissue of any additional preferred stock; and (vi) whether shares have voting rights. The preferred stock may be issued with a preference over the common stock as to the payment of dividends. The Company has no current plans to issue any series of preferred stock. Classes of stock such as the preferred stock may be used, in certain circumstances, to create voting impediments on extraordinary corporate transactions or to frustrate persons seeking to effect a merger or otherwise to gain control of the Company. For the foregoing reasons, any preferred stock issued by the Company could have an adverse effect on the rights of the holders of the common stock.

    Common Stock.

            In May 2001, the Company issued 1,889,523 shares of common stock in connection with the acquisition of Annovis, Inc. See Footnote O for further discussion of this acquisition.

            In May 2001, Company shareholders approved the adoption of the Transgenomic, Inc. 2001 Employee Stock Purchase Plan that was subsequently implemented in November 2001. Substantially all of the Company's U.S. employees are eligible to participate in the Plan. Eligible employees authorize payroll deductions to be made for the purchase of shares. Such deductions are accumulated during a defined participation period at the end of which each participant is deemed to have been granted an option to purchase shares of stock from the Company at 85% of the fair market value of the Company stock as measured by the closing price of the stock on either the first or last business day of the participation period, whichever is lower. The number of shares purchased under the option is based upon the participants elected withholding amount. At the end of the participation period such option is automatically exercised. This plan is structured to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986, as amended. During 2002 there were 56,842 shares issued under this plan. During 2001 there were no shares issued under this plan.

            In August 2000, the Company's Board of Directors authorized conversion of the Company's $12 million aggregate principal amount 6% convertible notes due March 25, 2002 into common stock upon meeting the required conversion conditions. On August 15, 2000, such conditions were met, and the notes were converted into 2,750,906 shares of common stock. All principal and accrued interest at the conversion date of approximately $13.9 million was converted to stockholders equity.

            On July 21, 2000, the Company issued 5,152,000 shares of common stock in its initial public offering at $15.00 per share. After payment of the underwriters' discounts and commissions and other expenses, the Company received net proceeds of approximately $69.9 million from this offering. In addition, since the date of the initial public offering, holders of warrants and options to purchase shares of common stock have exercised at various times.

            In March 2000, the Company issued 25,000 common shares at $10.00 per share to an individual who was subsequently elected to the Company's Board of Directors.

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    J.    STOCK OPTIONS

            The Company's 1997 Stock Option Plan, as amended (the "Stock Option Plan"), allows the Company to grant both incentive stock options and nonqualified stock options to acquire shares of the Company's common stock to employees and directors of the Company and to nonemployee advisors. Either incentive or non-qualified stock options may be granted to employees of the Company, but only nonqualified stock options may be granted to nonemployee directors and advisors. The maximum number of shares for which options may be granted under the Stock Option Plan is 7,000,000. The Stock Option Plan is administered by the Compensation Committee of the Board of Directors (the "Committee") which has the authority to set the number, exercise price, term and vesting provisions of the options granted under the Stock Option Plan, subject to the terms thereof. The options must be granted at exercise prices not less than the fair market value of the common stock on the date of the grant. Generally, the stock options vest at a rate of either 20% per year over a five-year period or 331/3% per year over a three-year period and expire 10 years after the date the option was granted. If the option holder ceases to be employed by the Company, the Company will have the right to terminate any outstanding but unexercised options.

            The following table summarizes activity under the Stock Option Plan during the three years ended December 31, 2002:

     
     Number of
    Options

     Weighted Average
    Exercise Price

    Balance at January 1, 2000:  3,537,750 $5.00
     Granted  1,137,000  10.57
     Exercised  (200,969) 5.28
     Canceled  (438,900) 6.45
      
     
    Balance at December 31, 2000  4,034,881  6.43
     Granted  1,865,950  7.88
     Exercised  (470,900) 5.00
     Canceled  (296,100) 9.75
      
     
    Balance at December 31, 2001:  5,133,831  6.90
     Granted  632,000  5.09
     Exercised  (81,900) 5.01
     Canceled  (539,021) 7.69
      
     
    Balance at December 31, 2002:  5,144,910 $6.62
      
     
    Exercisable at December 31, 2002  3,295,683 $6.38

            The weighted average fair value per share of options granted in 2002, 2001 and 2000 was $2.92, $2.32 and $5.43, respectively.

            The Company has elected to follow the measurement provisions of APB No. 25, under which no recognition of expense is required in accounting for stock options granted to employees for which the exercise price equals or exceeds the deemed fair market value of the stock at the grant date. In those cases where options have been granted with an exercise price below the deemed fair market value, the Company recognizes compensation expense using the straight-line method over the vesting periods of the individual stock options.

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            Stock-based compensation expense recorded by the Company represents amortization of unearned compensation related to options granted to employees with an exercise price less than the deemed fair market value at the date of grant and options granted to non-employees. During 2002, 2001 and 2000, the Company recorded compensation expense of $131,000, $139,000 and $861,000, respectively. The expense amounts were calculated using the Black-Scholes option pricing model with the following assumptions: no common stock dividends, risk-free interest rates ranging from 3.10% to 6.53%; volatility ranging from 35% to 85%; and an expected option life of 1 to 7.5 years. Additionally, in connection with the 2000 sale of the Company's non-life sciences instrument product line, the Company accelerated the vesting of 71,700 options, which would have otherwise been forfeited. Compensation expense of approximately $574,000 was recorded for these options during the first quarter of 2000, representing the difference between the exercise price of the options and the deemed fair value of the common stock at the date the vesting was accelerated. In addition, 218,700 options were forfeited as a result of the sale.

            The following table summarizes information about options outstanding as of December 31, 2002:

     
     Options Outstanding
     Options Exercisable
    Range of Exercise Prices
     Number Outstanding
     Weighted-Average
    Remaining
    Contractual Life

     Weighted-Average
    Exercise Price

     Number Exercisable
     Weighted-Average
    Exercise Price

     
      
     (in years)

      
      
      
    $  2.51—$  5.00 2,628,550 5.5 $4.72 2,115,150 $5.00
    $  5.01—$  7.50 1,217,787 7.2 $6.17 533,457 $6.15
    $  7.51—$10.00 821,942 6.6 $9.84 367,845 $9.79
    $10.01—$12.50 105,000 7.3 $11.94 48,600 $11.93
    $12.51—$15.00 371,631 6.5 $13.00 230,631 $13.00
      
     
     
     
     
      5,144,910 6.2 $6.62 3,295,683 $6.38
      
     
     
     
     

    K.    SALE OF BUSINESS LINE

            In May 2000, the Company sold the assets related to its non-life sciences instrument product line for a total adjusted purchase price of $5.65 million plus reimbursement by the purchaser of approximately $400,000 of expenses paid by the Company in connection with this product line since March 31, 2000. The effective date of the transaction was April 1, 2000. The Company realized a gain on the sale of these assets of approximately $784,000 before taxes.

    L.    OPERATING SEGMENT AND GEOGRAPHIC INFORMATION

            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

    41



    operating income 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 decision makers.

            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.

            The following is information for net sales and operating income by segment.

     
     2002
     2001
     2000
     
    Sales          
     BioSystems $24,235 $28,040 $23,712 
     Nucleic Acids  13,319  10,427   
      
     
     
     
     Sub-total  37,554  38,467  23,712 
     Divested product line      2,171 
      
     
     
     
     Total $37,554 $38,467 $25,883 
      
     
     
     
    Loss/Income from operations          
     BioSystems $(9,417)$(4,595)$(3,549)
     Nucleic Acids  (1,004) 1,090   
     Corporate  (11,276) (6,234) (4,473)
      
     
     
     
     Sub-total  (21,697) (9,739) (8,022)
     Divested product line      (671)
      
     
     
     
     Total $(21,697)$(9,739)$(8,693)
      
     
     
     

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            The following is information for fixed assets and fixed asset additions by segment. Fixed assets are tracked by location and department and thus can be identified to operating segments even though specific segment Balance Sheets are not produced.

     
     2002
     2001
    Fixed Assets      
     BioSystems $4,895 $3,865
     Nucleic Acids  8,892  1,811
     Corporate  1,865  2,509
      
     
     Total $15,652 $8,185
      
     
    Fixed Asset Additions      
     BioSystems $2,533 $2,725
     Nucleic Acids  8,563  1,365
     Corporate  372  1,616
      
     
     Total $11,468 $5,706
      
     

            The following is supplemental information for net sales by geographic area.

     
     2002
     2001
     2000
    Sales by Geographic Area:         
     United States $16,805 $18,063 $11,586
     Europe  16,011  15,918  10,237
     Pacific Rim  4,129  2,901  3,313
     Other  609  1,585  747
      
     
     
     Total $37,554 $38,467 $25,883
      
     
     

            Long-lived assets by geographic area as of December 31 are as follows:

     
     2002
     2001
    United States $23,882 $21,865
    Europe  8,203  2,223
    Pacific Rim  30  44
      
     
    Total $32,115 $24,132
      
     

            During 2002 no single customer accounted for more than 10% of total sales. During 2001, one customer accounted for approximately 14% of our total sales. No single customer accounted for more than 10% of total sales in 2000.

    43



    M.    SUPPLEMENTAL CASH FLOW INFORMATION

     
     2002
     2001
     2000
    Cash paid for interest $30 $10 $233
    Cash paid for income taxes $120 $3 $4
    Noncash investing and financing activities:         
    Liabilities assumed in connection with business acquisitions $ $3,388 $
    Conversion of Notes Payable and Accrued Interest into Common Stock $ $ $13,909
    Reclassification of demonstration inventory to property $ $ $975
    Issuance of common stock as acquisition consideration $ $13,084 $

    N.    ALLOWANCE FOR DOUBTFUL ACCOUNTS

            The following is a summary of activity for the allowance for doubtful accounts during each of the three years ended December 31, 2002:

     
     Beginning
    Balance

     Additional
    Charges
    to Income

     Deductions
    from Reserve

     Ending
    Balance

    Year Ended December 31, 2002 $213 $418 $181 $450
    Year Ended December 31, 2001 $180 $65 $32 $213
    Year Ended December 31, 2000 $161 $19 $ $180

    O.    ACQUISITION

            Effective May 1, 2001, the Company acquired Annovis, Inc, a privately held company, for approximately $16.9 million through the issuance of approximately 1.9 million shares of Transgenomic, Inc. common stock, the payment of approximately $563,000 in cash in lieu of common stock to certain Annovis stockholders and the payment of approximately $3.2 million of direct acquisition related expenses. The acquisition was structured as a merger of Annovis with a subsidiary of the Company and resulted in Annovis becoming a wholly-owned subsidiary of the Company. Annovis is a specialty chemicals company that develops, manufactures and markets a wide variety of nucleic acid based products and service for the life sciences industry. Annovis's results of operations have been included in the accompanying financial statements beginning on May 1, 2001.

            The Company accounted for this transaction as a purchase. The Company obtained an appraisal of the fair value of the tangible and intangible assets acquired from an independent appraiser. All identifiable

    44



    tangible and intangible assets acquired and liabilities assumed have been allocated a portion of the cost equal to their estimated fair values as follows:

    Net tangible assets and liabilities $1,390
    Intangible assets $60
    Goodwill $15,463
      
    Total Purchase Price (including direct expenses) $16,913
      

            The costs assigned to intangible assets have been amortized through December 31, 2002 on a straight-line basis over a period averaging 5 years.

            The Company's unaudited pro forma results of operations for the year ended December 31, 2001, assuming the acquisition of Annovis, Inc. occurred as of the beginning of the period presented is as follows:

     
     Twelve Months Ended December 31,
     
     
     2001
     2000
     
    Net Sales $42,581 $32,728 
    Net Loss $(7,672)$(10,293)
    Basic and diluted loss per share $(0.33)$(0.56)

    P.    QUARTERLY RESULTS (UNAUDITED)

            The following table contains selected unaudited consolidated statements of operations data for each quarter for fiscal years 2002 and 2001.

     
     2002
     
     
     1st Quarter
     2nd Quarter
     3rd Quarter
     4th Quarter
     Total
     
    Net Sales $9,831 $9,424 $9,087 $9,212 $37,554 
    Gross Profit  5,108  4,862  4,249  3,766  17,985 
    Net loss $(3,359)$(3,981)$(4,727)$(9,298)$(21,365)
    Basic & Diluted Loss Per Share $(0.14)$(0.17)$(0.20)$(0.40)$(0.91)
    Basic and Diluted Weighted Average Shares Outstanding  23,653,544  23,699,047  23,483,315  23,498,935  23,582,687 

    45


     
     2001
     
     
     1st Quarter
     2nd Quarter
     3rd Quarter
     4th Quarter
     Total
     
    Net Sales $7,930 $9,545 $10,254 $10,738 $38,467 
    Gross Profit  4,263  5,408  5,663  5,935  21,269 
    Net loss $(1,128)$(1,648)$(1,910)$(2,715)$(7,401)
    Basic & Diluted Loss Per Share $(0.05)$(0.07)$(0.08)$(0.12)$(0.33)
    Basic and Diluted Weighted Average Shares Outstanding  21,227,564  22,504,309  23,183,637  23,302,793  22,560,057 

            Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly per share losses may not equal the annual loss per share. Effective May 1, 2001, the Company acquired Annovis, Inc. Annovis's results of operations have been included in the accompanying financial statements beginning on May 1, 2001.

    Q.    CORPORATE RESTRUCTURING AND ADDITIONAL FINANCING

            The Company has experienced net losses and negative cash flows from operations. As a result, 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. Management expects 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.

            Additionally, in March 2003 the Company entered into a loan commitment agreement with a financial institution for a secured line of credit up to a maximum commitment of $5.0 million. Collateral for the line of credit consists of qualified accounts receivable balances. Funds available under the line are equal to 80% of eligible accounts receivable 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. Management believes, as a result of the restructuring activities, current cash balances and funds available from the secured line of credit will be sufficient to fund operations through at least fiscal year 2003.

    46



    Item 9.    Changes in and Disagreement With Accountants on Accounting and Financial Disclosure.

            None.


    Part III

    Item 10.    Directors and Executive Officers of the Registrant.

            We will file a definitive Proxy Statement with the Securities Exchange Commission not later than April 30, 2003. Information about our directors required by Item 401 of Regulation S-K and information about our directors and executive officers required by Item 405 of Regulation S-K is incorporated by reference to the Proxy Statement. Information about our Executive Officers is shown in Part I of this filing.

    Item 11.    Executive Compensation.

            Information required by this Item is incorporated by reference to our definitive Proxy Statement.

    Item 12.    Security Ownership of Certain Beneficial Owners and Management.

            Information required by this Item is incorporated by reference to our definitive Proxy Statement.

    Item 13.    Certain Relationships and Related Transactions

            Information required by this Item is incorporated by reference to our definitive Proxy Statement.

    Item 14.    Controls and Procedures

            Our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation within 90 days of the filing date of this report, that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports under the Securities Exchange Act of 1934. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the previously mentioned evaluation.


    Part IV

    Item 15.    Exhibits, Financial Statement Schedules and Reports of Form 8-K.

      (a)
      The following documents are filed as part of this report:

      1.
      Financial Statements

          The financial statements listed on page 2 of this report are filed herewith.

        2.
        Financial Statement Schedules—None.

        3.
        Exhibits. The Exhibits required by Item 601 of Regulation S-K of the Securities and Exchange Act of 1934, as amended, filed as part of this report are listed in the Exhibit Index under paragraph (c) of this Item 14.

      (b)
      Reports on Form 8-K. The Company did not file any reports on Form 8-K during the quarter ended December 31, 2002.

    47


        (c)
        Exhibits.

      2.1 Asset Purchase Agreement, dated May 16, 2000 between the Registrant and SD Acquisition Inc.(2)
      2.2 Agreement and Plan of Merger, dated as of April 30, 2001 among Transgenomic, Inc., TBIO Nebraska, Inc., TBIO, Inc. and Annovis, Inc.(3)
      2.3 Addendum to Agreement and Plan of Merger, dated as of May 18, 2001 among Transgenomic, Inc., TBIO Nebraska, Inc., TBIO, Inc. and Annovis, Inc.(3)
      3.1 Second Amended and Restated Certificate of Incorporation of the Registrant(2)
      3.2 Bylaws of the Registrant(1)
      4 Form of Certificate of the Registrant's Common Stock(1)
      10.1 Amended and Restated 1997 Stock Option Plan of the Registrant(4)
      10.2 1999 UK Approved Stock Option Sub Plan of the Registrant(1)
      10.3 Employment Agreement, dated April 1, 2000, between the Registrant and Collin J. D'Silva(1)
      10.4 Employee Stock Purchase Plan of the Registrant(5)
      10.5 Employment Agreement, dated June 1, 2001, between the Registrant and John L. Allbery(7)
      10.6 License Agreement, dated September 1, 1994, between Registrant and Professor Dr. Gunther Bonn, et. al. and Amendment thereto, dated March 14, 1997(1)
      10.7 License Agreement, dated August 20, 1997, between the Registrant and Leland Stanford Junior University(1)
      10.8 Supply Agreement, dated January 1, 2000, between the Registrant and Hitachi Instruments(1)
      10.9 Services Provider Agreement, dated December 28, 2001, between the Registrant and Genodyssee S.A.(7)
      10.10 Revolving Line of Credit Agreement, dated December 28, 2001, between the Registrant and Genodyssee S.A.(7)
      10.11 License Agreement, dated December 1, 1989, between Cruachem Holdings Ltd. (a wholly owned subsidiary of the Registrant) and Millipore Corporation(7)
      10.12 Sublicense Agreement, dated October 1, 1991, between Cruachem Holdings Ltd. (a wholly owned subsidiary of the Registrant) and Applied Biosystems, Inc.(7)
      10.13 Employment Agreement, dated January 22, 2002, between the Registrant and Keith A. Johnson(8)
      10.14 Term Loan Agreement, dated February 1, 2002, between the Registrant and Genodyssee S.A. Certain confidential portion s of this Exhibit were omitted by means of redacting a portion of the text. This Exhibit has been filed separately with the Secretary of the Commission with the redacted text pursuant to the Registrant's Application Requesting Confidential Treatment under Rule 24b-2 of the Securities Exchange Act(8)
      10.15 Missives, dated May 17, 2002, between Cruachem Limited (a wholly-owned subsidiary of the Registrant) and Robinson Nugent (Scotland) Limited(9)
      10.16 Agreement between The Royal Bank of Scotland plc and Cruachem Limited (a wholly-owned subsidiary of the Registrant), dated August 18, 2002(10)
      10.17 Standard Security by Cruachem Limited (a wholly-owned subsidiary of the Registrant) in Favour of The Royal Bank of Scotland plc, dated August 13, 2002(10)
      10.18 Lease Agreement by and between Yew Tree Investments LTD., LLLP and the Registrant, dated August 23, 2002(10)

      48


      10.19 Master Lease Agreement between General Electric Capital Corporation and the Registrant, dated December 12, 2002
      21 Subsidiaries of the Registrant
      23 Consent of Deloitte & Touche LLP
      24 Powers of Attorney

      (1)
      This Exhibit is incorporated by reference to the Registration Statement of the Registrant (Registration No. 333-32174), which was filed on March 10, 2000.

      (2)
      This Exhibit is incorporated by reference to the Registration Statement of the Registrant (Registration No. 333-32174), as amended by Amendment 1, which amendment was filed on May 17, 2000.

      (3)
      This Exhibit is incorporated by reference to the Registration Statement of the Registrant (Registration No. 000-30975), which was filed on May 31, 2001.

      (4)
      This Exhibit is incorporated by reference to the Registrant's Report on Form 10-Q, which was filed on August 14, 2001.

      (5)
      This Exhibit is incorporated by reference to the Registration Statement of the Registrant (Registration No. 333-71866), which was filed on October 19, 2001.

      (6)
      This Exhibit is incorporated by reference to the Registrant's Report on Form 10-Q, which was filed on May 14, 2001.

      (7)
      This Exhibit is incorporated by reference to the Registrant's Annual Report on Form 10-K, which was filed on March 25, 2002.

      (8)
      This Exhibit is incorporated by reference to the Registrant's Report on Form 10-Q, which was filed on May 14, 2002.

      (9)
      This Exhibit is incorporated by reference to the Registrant's Report on Form 10-Q, which was filed on August 14, 2002.

      (10)
      This Exhibit is incorporated by reference to the Registrant's Report on Form 10-Q, which was filed on November 12, 2002.

      49



      SIGNATURES

              Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 31st day of March 2003.

        TRANSGENOMIC, INC.

       

       

      By

       

      /s/  
      COLLIN J. D'SILVA      
      Collin J. D'Silva,
      Chairman and Chief Executive Officer

              Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on this 31st day of March 2003.

      Signature

       Title


      /s/  
      COLLIN J. D'SILVA      
      Collin J. D'Silva

       

      Chairman of the Board, Director and Chief Executive Officer (Principal Executive Officer)

      /s/  
      WILLIAM P. RASMUSSEN      
      William P. Rasmussen

       

      Chief Financial Officer (Principal Financial Officer)

      /s/  
      GREGORY J. DUMAN*      
      Gregory J. Duman

       

      Director

      /s/  
      JEFFREY SKLAR*      
      Jeffrey Sklar, M.D., Ph.D.

       

      Director

      /s/  
      ROLAND J. SANTONI*      
      Roland J. Santoni

       

      Director

      /s/  
      PARAG SAXENA*      
      Parag Saxena

       

      Director

      *By Collin J. D'Silva, as attorney-in-fact

       

       

      /s/  
      COLLIN J. D'SILVA      
      Collin J. D'Silva
      Attorney-in-fact for the individuals as indicated.

       

       

      50



      CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

      I, Collin J. D'Silva, certify that:

        1.
        I have reviewed this annual report on Form 10-K of Transgenomic, Inc. (the Registrant);

        2.
        Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

        3.
        Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

        4.
        The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:

        a)
        Designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

        b)
        Evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

        c)
        Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.
        The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent function):

        a)
        all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and

        b)
        any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and

        6.
        The Registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

      Date: March 31, 2003 /s/COLLIN J. D'SILVA
      Collin J. D'Silva,Chief Executive Officer

      51



      CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

      I, William P. Rasmussen, certify that:

        1.
        I have reviewed this annual report on Form 10-K of Transgenomic, Inc. (the Registrant);

        2.
        Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

        3.
        Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

        4.
        The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:

        a)
        Designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

        b)
        Evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and

        c)
        Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

        5.
        The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of the Registrant's board of directors (or persons performing the equivalent function):

        a)
        all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and

        b)
        any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and

        6.
        The Registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

      Date: March 31, 2003 /s/WILLIAM P. RASMUSSEN
      William P. Rasmussen,Chief Financial Officer

      52




      QuickLinks

      Index
      PART I
      FORWARD-LOOKING STATEMENTS
      Part II
      INDEPENDENT AUDITORS' REPORT
      TRANSGENOMIC, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of December 31, 2002 and 2001 (In thousands except share and per share data)
      TRANSGENOMIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, 2002, 2001 and 2000 (in thousands except share and per share data)
      TRANSGENOMIC, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) Years Ended December 31, 2002, 2001 and 2000 (in thousands except share data)
      TRANSGENOMIC INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2002, 2001 and 2000 (In thousands)
      TRANSGENOMIC, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 2002, 2001 and 2000 (Tabular amounts in thousands except share and per share data)
      Part III
      Part IV
      SIGNATURES
      CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
      CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER