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PRPO Precipio

Filed: 13 Aug 07, 8:00pm
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


(Mark One)

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

For the Quarterly Period Ended June 30, 2007

Or

 

¨TRANSITION 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 911789357

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

12325 Emmet Street, Omaha, Nebraska 68164
(Address of principal executive offices) (Zip Code)

(402) 452-5400

(Registrant’s telephone number, including area code)

 


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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Securities Exchange Act of 1934.

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934)    Yes  ¨    No  x

As of August 14, 2007, the number of shares of common stock outstanding was 49,189,672.

 



Table of Contents

TRANSGENOMIC, INC.

INDEX

 

     Page No.
PART I. FINANCIAL INFORMATION  3
Item 1. 

Financial Statements

  3
 

Unaudited Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006

  3
 

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2007 and 2006

  4
 

Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2007

  5
 

Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2007 and 2006

  6
 

Notes to Unaudited Condensed Consolidated Financial Statements

  7
Item 2. 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  16
Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

  22
Item 4. 

Controls and Procedures

  22
PART II. OTHER INFORMATION  23
Item 1. Legal Proceedings  23
Item 1A. Risk Factors  23
Item 4. Submission of Matters to a Vote of Security Holders  23
Item 6. Exhibits  23
Signatures  24

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1.Financial Statements

TRANSGENOMIC, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except per share data)

 

   

June 30,

2007

(unaudited)

  

December 31,

2006

 
ASSETS   

CURRENT ASSETS:

   

Cash and cash equivalents

  $7,883  $5,868 

Accounts receivable (net of allowances for doubtful accounts of $476 and $444, respectively)

   6,474   6,525 

Inventories

   3,243   2,672 

Prepaid expenses and other current assets

   571   540 

Current assets of discontinued operations

   4   —   
         

Total current assets

   18,175   15,605 
         

PROPERTY AND EQUIPMENT:

   

Equipment

   10,416   10,345 

Furniture and fixtures

   3,822   3,820 
         
   14,238   14,165 

Less: Accumulated depreciation

   13,008   12,667 
         
   1,230   1,498 

OTHER ASSETS:

   

Goodwill

   638   638 

Other assets

   733   853 

Non-current assets of discontinued operations

   —     2,773 
         
  $20,776  $21,367 
         
LIABILITIES AND STOCKHOLDERS’ EQUITY   

CURRENT LIABILITIES:

   

Accounts payable

  $1,386  $1,558 

Other accrued expenses

   3,454   2,898 

Accrued compensation

   491   689 

Current liabilities of discontinued operations

   176   184 
         

Total current liabilities

   5,507   5,329 

Other long-term liabilities

   129   —   
         

Total liabilities

   5,636   5,329 

COMMITMENTS AND CONTINGENCIES

   

STOCKHOLDERS’ EQUITY:

   

Preferred stock, $0.01 par value, 15,000,000 shares authorized, none outstanding

   —     —   

Common stock, $0.01 par value, 100,000,000 shares authorized, 49,189,672 shares outstanding

   497   497 

Additional paid-in capital

   139,012   138,966 

Accumulated other comprehensive income

   2,255   2,100 

Accumulated deficit

   (126,624)  (125,525)
         

Total stockholders’ equity

   15,140   16,038 
         
  $20,776  $21,367 
         

See notes to unaudited condensed consolidated financial statements.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands except per share data)

 

   

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
   2007  2006  2007  2006 

NET SALES

  $6,272  $6,189  $11,494  $12,686 

COST OF GOODS SOLD

   2,859   3,140   5,373   6,654 
                 

Gross profit

   3,413   3,049   6,121   6,032 

OPERATING EXPENSES:

     

Selling, general and administrative

   3,067   2,820   6,047   5,529 

Research and development

   492   531   1,550   1,135 

Restructuring costs

   624   —     624   —   
                 
   4,183   3,351   8,221   6,664 
                 

LOSS FROM OPERATIONS

   (770)  (302)  (2,100)  (632)

OTHER INCOME (EXPENSE):

     

Interest income, net of interest expense

   79   44   141   88 

Other, net

   —     —     4   —   

Gain on sale of investment

   938   —     938   —   
                 
   1,017   44   1,083   88 
                 

INCOME (LOSS) BEFORE INCOME TAXES

   247   (258)  (1,017)  (544)

INCOME TAX EXPENSE

   14   —     19   17 
                 

INCOME (LOSS) FROM CONTINUING OPERATIONS

   233   (258)  (1,036)  (561)

INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX

   (7)  (125)  66   (139)
                 

NET INCOME (LOSS)

  $226  $(383) $(970) $(700)
                 

BASIC AND DILUTED LOSS PER SHARE:

     

From continuing operations

  $0.00  $(0.01) $(0.02) $(0.01)

From discontinued operations

   0.00   0.00   0.00   0.00 
                 
  $0.00  $(0.01) $(0.02) $(0.01)
                 

BASIC WEIGHTED AVERAGE SHARES
OUTSTANDING

   49,189,672   49,189,672   49,189,672   49,187,211 

DILUTED WEIGHTED AVERAGE SHARES
OUTSTANDING

   62,141,863   49,189,672   49,189,672   49,187,211 

See notes to unaudited condensed consolidated financial statements.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Six Months Ended June 30, 2007

(Dollars in thousands except per share data)

 

   Common Stock             
   

Outstanding

Shares

  

Par

Value

  

Additional

Paid-in

Capital

  

Accumulated

Deficit

  

Accumulated

Other

Comprehensive

Income (Loss)

  Total 

Balance, December 31, 2006

  49,189,672  $497  $138,966  $(125,525) $2,100  $16,038 

Cumulative effect of adoption of FIN 48 (Note H)

  —     —     —     (129)  —     (129)
                        

Balance, January 1, 2007

  49,189,672  $497  $138,966  $(125,654) $2,100  $15,909 

Net loss

  —     —     —     (970)  (970)  (970)

Other comprehensive loss:

          

Foreign currency translation adjustment

  —     —     —     —     155   155 
             

Comprehensive loss

  —     —     —     —     (815)  —   

Stock-based compensation

  —     —     46   —     —     46 
                        

Balance, June 30, 2007

  49,189,672  $497  $139,012  $(126,624) $2,255  $15,140 
                        

See notes to unaudited condensed consolidated financial statements.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

   

Six Months Ended

June 30,

 
   2007  2006 

CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES:

   

Net loss

  $(970) $(700)

Adjustments to reconcile net loss to net cash flows provided by (used in) operating activities:

   

Depreciation and amortization

   742   956 

Non-cash, stock-based compensation

   46   —   

(Gain) Loss on sale of investment and assets

   (1,034)  7 

Changes in operating assets and liabilities:

   

Accounts receivable

   149   1,131 

Inventories

   (567)  785 

Prepaid expenses and other current assets

   (28)  (90)

Accounts payable

   (216)  (477)

Accrued expenses

   314   (947)
         

Net cash flows provided by (used in) operating activities

   (1,564)  665 
         

CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES:

   

Purchase of property and equipment

   (181)  (178)

Change in other assets

   (119)  (41)

Proceeds from asset sales

   3,872   40 
         

Net cash flows provided by (used in) investing activities

   3,572   (179)
         

CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:

   

Issuance of common stock

   —     5 
         

Net cash flows provided by financing activities

   —     5 
         

EFFECT OF FOREIGN CURRENCY EXCHANGE RATE CHANGES ON CASH

   7   135 
         

NET CHANGE IN CASH AND CASH EQUIVALENTS

   2,015   626 

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

   5,868   6,736 
         

CASH AND CASH EQUIVALENTS AT END OF PERIOD

  $7,883  $7,362 
         

SUPPLEMENTAL CASH FLOW INFORMATION

   

Cash paid during the period for:

   

Interest

  $5  $—   

Income taxes, net

   19   17 

See notes to unaudited condensed consolidated financial statements.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

A.BUSINESS DESCRIPTION

Business Description.

Transgenomic, Inc. (the “Company”) provides innovative products for the synthesis, purification and analysis of nucleic acids used in the life sciences industry for research focused on molecular genetics and diagnostics. The Company also provides genetic variation analytical services to the medical research, clinical and pharmaceutical markets. Net sales are categorized as bioinstruments, bioconsumables and discovery services.

 

 

 

Bioinstruments. The Company’s flagship product is the WAVE® System which has broad applicability to genetic variation detection in both molecular genetic research and molecular diagnostics. There is a worldwide installed base of over 1,375 WAVE Systems as of June 30, 2007. The Company also distributes bioinstruments produced by other manufacturers through its sales and distribution network. Service contracts to maintain installed systems are sold and supported by technical support personnel.

 

 

 

Bioconsumables. The installed WAVE base and some third-party installed platforms generate a demand for consumables that are required for the system’s continued operation. The Company develops, manufactures and sells these products. In addition, the Company manufactures and sells consumable products that can be used on multiple, independent platforms. These products include SURVEYOR® Nuclease and a range of HPLC separation columns.

 

  

Discovery Services. The Company provides various genetic laboratory services through a contract research lab in Gaithersburg, Maryland and a second laboratory in Omaha, Nebraska. The lab in Omaha operates in a Good Laboratory Practices (“GLP”) compliant environment and is certified under the Clinical Laboratory Improvement Amendment. The services provided by the Company’s laboratories primarily include (1) genomic biomarker analysis services to pharmaceutical and biopharmaceutical companies to support preclinical and clinical development of targeted therapeutics, and (2) molecular-based testing for hematology, oncology and certain inherited diseases for physicians and third-party laboratories.

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

Although the Company has experienced declining sales and recurring net losses (resulting in an accumulated deficit of $127 million at June 30, 2007), management believes existing sources of liquidity, including cash and cash equivalents of $7.9 million, are sufficient to meet expected cash needs through 2007. The Company will need to increase net sales and further reduce operating expenses in order to meet its liquidity needs for the existing business on a long-term basis. The Company has announced consolidation plans which are underway and will help reduce operating costs. There is no assurance that the Company will be able to increase net sales or further reduce expenses and, accordingly, the Company may not have sufficient sources of liquidity to continue operations indefinitely. If necessary, management believes they can further reduce costs and expenses to conserve working capital. However, such cost and expense reductions could have an adverse impact on the Company’s new product pipeline and ultimately net sales. The Company could also pursue additional financing, but ultimately, the Company must achieve sufficient net sales to consistently generate net income and cash flows from operations.

 

B.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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.

Use of Estimates.

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

financial statements and the reported amounts of net sales and expenses during the reporting period. In addition, estimates and assumptions associated with the determination of the fair value of certain assets and related impairments and the determination of goodwill impairments require considerable judgment by management. Actual results could differ from the estimates and assumptions used in preparing these financial statements.

Cash and Cash Equivalents.

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

Accounts Receivable.

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

 

   Three Months Ended  Six Months Ended 
   

June 30,

2007

  

June 30,

2006

  

June 30,

2007

  

June 30,

2006

 

Beginning balance

  $420  $581  $444  $615 

Charges to income

   57   (75)  33   (45)

Deductions from reserves

   (1)  (128)  (1)  (192)
                 

Ending balance

  $476  $378  $476  $378 
                 

While payment terms are generally 30 days, the Company has also provided extended payment terms of up to 90 days in certain cases. The Company reviews accounts receivables on a quarterly basis and adjusts its bad debt reserve accordingly.

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.

Equipment, Furniture and Fixtures.

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

 

Leasehold improvements

  3 to 10 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

Depreciation and amortization during the three months ended June 30, 2007 and 2006, respectively, included $218 and $350, respectively, related to depreciation of property and equipment. Depreciation and amortization during the six months ended June 30, 2007 and 2006, respectively, included $463 and $721, respectively, related to depreciation of property and equipment.

Goodwill

Statement of Financial Accounting Standards (“SFAS”) No. 142,Goodwill and Other Intangible Assets,provides that goodwill will not be amortized, but will be tested for impairment annually. The Company performs this impairment analysis during the fourth quarter of each year. Impairment occurs when the carrying value is determined to be not recoverable thereby causing the fair value of the goodwill to exceed the carrying value. If impaired, the asset’s carrying value is reduced to its fair value.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

Other Assets.

Long-Lived Assets

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, (SFAS No. 144) which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, and the accounting and reporting provisions of Accounting Principles Board (APB) Opinion No. 30,Reporting the Results of Operations, for a disposal of a segment of a business. The Company periodically reviews the carrying value of its long-lived assets to assess recoverability and impairment. The Company recorded no impairments during the three and six months ended June 30, 2007 or 2006.

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

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

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

Other Intangible Assets. Identifiable intangible assets with definite lives are amortized over their estimated useful lives and tested for impairment as events or changes in circumstances indicate the carrying amount of the asset may be impaired.

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

Stock Based Compensation.

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

The Company adopted Financial Accounting Standards Board (FASB) Statement No. 123(R),Share-Based Payment (“FAS 123(R)”), on January 1, 2006. FAS 123(R) requires the Company to measure and recognize compensation expense for all stock-based awards made to employees and directors, including stock options. Compensation expense is based on the calculated fair value of the awards as measured at the grant date and is expensed ratably over the service period of the awards (generally the vesting period).

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

During the six months ended June 30, 2007 and 2006, the Company recorded compensation expense of $46 and $0, respectively, within the general administrative expense related to the vesting of 685,000 and 0 options, respectively during these periods. The fair value of the options was estimated on their respective grant dates using the Black-Scholes option pricing model. The Black-Scholes model was used with the following assumptions: risk-free interest rates of 4.71% to 5.08%, based on the U.S.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

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

Income Taxes.

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

Revenue Recognition.

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

Research and Development.

Research and development costs are charged to expense when incurred.

Translation of Foreign Currency.

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

Comprehensive Income.

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

Earnings Per Share.

Basic earnings per share is calculated based on the weighted-average number of common shares outstanding during each period. Diluted earnings per share include shares issuable upon exercise of outstanding stock options, warrants or conversion rights that have exercise or conversion prices below the market value of the Company’s common stock. Options, warrants and conversion rights pertaining to 12,175,141 and 13,538,841 shares of the Company’s common stock have been excluded from the computation of diluted earnings per share at June 30, 2007 and 2006, respectively, because the exercise or conversion price of these instruments exceeded the market price of the Company’s common stock on those dates.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

Recently Issued Accounting Pronouncements

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

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

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

 

C.DISCONTINUED OPERATIONS

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

 

   

Three Months Ended

June 30,

  

Six Months Ended

June 30,

 
   2007  2006  2007  2006 

NET SALES

  $—    $581  $—    $1,135 

COST OF GOODS SOLD

   —     463   —     843 
                 

Gross profit

   —     118   —     292 

OPERATING EXPENSES

   7   244   (66)  433 
                 

INCOME (LOSS) FROM OPERATIONS

   (7)  (126)  66   (141)

OTHER INCOME

   —     1   —     2 
                 

INCOME (LOSS) BEFORE INCOME TAXES

   (7)  (125)  66   (139)

INCOME TAX

   —     —     —     —   
                 

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

  $(7) $(125) $66  $(139)
                 

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

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

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

 

   June 30,
2007
  

December 31,

2006

Accounts receivable (net of allowances for doubtful accounts of $173 and $169, respectively)

  $—    $—  

Prepaid expenses and other current assets

   4   —  
        

Current assets of discontinued operations

  $4  $—  
        

Property and equipment, net

  $—    $2,773
        

Non-current assets of discontinued operations

  $—    $2,773
        

Accounts payable

  $34  $45

Other accrued expenses

   142   139
        

Current liabilities of discontinued operations

  $176  $184
        

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

 

D.RESTRUCTURING CHARGES

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

 

E.INVENTORIES

Inventories consisted of the following:

 

   June 30,
2007
  

December 31,

2006

Finished goods

  $2,128  $2,146

Raw materials and work in process

   1,101   443

Demonstration inventory

   14   83
        
  $3,243  $2,672
        

 

F.OTHER ASSETS

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

 

   June 30, 2007  December 31, 2006
   Cost  

Accumulated

Amortization

  

Net Book

Value

  Cost  

Accumulated

Amortization

  

Net Book

Value

Intellectual property

  $865  $692  $173  $765  $677  $88

Patents

   643   177   466   676   155   521

Other

   302   208   94   705   461   244
                        

Total

  $1,810  $1,077  $733  $2,146  $1,293  $853
                        

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

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

G.COMMITMENTS AND CONTINGENCIES

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

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

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

 

H.INCOME TAXES

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

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

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

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

 

I.EMPLOYEE BENEFIT PLAN

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

 

J.STOCKHOLDERS’ EQUITY

Common Stock Warrants.

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

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

Warrant Holder

  Issue Year  Expiration Year  Underlying Shares  Exercise Price

Various Institutional Holders(1)

  2005  2010  6,903,156  $1.20

Laurus Master Fund, Ltd.(2)

  2003  2010  200,000  $1.92

Laurus Master Fund, Ltd.(2)

  2003  2010  200,000  $2.07

Laurus Master Fund, Ltd.(2)

  2003  2010  150,000  $2.35

Laurus Master Fund, Ltd.(2)

  2004  2011  125,000  $2.57

Laurus Master Fund, Ltd.(2)

  2004  2011  400,000  $1.18

TN Capital Equities, Ltd.(2)

  2003  2008  45,918  $2.94

TN Capital Equities, Ltd.(2)

  2004  2009  15,566  $3.18

GE Capital(3)

  2002  2007  13,762  $3.27

GE Capital(3)

  2003  2008  9,175  $3.27
         

Total

      8,062,577  
         

(1)These warrants were issued in conjunction with a private placement of common stock in October 2005 (the “2005 Private Placement”).
(2)These warrants were issued in conjunction with two loans that had been made by Laurus Master Fund, Ltd. to the Company (the “Laurus Loans”), and subsequent modifications of these loans. In conjunction with the 2005 Private Placement, the exercise prices of these warrants were adjusted according to repricing provisions contained in the original warrant agreements. While the Laurus Loans have been terminated, the warrants remain outstanding.
(3)These warrants were issued in conjunction with operating leases with GE Capital. While the leases have since been terminated, the warrants remain outstanding.

 

K.STOCK OPTIONS

The following table summarizes stock option activity during the six months ended June 30, 2007:

 

   

Number of

Options

  

Weighted Average

Exercise Price

Balance at January 1, 2007

  5,467,664  $4.07

Granted

  345,000   0.73

Exercised

  —     —  

Forfeited

  (1,700,100)  4.23
     

Balance at June 30, 2007

  4,112,564  $3.72
     

Exercisable at June 30, 2007

  3,442,564  $4.32
     

During the six months ended June 30, 2007, the Company granted 345,000 stock options at a weighted average exercise price of $0.73 under its 2006 Equity Incentive Plan (formerly, the 1997 Stock Option Plan). The weighted average grant date fair value per share of options granted during the six months ended June 30, 2007 was $0.56.

During the six months ended June 30, 2007 and 2006, the Company recorded compensation expense of $46 and $0, respectively, within the general administrative expense related to the vesting of 685,000 and 0 options, respectively during these periods. The fair value of the options was estimated on their respective grant dates using the Black-Scholes option pricing model. The Black-Scholes model was used with the following assumptions: risk-free interest rates of 4.71% to 5.08%, based on the U.S. Treasury yield in effect at the time of grant; dividend yields of zero percent; expected lives of 2 to 10 years, based on historical exercise activity behavior; and volatility of 89.14% and 79.10% for grants issued for the three months ended March 31, 2007 and June 30, 2007, respectively, based on the historical volatility of our stock over a time that is consistent with the expected life of the option. As of June 30, 2007, there was $272 of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of nearly three years.

 

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2007 and 2006

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

 

L.OPERATING SEGMENT AND GEOGRAPHIC INFORMATION

The Company has one reportable operating segment. Although net sales are analyzed by type, net financial results are analyzed as one segment due to the integrated nature of the products. Net sales by product were as follows:

 

   Three Months Ended  Six Months Ended
   

June 30,

2007

  

June 30,

2006

  

June 30,

2007

  

June 30,

2006

Bioinstruments

  $3,383  $3,743  $6,006  $7,784

Bioconsumables

   2,218   2,296   4,448   4,540

Discovery Services

   671   150   1,040   362
                
  $6,272  $6,189  $11,494  $12,686
                

Net cost of goods sold was as follows:

 

   Three Months Ended  Six Months Ended
   

June 30,

2007

  

June 30,

2006

  

June 30,

2007

  

June 30,

2006

Bioinstruments

  $1,368  $1,492  $2,359  $3,252

Bioconsumables

   1,013   1,222   2,078   2,495

Discovery Services

   478   426   936   907
                
  $2,859  $3,140  $5,373  $6,654
                

Net sales by geographic region were as follows:

 

   Three Months Ended  Six Months Ended
   

June 30,

2007

  

June 30,

2006

  

June 30,

2007

  

June 30,

2006

United States

  $2,365  $1,454  $3,658  $3,284

Europe

   3,411   4,042   6,650   7,782

Pacific Rim

   326   492   641   910

Other

   170   201   545   710
                
  $6,272  $6,189  $11,494  $12,686
                

No customer accounted for more than 10% of consolidated net sales during the three and six months ended June 30, 2007 and 2006.

Substantially, all the Company’s long-lived assets are within the United States.

 

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

Overview

We develop, assemble, manufacture and market versatile products for the synthesis, purification and analysis of nucleic acids used in life sciences industry for research focused on molecular genetics and diagnostics. We also provide analytical services to the medical research, clinical and pharmaceutical markets for use in genetic variation analysis. Products and services are sold through a direct sales force in the United States and throughout much of Western Europe. For the rest of the world, products and services are sold through more than 35 dealers and distributors located in those local markets. Net sales are categorized as bioinstruments, bioconsumables and discovery services.

 

  

Bioinstruments. Our flagship product is the WAVE System which has broad applicability to genetic variation detection in both molecular genetic research and molecular diagnostics. There is a worldwide installed base of over 1,375 WAVE Systems as of June 30, 2007. We also sell a number of complementary equipment platforms manufactured by others (“OEM Instruments”). Service contracts to maintain installed systems are sold and supported by technical support personnel.

 

  

Bioconsumables. The installed WAVE base and some third-party installed platforms generate a demand for consumables that are required for the system’s continued operation. We develop, manufacture and sell these products. In addition, we manufacture and sell consumable products that can be used on a number of equipment platforms manufactured by others. These products include SURVEYOR Nuclease and a range of HPLC separation columns.

 

  

Discovery Services. We provide various genetic laboratory services through a contract research lab in Gaithersburg, Maryland and a second laboratory in Omaha, Nebraska. The lab in Omaha operates in a Good Laboratory Practices (“GLP”) compliant environment and is certified under the Clinical Laboratory Improvement Amendment (“CLIA”). The services provided by our labs primarily include (1) genomic biomarker analysis services to pharmaceutical and biopharmaceutical companies to support preclinical and clinical development of targeted therapeutics, and (2) molecular-based medical testing services for hematology, oncology and certain inherited diseases for physicians and third-party laboratories.

Historically, we operated a segment (the “Nucleic Acids operating segment”) that developed, manufactured and marketed chemical building blocks for nucleic acid synthesis to biotechnology, pharmaceutical and oligonucleotide synthesis companies and research institutions throughout the world. In the fourth quarter of 2005, we implemented a plan to exit this operating segment. Accordingly, results of this operating segment are reflected as discontinued operations for all periods presented in this filing. In the first quarter of 2007, the Company completed the sale of the remaining assets associated with the segment.

Executive Summary

Net sales for the three months ended June 30, 2007 increased by 1%, compared to the same period in 2006. The increase is all attributable to our Discovery Services products. Net sales from bioinstruments were down 10%. Fewer WAVE sales were the cause of this decrease. Net sales from bioconsumables were down by 3%. Net sales from Discovery Services grew more than 300%, or $521,000, compared to the same quarter in 2006. The majority of the increase was related to the CLIA laboratory services. We also had strong sequential quarter over quarter growth in sales of CLIA laboratory services of 82%, or $300,000 in net sales. We continue to see improvement in gross margins. Our gross profit margins improved from 49% in the second quarter of 2006 to 54% in the current quarter ended June 30, 2007. The largest contributor to this increase is our Discovery Services product line which went from a negative gross profit in both the second quarter of 2006 and the first quarter of 2007 to a positive gross profit margin of 29% in the quarter ended June 30, 2007. Overall operating expenses included $624,000 of restructuring charges, primarily related to closings in France and the United Kingdom. Net profit was $226,000 for the second quarter ended June 30, 2007. This included two non-recurring items. First, we completed the sale of an investment in equity securities realizing a gain of $937,500. The second item noted above was the $624,000 of restructuring charges. As of the end of the second quarter ended June 30, 2007, we had cash and cash equivalents of $7.9 million and believe we will have sufficient liquidity to meet our operating needs throughout the year.

Outlook

We continue to work toward our objective of generating income from continuing operations and positive cash flows from continuing operations. To accomplish these goals, we must generate growth in net sales and continue to control manufacturing and other operating expenses. Sales of bioinstruments, including both our WAVE System and instruments we

 

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sell for other manufacturers, continue to be affected by competition from other technologies. In addition, ongoing changes in the marketplace and the funding arrangements of our customers have led to sporadic sales in some markets. We continue to work to develop new applications for our WAVE System in an attempt to expand its market and sales. Sales of our OEM instruments continue to be a priority. We are also focusing increased efforts to expand our Discovery Services sales. In particular, the growth in our CLIA laboratory services has been promising and we believe we will continue to see ongoing growth from this business. We recently announced further cost reduction initiatives, including the closing of facilities in Europe. While the effects of these efforts have not been realized in the first half of 2007, we expect to see a more noticeable impact in the second half of the year.

Results of Continuing Operations

Three Months Ended June 30, 2007 and 2006

Net Sales. Net sales consisted of the following (dollars in thousands):

 

   Three Months Ended
June 30,
  Change 
   2007  2006  $  % 

Bioinstruments

  $3,383  $3,743  $(360) (10)%

Bioconsumables

   2,218   2,296   (78) (3)%

Discovery Services

   671   150   521  347%
              

Net sales

  $6,272  $6,189  $83  1%
              

The bioinstrument net sales decrease of 10% was due to fewer WAVE Systems being sold. Sixteen WAVE Systems were sold during the three months ended June 30, 2007, compared to 24 during the same period of 2006. WAVE sales in each period include sales of refurbished WAVEs. This decrease resulted from lower demand primarily in our largest markets throughout Western Europe. The sale of OEM instruments increased from 2 in the three months ended June 30, 2006 to 3 in the same period in 2007. There are significant competitive challenges from traditional (i.e. sequencing) and evolving technologies. Net sales of consumables related to our WAVE Systems and other third-party instruments were down slightly year over year, primarily related to our separations product. The largest growth was in our discovery services net sales. The 347% increase was all attributable to CLIA laboratory services.

Costs of Goods Sold.Costs of goods sold include material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs, rent, supplies and depreciation) associated with our discovery services operations. Cost of goods sold consisted of the following (dollars in thousands):

 

   

Three Months Ended

June 30,

  Change 
   2007  2006  $  % 

Bioinstruments

  $1,368  $1,492  $(124) (8)%

Bioconsumables

   1,013   1,222   (209) (17)%

Discovery Services

   478   426   52  12%
              

Cost of goods sold

  $2,859  $3,140  $(281) (9)%
              

Gross profit was $3.4 million or 54% of total net sales during the three months ended June 30, 2007, compared to $3.0 million or 49% during the same period of 2006. Although net sales declined, gross profits as percentage of net sales increased due to lower consumable material and manufacturing costs and also due to the leverage of the discovery services costs. Some of the decrease in manufacturing costs was due to a shifting of personnel to research and development efforts. The Company continues to have a large fixed expense base outside of direct material costs. Discovery services costs have a large fixed component, so increases in net sales drive gross profit improvement.

Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily consist of personnel costs, marketing, travel and entertainment costs, professional fees, and facility costs. These costs totaled $3.1 million during the three months ended June 30, 2007, compared to $2.8 million during the same period of 2006, an increase of $0.3 million or 11%. This increase was primarily due to increased compensation expense associated with personnel reassigned from Nucleic Acids production. These expenses are consistent with the third and fourth quarters of 2006 which we believe is a better comparison as all three quarters are comparable with no realignment of expenses between areas.

 

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Research and Development Expenses. Research and development expenses primarily include personnel costs, outside services, supplies, and facility costs and are expensed in the period in which they are incurred. These costs remained flat and totaled $0.5 million during the three months ended June 30, 2007, compared to $0.5 million during the same period of 2006.

Research and development expenses totaled 8% and 9% of net sales during the three months ended June 30, 2007 and 2006, respectively.

Restructuring Charges. Restructuring charges consist of costs related to a reduction in force at our Omaha, Nebraska facility, ongoing activities to close a production facility in Cramlington, England, and ongoing activities to close an administrative office outside of Paris, France.

Other Income (Expense). Other income during the three months ended June 30, 2007 was $1.0 million as compared to less than $0.1 million for the three months ended June 30, 2006. The increase was attributable to the sale of an investment in equity securities. On May 10, 2007, the Company sold 250,000 shares of stock in Pinnacle Pharmaceuticals, Inc. at a price of $3.75 per share. Gross proceeds realized from the sale were $937,500 which resulted in a gain of $937,500 and is reflected in other income during the period. Remaining other income consisted primarily of interest income from cash and cash equivalents invested in overnight instruments.

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

Six Months Ended June 30, 2007 and 2006

Net Sales. Net sales consisted of the following (dollars in thousands):

 

   

Six Months Ended

June 30,

  Change 
   2007  2006  $  % 

Bioinstruments

  $6,006  $7,784  $(1,778) (23)%

Bioconsumables

   4,448   4,540   (92) (2)%

Discovery Services

   1,040   362   678  187%
              

Net sales

  $11,494  $12,686  $(1,192) (9)%
              

The bioinstrument net sales decrease of 23% was due to fewer WAVE Systems and OEM instruments being sold. Thirty WAVE Systems were sold during the six months ended June 30, 2007, compared to 47 during the same period of 2006. There were 5 OEM instruments sold during the six months ended June 30, 2007 compared to 8 during the same period in 2006. WAVE sales in each period include sales of refurbished WAVEs. This decrease resulted from lower demand in all major geographic markets and among both research and diagnostic users, particularly in our largest markets throughout Western Europe. There are significant competitive challenges from traditional (i.e. sequencing) and evolving technologies. Net sales of consumables related to our WAVE Systems and other third-party instruments were relatively flat year over year. The largest growth, an increase of 187%, was in discovery services, and all attributable to our CLIA laboratory services.

Costs of Goods Sold.Costs of goods sold include material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs, rent, supplies and depreciation) associated with our discovery services operations. Cost of goods sold consisted of the following (dollars in thousands):

 

   

Six Months Ended

June 30,

  Change 
   2007  2006  $  % 

Bioinstruments

  $2,359  $3,252  $(893) (27)%

Bioconsumables

   2,078   2,495   (417) (17)%

Discovery Services

   936   907   29  3%
              

Cost of goods sold

  $5,373  $6,654  $(1,281) (19)%
              

 

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Gross profit was $6.1 million or 53% of total net sales during the six months ended June 30, 2007 compared to $6.0 million or 48% during the same period of 2006. Although net sales declined, gross profits as percentage of net sales increased due to lower costs for refurbished WAVE Systems, the mix of instruments sold, lower consumable material and manufacturing costs and the leverage related to the discovery services net sales. Some of the decrease in manufacturing costs was due to a shifting of personnel to research and development efforts. The Company continues to have a large fixed expense base outside of direct material costs. Discovery Services costs have a large fixed component, so increases in net sales drive gross profit improvement.

Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily consist of personnel costs, marketing, travel and entertainment costs, professional fees, and facility costs. These costs totaled $6.0 million during the six months ended June 30, 2007, compared to $5.5 million during the same period of 2006, an increase of $0.5 million or 9%. This increase was primarily due to increased compensation expense associated with personnel reassigned from Nucleic Acids production. These expenses are consistent with the third and fourth quarters of 2006 which we believe is a better comparison as all three quarters are comparable with no realignment of expenses between areas.

Research and Development Expenses. Research and development expenses primarily include personnel costs, outside services, supplies, and facility costs and are expensed in the period in which they are incurred. These costs totaled $1.6 million during the six months ended June 30, 2007, compared to $1.1 million during the same period of 2006, an increase of $0.5 million, primarily from collaboration expense on new WAVE applications, increased compensation costs associated with personnel reassigned from Nucleic Acid production and patent costs for discovery services.

Research and development expenses totaled 13% and 9% of net sales during the six months ended June 30, 2007 and 2006, respectively.

Restructuring Charges. Restructuring charges consist of costs related to a reduction in force at our Omaha, Nebraska facility, ongoing activities to close a production facility in Cramlington, England, and ongoing activities to close an administrative office outside of Paris, France.

Other Income (Expense). Other income during the six months ended June 30, 2007 and 2006 was $1.1 million and $0.1 million, respectively. The increase was attributable to the sale of an investment in equity securities. On May 10, 2007, the Company sold 250,000 shares of stock in Pinnacle Pharmaceuticals, Inc. at a price of $3.75 per share. Gross proceeds realized from the sale were $937,500 which resulted in a gain of $937,500 and is reflected in other income during the period. Remaining other income consisted primarily of interest income from cash and cash equivalents invested in overnight instruments.

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

Results of Discontinued Operations

Three Months Ended June 30, 2007 and 2006

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

 

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   Three Months Ended
June 30,
 
   2007  2006 

NET SALES

  $—    $581 

COST OF GOODS SOLD

   —     463 
         

Gross profit

   —     118 

OPERATING EXPENSES

   7   244 
         

INCOME (LOSS) FROM OPERATIONS

   (7)  (126)

OTHER INCOME

   —     1 
         

INCOME (LOSS) BEFORE INCOME TAXES

   (7)  (125)

INCOME TAX

   —     —   
         

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

  $(7) $(125)
         

Six Months Ended June 30, 2007 and 2006

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

 

   Six Months Ended
June 30,
 
   2007  2006 

NET SALES

  $—    $1,135 

COST OF GOODS SOLD

   —     843 
         

Gross profit

   —     292 

OPERATING EXPENSES

   (66)  433 
         

INCOME (LOSS) FROM OPERATIONS

   66   (141)

OTHER INCOME

   —     2 
         

INCOME (LOSS) BEFORE INCOME TAXES

   66   (139)

INCOME TAX

   —     —   
         

INCOME (LOSS) FROM DISCONTINUED OPERATIONS

  $66  $(139)
         

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

Liquidity and Capital Resources

Our working capital positions at June 30, 2007 and December 31, 2006 were as follows (in thousands):

 

   

June 30,

2007

  

December 31,

2006

  Change 

Current assets (including cash and cash equivalents of $7,883 and $5,868, respectively)

  $18,175  $15,605  $2,570 

Current liabilities

   5,507   5,329   (178)
             

Working capital

  $12,668  $10,276  $2,392 
             

 

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The increase in working capital was largely driven by the proceeds from the sale of the Glasgow facility and related equipment for $2.9 million and the sale of an investment in equity securities of $0.9 million, offset by the net loss for the six months ended June 30, 2007.

Although we have experienced declining sales and recurring net losses (resulting in an accumulated deficit of $127 million at June 30, 2007), management believes existing sources of liquidity, including cash and cash equivalents of $7.9 million, are sufficient to meet expected cash needs through 2007. We will need to increase our net sales and further reduce operating expenses in order to meet our liquidity needs for the existing business on a long-term basis. We cannot assure you that we will be able to increase net sales or further reduce our expenses and, accordingly, we may not have sufficient sources of liquidity to continue operations of the Company indefinitely. If necessary, management believes they can further reduce costs and expenses to conserve working capital. However, such cost and expense reductions could have an adverse impact on the Company’s new product pipeline and ultimately net sales. The Company could also pursue additional financing, but ultimately, the Company must achieve sufficient net sales to consistently generate net income and cash flows.

Analysis of Cash Flows

Six Months Ended June 30, 2007 and 2006

Net Change in Cash and Cash Equivalents.Cash and cash equivalents increased $2.0 million during the six months ended June 30, 2007 compared to an increase of $0.6 million during the six months ended June 30, 2006. The 2007 increase was the result of net cash provided by investing activities of $3.6 million, offset by net cash used by operating activities of $1.6 million. These were minimally offset from foreign currency exchange rates. The 2006 increase was similarly the result of net cash provided by operating activities of $0.7 million and the effect of foreign currency exchange rates of $0.1 million offset by net cash used in investing activities of $0.2 million.

Cash Flows used in Operating Activities. Cash flows used in operating activities totaled $1.6 million during the six months ended June 30, 2007, compared to cash flows generated from operating activities of $0.7 million during the same period of 2006. The use of cash flows in 2007 related primarily to the gain on sale of an investment in equity securities of $0.9 million, as well as higher inventory levels of $0.6 million related to the OEM instruments.

Cash flows generated from operating activities in 2006 related primarily to a net loss of $0.7 million offset by non-cash charges of $1.0 million. Non-cash charges consisted of depreciation and amortization. Working capital and other adjustments increased cash flows from operating activities by $0.4 million.

Cash Flows from Investing Activities. Cash flows provided by investing activities totaled $3.6 million during the six months ended June 30, 2007 compared to cash flows used in investing activities of $0.2 million during the same period of 2006. Cash flows provided by investing activities in 2007 consisted primarily of sales proceeds from our Glasgow facility and equipment of $2.9 million and sales proceeds of an investment in equity securities of $0.9 million. Cash flows used by investing activities in 2006 consisted of purchases of property and equipment and patent costs.

Cash Flows from Financing Activities. Cash flows from financing activities were minimal during the six months ended June 30, 2007 and June 30, 2006.

Obligations and Commitments

The following identifies material obligations and commitments as of June 30, 2007:

 

   Payments Due by Period
Contractual Obligations                    After

Millions of dollars

  Total  2007  2008  2009  2010  2011  2011

Operating leases(a)

  $3.75  $0.54  $0.86  $0.77  $0.66  $0.50  $0.42

Purchase obligations(b)

   1.25   1.25   —     —     —     —     —  
                            

Total contractual obligations

  $5.00  $1.79  $0.86  $0.77  $0.66  $0.50  $0.42
                            

(a)Operating leases include facility, automobile and other equipment leases.
(b)Purchase obligations include purchase commitments for components used in WAVE Systems and OEM instruments.

 

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Off-Balance Sheet Arrangements

At June 30, 2007 and December 31, 2006, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates

Accounting policies used in the preparation of the consolidated financial statements may involve the use of management judgments and estimates. Certain of our accounting policies are considered critical as they are both important to the portrayal of our 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 judgments or estimates may vary under different assumptions or circumstances. Our critical accounting policies are discussed in our annual report on Form 10-K for the fiscal year ended December 31, 2006. There have been no significant changes with respect to these estimates during the six months ended June 30, 2007, except for the treatment of the contingency accruals.

Effective January 1, 2007, we began to measure and record tax contingency accruals in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 48,Accounting for Uncertainty in Income Taxes,an Interpretation of FASB Statement No. 109 (“FIN 48”). Under FIN 48, tax benefits are recognized only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is more than likely not to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in our tax returns that do not meet these recognition and measurement standards. For additional information on the adoption of FIN 48, see Note H in Part I, Item 1 of this report.

Recently Issued Accounting Pronouncements

Please refer to our annual report on Form 10-K for the fiscal year ended December 31, 2006. There have been no changes to those listed except as noted in Note B.

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.

 

Item 3.Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Translation Risk.During the six months ended June 30, 2007 and 2006, our international sales represented more than 68% of our net sales. These sales of products in foreign countries are mainly completed in either British Pounds Sterling or the Euro. Additionally, we have two wholly-owned subsidiaries, Transgenomic Limited, and Cruachem Limited, whose operating currencies are British Pounds Sterling and the Euro. Results of operations for our foreign subsidiaries 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. As a result we are subject to exchange rate risk. The operational expenses of our foreign subsidiaries help to reduce the currency exposure we have based on our sales denominated in foreign currencies by converting foreign currencies directly into goods and services. As such, we feel we do not have a material exposure to foreign currency rate fluctuations at this time.

 

Item 4.Controls and Procedures

 

 (a)Evaluation of Disclosure Controls and Procedures. A review and evaluation was performed by our President, Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that review and evaluation, the CEO and CFO concluded that the Corporation’s disclosure controls and procedures, as designed and implemented, were effective in assuring that information required to be disclosed is recorded, processed, summarized and reported in the reports we submit under the Securities Exchange Act of 1934.

 

 (b)Change in Internal Control Over Financial Reporting. There have been no changes in our internal control over financial reporting during the quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1.Legal Proceedings

We are subject to a number of claims of various amounts which arise out of the normal course of business. In our opinion, the disposition of pending claims will not have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 1A.Risk Factors

There have been no material changes in our risk factors from those described in Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2006.

 

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

We held our Annual Meeting of Stockholders on May 23, 2007 in Omaha, Nebraska for the purpose of electing two Class I directors (for terms to expire in 2010) and one Class III director (for a term to expire in 2009). The following sets forth the results of the voting at the Annual Meeting:

 

Director Nominee

  Class/Term Ending  Votes For  Votes Withheld

Craig J. Tuttle

  Class I /2010  30,063,591  816,802

Frank R. Witney, Ph.D.

  Class I /2010  30,809,567  70,826

Rodney S. Markin, M.D., Ph.D.

  Class III /2009  30,809,567  70,826

Accordingly, Messrs. Tuttle, Witney and Markin were re-elected to the Board of Directors at the Annual Meeting. Each of our other directors, Gregory T. Sloma, Jeffrey L. Sklar, M.D., Ph.D., and Gregory J. Duman, continued in office as a director after the Annual Meeting.

 

Item 6.Exhibits

 

(a)Exhibits

 

  3.1  Third Amended and Restated Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1 to Registrant’s Report on Form 10-Q (Registration No. 000-30975) filed on November 14, 2005
  3.2  Amended and Restated Bylaws of the Registrant filed on May 25, 2007
  4  Form of Certificate of the Registrant’s Common Stock (incorporated by reference to Exhibit 4 to Registration Statement on Form S-1 (Registration No. 333-32174) filed on March 10, 2000
10.1  Stock Purchase Agreement, dated May 10, 2007, between the Registrant and New River Management IV, LP
31  Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32  Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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SIGNATURES

Pursuant to the requirements 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.

 

 TRANSGENOMIC, INC.
Date: August 14, 2007 By: 

/s/ CRAIG J. TUTTLE

  

Craig J. Tuttle

President and Chief Executive Officer

 

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