Overview

Transgenomic, Inc. provides innovative products for the purification and analysis of nucleic acids used in the life sciences industry for research focused on molecular genetics and diagnostics. We also provide genetic variation analytical services to the medical research, clinical and pharmaceutical markets. Net sales are categorized as Instrument Related and Laboratory Services.

Instrument Related Business:

• 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 1,425 WAVE Systems as of June 30, 2008. We also distribute bioinstruments produced by other manufacturers ("OEM Equipment") through our 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. We develop, manufacture and sell these products. In addition, we manufacture and sell consumable products that can be used on multiple, independent platforms. These products include SURVEYOR® Nuclease and a range of HPLC separation columns.

Laboratory Services:

• Molecular Clinical Reference Laboratory. The Molecular Clinical Reference Laboratory specializes in mitochondrial and molecular diagnostic testing including genetic testing for oncology, hematology and inherited disorders. Located in Omaha, Nebraska the clinical laboratory operates in a Good Laboratory Practices compliant environment and is certified under the Clinical Laboratory Improvement Amendment.

• Pharmacogenomics Research Services. Pharmacogenomics Research Services is a Contract Research Organization located in Gaithersburg, Maryland. It specializes in pharmocogenomic, biomarker and mutation discovery research serving the pharmaceutical and biomedical industries world-wide for disease research, drug and diagnostic development and clinical trial support.

Historically, we 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, we implemented a plan to exit the Nucleic Acids operating segment and during the three months ended March 31, 2007, we 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.

Executive Summary

Net sales for the six months ended June 30, 2008 increased by $1.0 million or 9% compared to the same period in 2007. Net sales from bioinstruments were down 4% and net sales of consumables were up 6% for the comparable 6-month periods. During the six months ended June 30, 2008, net sales from laboratory services grew 91%, or $1.0 million, compared to the same 6-month period in 2007. The Clinical Reference Laboratory showed growth of 49% and Pharmacogenomics Research Services grew by 246%. Gross margins improved year over year. Our gross profit margin improved from 53% for the six months ended June 30, 2007 to 59% for the same period in 2008. The largest contributor to our improved gross margin was our laboratory services product line which went from 10% gross profit in the six months ended June 30, 2007 to 43% for the same period in 2008. Net income was $0.2 million for the six months ended June 30, 2008.

Net sales for the three months ended June 30, 2008 were flat, compared to the same period in 2007. For the second quarter of 2008 net sales from bioinstruments were down 18%, while consumables were up 11% compared to the second quarter of 2007. Net sales from Laboratory Services grew 52%, or $0.3 million, compared to the same quarter in 2007. The Molecular Clinical Reference Laboratory showed growth of $0.2 million or 35% and Pharmacogenomics Research Services increased by $0.2 million or 113%. Gross margins improved year over year. Our gross profit margin improved from 54% in the second quarter of 2007 to 60% in the quarter ended June 30, 2008. The largest contributor to this increase is our laboratory services product line which went from a gross profit of 29% in the second quarter of 2007 to a gross profit margin of 45% in the quarter ended June 30, 2008. Net income was $0.1 million for the quarter ended June 30, 2008. As of June 30, 2008, we had cash and cash equivalents of $5.7 million.

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 sequential growth in net sales and continue to control manufacturing and other operating expenses. We are investing in all parts of our business to drive improved sales in 2008 and have added experienced sales staff. We continue to work on development of collaborative opportunities for our Molecular Clinical Reference Laboratory and Pharmacogenomics Research Services business. In addition, we have strengthened our Board of Directors, added key senior management and formed a Scientific Advisory Board to advise us on the latest developments and scientific opportunities in cancer detection screening and mitochondrial disease diagnosis.

Results of Continuing Operations

Three Months Ended June 30, 2008 and 2007

Net Sales. Net sales consisted of the following:



                                                       Dollars in Thousands
                                                Three Months Ended
                                                     June 30,              Change
                                                 2008         2007       $         %
    Instrument Related Business:
    Bioinstruments                            $    2,762    $  3,383   $ (621 )   (18 )%
    Bioconsumables                                 2,467       2,218      249      11 %

                                                   5,229       5,601     (372 )    (7 )%
    Laboratory Services:
    Molecular Clinical Reference Laboratory          708         526      182      35 %
    Pharmacogenomics Research Services               309         145      164     113 %

                                                   1,017         671      346      52 %

    Total Net sales                           $    6,246    $  6,272   $  (26 )     0 %

The bioinstrument net sales decrease of 18% was due to fewer WAVE Systems being sold. Five WAVE Systems were sold during the three months ended June 30, 2008, compared to sixteen during the same period of 2007. The average sales price of the WAVE's increased due to the shift in more sales in our European market. WAVE sales in each period include sales of refurbished WAVEs. There were three OEM instrument sales in each of the second quarters of 2008 and 2007. We continue to face significant competitive challenges for our instrument sales from traditional (i.e. sequencing) and evolving technologies. During the second quarter of 2008, net sales of consumables related to our WAVE Systems and other third-party instruments increased 11% compared to the same quarter in 2007. This increase was attributable to our international business. The largest growth in net sales was from our laboratory services group. The 52% increase was attributable to growth in our Molecular Clinical Reference Laboratory of 35% or $0.2 million. Pharmacogenomics research services increased 113% or $0.2 million compared to the same quarter in 2007.

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 laboratory services operations. Cost of goods sold consisted of the following:

                                                       Dollars in Thousands
                                                Three Months Ended
                                                     June 30,              Change
                                                 2008         2007       $         %
    Instrument Related Business:
    Bioinstruments                            $      914    $  1,368   $ (454 )   (33 )%
    Bioconsumables                                 1,034       1,013       21       2 %

                                                   1,948       2,381     (433 )   (18 )%
    Laboratory Services:
    Molecular Clinical Reference Laboratory          381         281      100      36 %
    Pharmacogenomics Research Services               178         197      (19 )   (10 )%

                                                     559         478       81      17 %

    Cost of goods sold                        $    2,507    $  2,859   $ (352 )   (12 )%

Gross profit was $3.7 million or 60% of total net sales during the three months ended June 30, 2008, compared to $3.4 million or 54% during the same period of 2007. Gross profit as a percentage of net sales increased due to a shift in sales to our European markets with a higher average sales price, lower manufacturing costs and the leverage related to the laboratory services net sales. The reduction in manufacturing costs is attributable to our restructuring plan which was executed in 2007. Laboratory services costs have a large fixed component, so increases in net sales drive gross profit improvement. The laboratory services revenue increased 52% for the second quarter of 2008 over the second quarter of 2007, while the increase in cost of goods sold was only 17%. During the 3 months ended June 30, 2007, the gross margin for the Clinical Reference Laboratory was negative.

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. For the second quarter of 2008 these costs were flat compared to the same period of 2007. Foreign currency translation adjustments decreased selling, general and administrative expenses by $0.3 million in the period ending June 30, 2008. This offset the increase in selling, general and administrative expenses due to the additions of executive staff, sales team and the Scientific Advisory Board.

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. For the second quarter of 2008 these costs increased by $0.1 million compared to the same period of 2007. They totaled $0.6 million during the three months ended June 30, 2008, compared to $0.5 million during the same period of 2007. The 2008 expenses were higher due to expenditures for collaboration projects.

Research and development expenses totaled 9% and 8% of net sales during the three months ended June 30, 2008 and 2007, respectively.

Other Income (Expense). Other income consists primarily of interest income from cash and cash equivalents invested in overnight instruments. Other income during the three months ended June 30, 2008 was less than $0.1 million as compared to $1.0 million for the three months ended June 30, 2007. The decrease was attributable to the sale of an investment in equity securities. On May 10, 2007 we sold 250,000 shares of stock in Pinnacle Pharmaceuticals, Inc. which we acquired in connection with a prior business acquisition. Gross proceeds realized from the sale were $0.9 million and because our carrying cost in this stock was $0, the sale resulted in a gain of $0.9 million.

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, 2008 and 2007

Net Sales. Net sales consisted of the following:



                                                        Dollars in Thousands
                                                 Six Months Ended
                                                     June 30,             Change
                                                 2008        2007        $         %
     Instrument Related Business:
     Bioinstruments                            $   5,791   $  6,006   $  (215 )    (4 )%
     Bioconsumables:                               4,720      4,448       272       6 %

                                                  10,511     10,454        57       1 %
     Laboratory Services:
     Molecular Clinical Reference Laboratory       1,215        816       399      49 %
     Pharmacogenomics Research Services              775        224       551     246 %

                                                   1,990      1,040       950      91 %

     Net Sales                                 $  12,501   $ 11,494   $ 1,007       9 %

The net sales of bioinstruments decreased 4% due to a couple factors. First, fewer WAVE Systems were sold. Fourteen WAVE Systems were sold during the six months ended June 30, 2008, compared to 30 during the same period of 2007. Offsetting this was an increase in the average sales price of WAVE instruments which was 60% higher in 2008 due to geographic mix and type of instrument mix. WAVE sales in each 6-month period include sales of refurbished WAVEs. This decrease in instruments sold 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. There were seven OEM instruments sold during the six months ended June 30, 2008 compared to 5 during the same period in 2007. Net sales of consumables related to our WAVE Systems and other third-party instruments increased over the same period in 2007 due to slight growth primarily in our international business. The largest growth, an increase of 91%, was in laboratory services. The Clinical Reference Laboratory increased 49% or $0.4 million over the same period in 2007. Pharmacogenomics Services increased 246% or $0.6 million over the 6 months ended June 30, 2007.

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
                                                  2008       2007       $         %
     Instrument Related Business:
     Bioinstruments                            $    1,943   $ 2,359   $ (416 )   (18 )%
     Bioconsumables                                 2,036     2,078      (42 )    (2 )%

                                                    3,979     4,437     (458 )   (10 )%
     Laboratory Services:
     Molecular Clinical Reference Laboratory          728       572      156      27 %
     Pharmacogenomics Research Services               415       364       51      14 %

                                                    1,143       936      207      22 %

     Cost of Goods Sold                        $    5,122   $ 5,373   $ (251 )    (5 )%

Gross profit was $7.4 million or 59% of total net sales during the six months ended June 30, 2008 compared to $6.1 million or 53% during the same period of 2007. Gross profits as a percentage of net sales increased due to a shift in sales to our European markets with a higher average sales price, lower manufacturing costs and the leverage related to the laboratory services net sales. The reduction in manufacturing costs is attributable to our restructuring plan which was implemented in 2007. Laboratory 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 $6.1 million during the six months ended June 30, 2008, compared to $6.0 million during the same period of 2007. Foreign currency translation adjustments decreased selling, general and administrative expenses by $0.5 million in the period ending June 30, 2008. This offset the increase in selling, general and administrative expenses due to the additions of executive staff, sales team and the Scientific Advisory Board.

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 $1.1 million during the six months ended June 30, 2008, compared to $1.5 million during the same period of 2007, a decrease of $0.4 million. Such costs for the 6-month period ended June 30, 2007 were higher primarily due to collaboration expense on new WAVE applications and patent costs for laboratory services.

Research and development expenses totaled 9% and 13% of net sales during the six months ended June 30, 2008 and 2007, respectively.

Restructuring Charges. Restructuring charges in 2007 consisted of costs related to a reduction in work force at our Omaha, Nebraska facility, activities to close a production facility in Cramlington, England, and activities to close an administrative office outside of Paris, France. Restructuring charges during the first six months of 2008 related to the relocation of laboratory personnel from Gaithersburg, Maryland to Omaha, Nebraska.

Other Income (Expense). Other income during the six month periods ended June 30, 2008 and June 30, 2007 was less than $0.1 million and $1.0 million, respectively. The decrease 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

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 were not directly identified to the Nucleic Acids operating segment or that were considered corporate overhead were not allocated in arriving at the loss from discontinued operations. 2008 results have no impact from these discontinued operations. For the three months ended March 31, 2007, there was a $7,000 loss from discontinued operations and for the six months ended June 30, 2007 there was a gain of $66,000.

The only remaining asset of the former Nucleic Acids operating segment is $0.2 million in Accounts Receivable which is fully reserved at June 30, 2008. There are no liabilities at June 30, 2008 associated with this discontinued operating segment.

Liquidity and Capital Resources

Our working capital positions at June 30, 2008 and December 31, 2007 were as
follows:



                                                                 Dollars in Thousands
                                                        June 30,      December 31,
                                                          2008            2007         Change
Current assets (including cash and cash equivalents
of $5,692 and $5,723, respectively)                     $  16,467    $       16,163    $   304
Current liabilities                                         4,618             4,847       (229 )

Working capital                                         $  11,849    $       11,316    $   533

Management believes existing sources of liquidity, including cash and cash equivalents of $5.7 million, are sufficient to meet expected cash needs during the remainder of 2008. We are investing in all parts of our business to drive improved sales in 2008 and have added experienced sales staff. 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 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 our new product pipeline and ultimately net sales. We could also pursue additional financing, but optimally, our goal is to achieve sufficient net sales to consistently generate net income and positive cash flow.

Analysis of Cash Flows

Six Months Ended June 30, 2008 and 2007

Net Change in Cash and Cash Equivalents. Cash and cash equivalents remained flat during the six months ended June 30, 2008 compared to an increase of $2.0 million during the six months ended June 30, 2007. In 2008 the net cash provided by operating activities of $0.2 million was offset by the net cash flow used in investing activities (largely purchases of property and equipment) and the impact of foreign currency exchange rates. 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 by foreign currency exchange rates.

Cash Flows from Operating Activities. Cash flows provided by operating activities totaled $0.2 million during the six months ended June 30, 2008, compared to cash flows used in operating activities of $1.6 million during the same period of 2007. The cash flows provided in 2008 related to the net income of $0.2 million. In addition, the increase in accounts receivable of $0.4 million was offset by the decrease in accounts payable. The use of cash flows in 2007 related primarily to the gain on sales of an investment in equity securities of $0.9 million, as well as higher inventory levels of $0.6 million related to OEM instruments.

Cash Flows from Investing Activities. Cash flows used in investing activities totaled $0.1 million during the six months ended June 30, 2008 compared to cash flows provided by investing activities of $3.6 million during the same period of 2007. Cash flows used in investing activities in 2008 consisted primarily of purchases of property and equipment. 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 from Financing Activities. Cash flows from financing activities were minimal during the six months ended June 30, 2008 and 2007.

Off-Balance Sheet Arrangements

At June 30, 2008 and December 31, 2007, 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, 2007.

Recently Issued Accounting Pronouncements

Please refer to our annual report on Form 10-K for the fiscal year ended December 31, 2007. There have been no changes to those accounting pronouncements listed except as noted in note B to the financial statements contained in this report.

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.