Precipio, Inc. - Quarter Report: 2006 June (Form 10-Q)

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended June 30, 2006

Or

For the transition period from              to             

Commission file number: 000-30975

TRANSGENOMIC, INC.

(Exact name of registrant as specified in its charter)

(402) 452-5400

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is 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, 2006, the number of shares of common stock outstanding was 49,189,672.

TRANSGENOMIC INC.

INDEX

2

PART I. FINANCIAL INFORMATION

TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except per share data)

See notes to condensed consolidated financial statements.

3

TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands except per share data)

See notes to condensed consolidated financial statements.

4

TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

Six Months Ended June 30, 2006

(Dollars in thousands except per share data)

See notes to condensed consolidated financial statements.

5

TRANSGENOMIC, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

See notes to condensed consolidated financial statements.

6

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

Business Description.

Transgenomic, Inc., a Delaware corporation, and its subsidiaries (the “Company”) provide innovative products and services for the synthesis, purification and analysis of nucleic acids. The Company’s products and services include automated instrument systems, associated consumables, and genetic variation discovery services. The Company develops, assembles, manufactures and markets its products and services to the life sciences industry to be used in research focused on molecular genetics of humans and other organisms. Such research could lead to development of new diagnostics and therapeutics. The Company’s business plan is to participate in the value chain associated with these activities by providing key technology, tools, consumables, biochemical reagents and services to entities engaged in basic biomedical research and the development of diagnostics and therapeutic agents.

The Company develops, assembles, manufactures and markets versatile products and provides 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 25 dealers and distributors located in those local markets. Net sales are categorized as bioinstruments, bioconsumables and discovery services.

Historically, the Company 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, the Company implemented a plan to exit this operating segment. Accordingly, results of this operating segment are reflected as discontinued operations for all periods presented.

The Company has experienced recurring net losses and had an accumulated deficit of $122,794 at June 30, 2006. Based on the Company’s operating plan, management believes its existing sources of liquidity will be sufficient to meet its cash needs during 2006. If necessary, the Company’s management believes they can manage costs and expenses at reduced levels to conserve working capital. The need for any such cost and expense reductions during 2006 would likely delay implementation of the Company’s business plan. Additionally, management may pursue additional financing alternatives. Ultimately, the Company must achieve sufficient revenue levels to support its cost structure.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

Principles of Consolidation.

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

Cash and Cash Equivalents.

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

Accounts Receivable.

Accounts receivable are shown net of allowance for doubtful accounts. The following is a summary of activity for the allowance for doubtful accounts during the three and six months ended June 30, 2006 and 2005:

While payment terms are generally 30 days, the Company has also provided extended payment terms of up to 90 days in certain cases.

During the three months ended June 30, 2006, the Company completed an extensive review of the accounts receivables, which generated a total write off to the bad debt reserve of $128 and a charge back to bad debt expense of $75.

Inventories.

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

Property and Equipment.

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

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

Depreciation and amortization totaled $519 and $1,052 during the three months ended June 30, 2006 and 2005, respectively, of which $350 and $473, respectively, related to depreciation of property and equipment from continuing operations. Depreciation and amortization totaled $956 and $2,101 during the six months ended June 30, 2006 and 2005, respectively, of which $721 and $964, respectively, related to depreciation of property and equipment from continuing operations.

Goodwill and other Intangible Assets

Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, provides that goodwill and other intangible assets with indefinite lives 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 not recoverable and the fair value of the asset is less than the carrying value. If impaired, the asset’s carrying value is reduced to its fair value. 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 Assets.

Other assets include capitalized software, intellectual property, patents, deferred financing costs and other long-term assets.

Capitalized Software. The Company capitalized software development costs for products offered for sale in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed. This Standard allows for the capitalization of certain development costs once a software product has reached technological feasibility. The Company capitalized no software development costs during the three or six months ended June 30, 2006 or 2005.

Intellectual Property. Initial costs paid to license intellectual property from 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 legal costs, filing fees and other expenses associated with obtaining patents and amortizes these costs using the straight-line method over the shorter of the legal life of the patent (17 to 20 years depending on when issued) or its economic life beginning on the date the patent is issued.

Deferred Financing Costs. Certain financing costs are capitalized and amortized to interest expense over the life of the related financing.

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.

The Company accounts for its employee stock option grants under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share Based Payment. The Company adopted this standard on January 1, 2006 using the modified prospective method. All share-based payment transactions (primarily employee stock options) that existed at December 31, 2005 were fully vested at that date. Therefore, the adoption of this standard had no material impact on the Company’s financial position, results of operations or cash flows during the three and six months ended June 30, 2006. The Company was not party to any share-based payment transactions during the three and six months ended June 30, 2006.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

The following table illustrates the effect on net loss and loss per share for the three and six months ended June 30, 2005 as if the Company had recorded compensation expense for all of its stock-based awards in the first quarter of 2005 based the fair value method under SFAS 123 “Accounting for Stock-Based Compensation”

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: risk-free interest rates ranging from 3.10% to 6.53%, volatility ranging from 35% to 100%, an expected option life of 3 years and no common stock dividends.

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 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. The Company’s sales terms do not provide for the right of return unless the product is damaged or defective. Revenue from certain services associated with our analytical instruments, to be performed subsequent to shipment of the products, is deferred and recognized when the services are provided. Such services, mainly limited to installation and training services that are not essential to the functionality of the instruments, typically are performed in a timely manner subsequent to shipment of the instrument. The Company also enters into various service contracts that cover installed WAVE^® systems. These contracts cover specific time periods and revenue associated with these contracts is deferred and recognized over the service period. At June 30, 2006 and December 31, 2005, deferred revenue mainly associated with the Company’s service contracts was approximately $1,770 and $2,124, 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, reduced net loss by $72 and $180 during the three and six months ended June 30, 2006, respectively and increased net loss $279 and $461 during the six months ended June 30, 2006 and 2005, respectively.

10

TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

Comprehensive Income.

Accumulated other comprehensive income at June 30, 2006 and December 31, 2005 consisted of foreign currency translation adjustments, net of applicable tax of $0. 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.

Fair Value of Financial Instruments.

The carrying amount of the Company’s cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair value because of the short maturity of those instruments. The Company derives the fair value of its investments based on quoted market prices.

Earnings (Loss) Per Share.

Basic earnings (loss) per share is calculated based on the weighted-average number of common shares outstanding during each period. Diluted earnings (loss) per share include shares issuable upon exercise of outstanding stock options and warrants or conversion of convertible notes, where dilutive. Potentially dilutive securities totaling 13,538,841 and 13,625,675 at June 30, 2006 and December 31, 2005, respectively, have been excluded from the computation of diluted earnings per share as they have an antidilutive effect.

Recently Issued Accounting Pronouncements

In December 2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets.” This statement addresses the prospective measurement for nonmonetary exchanges of nonmonetary assets. It specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS 153 will be effective for the Company beginning July 1, 2006. The Company is assessing the final impact of this standard on its financial position, results of operations or cash flows.

In July 2006, the FASB issued Interpretation (“FIN”) No. 48, “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. FIN 48 will become effective in the first quarter of 2007. Management continues to evaluate the effect that adoption of FIN 48 will have on the Company’s consolidated results of operations and financial position.

Use of Estimates.

The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. In addition, estimates and assumptions associated with the determination of 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.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

In the fourth quarter of 2005, the Company implemented a plan to exit the Nucleic Acids operating segment. Accordingly, the Company now reflects 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 loss from discontinued operations. Summary results of operations of the former Nucleic Acids operating segment were as follows:

At June 30, 2006 and December 31, 2005, the Company had accrued expenses of $208 and $715 related to statutory payments to affected employees and other costs specifically attributable to closure of the Glasgow facility. The Company expects to incur additional period costs attributable to closure of the facility that will be recorded in discontinued operations during the remainder of 2006.

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

Restructuring plans were implemented during 2004 and 2002 to better align the cost structure of the former Nucleic Acids operating segment with anticipated revenues. In conjunction with these plans, the Company accrued expenses associated with the former Nucleic Acids operating segment of $107 and $221 at June 30, 2006 and December 31, 2005, respectively, related to net rents on leased but unoccupied facilities. The future net lease payments required under these leases are approximately $82 for the remainder of 2006 and $13 in 2007.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

Inventories consisted of the following:

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

Amortization expense for intangible assets was $133 and $245 during the three months ended June 30, 2006 and 2005, and $150 and $495 for the six months ended June 30, 2006 and 2005, respectively. Amortization expense for intangible assets is expected to be approximately $21 for the remainder of 2006, $40 in each of the next four years and $37 in 2011.

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

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

Certain features of the Laurus Loans required the Company to separately account for the value of certain amounts related to the warrants issued and the conversion feature of the Laurus Loans. Specifically, Emerging Issues Task Force (“EITF”) No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, required the Company to separately value the warrants issued and the “beneficial conversion premium” related to the Laurus Loans. The values of the warrants and the beneficial conversion premium were recorded on the balance sheet as a debt discount and an increase to additional paid in capital. The debt discount recorded for these items was amortized as expense to the income statement over the terms of the Laurus Loans or as the debt was converted into common stock thereby increasing the effective interest rate on the Laurus Loans.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

On March 18, 2005, the Company agreed to allow Laurus to convert $1,872 of the outstanding principal balance under the Credit Line into 3,600,000 shares of its common stock. In addition, on March 24, 2005, the Company agreed to allow Laurus to convert $650 of the outstanding principal balance of the Term Note into 1,250,000 shares of common stock. The closing market price of the Company’s common stock the day before each of these conversions was $0.58 per share. No other provisions of the Credit Line or Term Note were modified, including the $1.00 conversion price for remaining debt. In conjunction with these conversions the Company accelerated amortization of $0.41 million of related debt premiums and discounts and recorded a charge to interest expense of $1.37 million related to the fair value of incremental shares received by Laurus.

The Company had no interest expense for the three and six months ended June 30, 2006. Interest expense during the three and six months ended June 30, 2005 consisted of the following:

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

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 2010. The future minimum lease payments required under these leases are approximately $610 for the remainder of 2006, $605 in 2007, $294 in 2008, $281 in 2009, and $252 in 2010 and $88 thereafter. Rent expense for continuing operations related to all operating leases for the three months ended June 30, 2006 and 2005 was approximately $302 and $290, respectively, and for the six months ended June 30, 2006 and 2005 was $596 and $632, respectively.

At June 30, 2006 and December 31, 2005, firm commitments to vendors to purchase components used in WAVE^® systems and instruments manufactured by others totaled $1,043 and $879, respectively. The Company expects to satisfy the majority of these purchase commitments during 2006 and 2007.

Income tax expense during the three and six months ended June 30, 2006 and 2005 relates to income taxes in states, foreign countries and other local jurisdictions offset by refunds received.

Due to the Company’s cumulative losses, expected losses in future years and inability to utilize any additional losses as carrybacks, no income tax benefit has been provided during the three and six months ended June 30, 2006 or 2005 based on a determination that it was more likely than not that such benefits would not be realized.

The Company will continue to assess the recoverability of deferred tax assets and the related valuation allowance. To the extent the Company begins to generate taxable income in future periods and a determination is made that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time. As of June 30, 2006 and December 31, 2005, deferred tax assets totaled $42,837 and $42,561, respectively, that were fully offset by valuation allowances.

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

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 $41 and $45 for the three months ended June 30, 2006 and 2005, respectively, and $83 and $90 for the six months ended June 30, 2006 and 2005, respectively.

Common Stock.

During the three and six months ended June 30, 2006, the Company issued zero and 7,551 shares of common stock, respectively, under the Transgenomic, Inc. 2001 Employee Stock Purchase Plan. During the three and six months ended June 30, 2005, the Company issued, 6,359 and 10,407, shares of common stock, respectively, under the Transgenomic, Inc. 2001 Employee Stock Purchase Plan. No additional stock will be issued under this plan as it was terminated in December 2005.

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

Common Stock Warrants.

No common stock warrants were issued during the six months ended June 30, 2006 or 2005. At June 30, 2006, 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 - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

No options were issued during the six months ended June 30, 2006. The following table summarizes activity under the Stock Option Plan during the six months ended June 30, 2006:

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

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

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TRANSGENOMIC, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Six Months Ended June 30, 2006 and 2005

(Dollars in thousands except per share data)

The Company has one reportable operating segment. Although revenue is 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:

Net sales by geographic region were as follows:

No customer accounted for more than 10% of consolidated net sales during the three and six months ended June 30, 2006. Sales to a large pharmaceutical company totaled $28 and $667 during the three months ended June 30, 2006 and 2005, respectively, and represented 0.5% and 9.7%, respectively, of consolidated net sales. Sales to the same company totaled $101 and $1,410 during the six months ended June 30, 2006 and 2005, respectively, and represented 0.8% and 10.2%, respectively, of consolidated net sales. Sales to this customer are governed by a non-binding master services agreement dated August 22, 2002. Accordingly, the amount of sales to this customer is subject to change.

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

17

Overview

We develop, assemble, manufacture and market versatile products and 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 25 dealers and distributors located in those local markets. Net sales are categorized as bioinstruments, bioconsumables and discovery services.

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.

Executive Summary

We have experienced recurring net losses and had an accumulated deficit at June 30, 2006 of $122.80 million. To respond to changes in the overall business climate for our products, our liquidity position and capital structure, we have taken a number of steps including the sale of our specialty oligonucleotide manufacturing facility and implementation of a wide-reaching restructuring plan both in the fourth quarter of 2004 and the fourth quarter 2005 exit from our former Nucleic Acids operating segment.

On July 12, 2006, Craig Tuttle was appointed as the President and Chief Executive Officer of Transgenomic, Inc. (the “Company”). Mr. Tuttle succeeds interim Chief Executive Officer, Michael Summers, who will continue to serve as the Company’s Chief Financial Officer. Mr. Tuttle, age 54, has over 25 years of general management, sales and marketing and research and development experience in medical diagnostic and biotechnology companies. During 2004 and 2005, Mr. Tuttle was the President and COO of Duke Scientific, a Northern California specialty chemistry manufacturer. Mr. Tuttle led the sale of Duke Scientific to Fisher Healthcare in 2005. From 1997 to 2003, Mr. Tuttle was with Apogent Technologies, Inc. where he served in various roles, including President of Applied Biotech, Inc., the manufacturer of the market leading home pregnancy test, and General Manager at Seradyn, Inc., a specialty chemical and diagnostic test manufacturer. Mr. Tuttle earned a B.S in Biochemistry from UCLA, an M.S. in Biochemistry from the University of Colorado and an M.B.A from St. Mary’s College.

2006 Results

Net sales for the three and six months ended June 30, 2006 were down 10% and 8%, respectively, compared to the same periods in 2005. The shortfalls in both periods were due primarily to lower net sales of discovery services which also had an adverse impact on gross profits, as costs related to our laboratories are largely fixed in nature. Despite the decline in net sales and gross profits, our loss from operations and loss from continuing operations during the three and six months ended June 30, 2006 were significantly improved as compared to the same period of 2005 due to lower operating expenses and interest expense. Loss from discontinued operations also improved from prior periods reflecting our efforts to exit the former Nucleic Acids operating segment.

For the first time in our history, we generated positive quarterly net cash flows from operating activities. For the three and six month ended June 30, 2006, net cash flows from operating activities totaled $0.69 million and $0.67 million, respectively. These results were due largely to improvements in working capital accounts, principally accounts receivable and inventory. On an overall basis, cash and cash equivalents increased by $0.63 million during the quarter.

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2006 Outlook

Timing of the demand for our products, particularly our flagship WAVE^® systems, has been difficult to predict due largely to ongoing changes in the marketplace and the funding arrangements of our customers. Because our net sales are largely dependent upon sales of a limited number of products, including WAVE^® systems, and our cost structure is largely fixed, historical results have been somewhat sporadic. For these reasons, it is not our practice to provide prospective financial guidance related specifically to revenues, costs, net income (loss) or cash flows. However, our financial objectives are to generate income from continuing operations and positive cash flows from continuing operations. To accomplish these goals we must generate sequential growth in net sales, convert manufacturing expenses from fixed to variable costs and continue to better control operating expenses. These objectives are more thoroughly discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Results of Continuing Operations

Three Months Ended June 30, 2006 and 2005

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

WAVE^® systems sold totaled 24 during the three months ended June 30, 2006 compared to 25 during the same period of 2005. Although the number of WAVE^® systems sold declined, overall bioinstrument net sales increased due primarily to an increase in net sales of equipment manufactured by others, product upgrades, and higher revenues from service contracts.

Net sales of consumables related to our WAVE^® systems fell during the three months ended June 30, 2006 compared to the same period of 2005 due primarily to competitive pricing changes principally in Europe and to a lesser extent the impact of foreign currency fluctuations. These declines were offset by increases in sales of non-WAVE^® consumables, primarily HPLC separation columns.

The decrease in discovery services revenue was primarily attributable to the expiration of certain onocology research contracts with a large pharmaceutical company in 2005. We continue to seek opportunities to provide genetic variation discovery and analysis services to pharmaceutical and other customers and believe that these services provide us a significant opportunity to expand revenues in the future.

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 and supplies) associated with our discovery services operations. Cost of goods sold consisted of the following (dollars in thousands):