Forward-Looking Statements

This Form 10-Q contains certain forward-looking statements reflecting the current expectations of Strategic Diagnostics Inc. and its subsidiaries (the "Company" or "SDI"). These statements include, among others, statements regarding: the Company's intentions with respect to future spending on research and development; the development, market acceptance and sales of tests for food-borne pathogens and related growth media; the size and nature of demand in the markets for the Company's products and related effects on operating results; the need for water quality and toxicity tests; approval and validation by third parties of the Company's food pathogen tests; the performance of the Company's testing products; sales of the Company's antibodies; timing of new product introductions and other information that may be predictive of future operating results; the Company's ability to reduce operating expenses; and the Company's ability to improve operating results thus enabling it to meet future loan covenants. In addition, when used in this Form 10-Q, the words "anticipate," "enable," "estimate," "intend," "expect," "believe," "potential," "may," "will," "should," "project" and similar expressions as they relate to the Company are intended to identify said forward-looking statements. Investors are cautioned that all forward-looking statements involve risks and uncertainties, which may cause actual results to differ from those anticipated at this time. Such risks and uncertainties include, without limitation, changes in demand for products, delays in product development, delays in market acceptance of new products, retention of customers, attraction and retention of management and key employees, adequate supply of raw materials, inability to obtain or delays in obtaining third party approvals, or required government approvals, the ability to meet increased market demand, competition, protection of intellectual property, non-infringement of intellectual property, seasonality, the ability to obtain financing and other factors more fully described in the Company's public filings with the U.S. Securities and Exchange Commission, including, without limitation, its Annual Report on Form 10-K for the year ended December 31, 2007.

Background

The Company is an antibody technology company with a core mission of developing, commercializing and marketing innovative and proprietary biotechnology that preserves and enhances the quality of human health. By applying its core competencies of proprietary antibody and assay development, the Company produces unique, sophisticated diagnostic testing and reagent systems that are responsive to customer diagnostic and information needs. Customers benefit from a quantifiable "return on investment" by reducing time, labor, and/or material costs associated with applications for which the Company's products are used. This is accomplished while increasing accuracy, reliability and actionability of essential test results. The Company is focused on sustaining this competitive advantage by leveraging its expertise in immunology, proteomics, bio-luminescence and other bio-reactive technologies to continue its successful customer-focused research and development efforts. Recent innovations in high throughput production of antibodies from genetic antigens will complement the Company's established leadership in commercial and custom antibody production for the research, human and animal diagnostics, and pharmaceutical industries, and position the Company for broader participation in proteomics research and discovery.

Our antibody product group provides a wide array of antibodies and antibody services, including hybridoma development, genomic antibody development, calibrators, antigens and reagents and the production of monoclonal and polyclonal antibodies. These antibodies are incorporated into test kits we manufacture and diagnostic and therapeutic products, and used in clinical research.

Our food safety product group markets tests for food pathogens, tests to detect specific traits in genetically engineered plants, tests to detect Genetically Modified (GM) traits in food ingredients and food fractions and tests to detect naturally occurring fungi in grains (mycotoxins).

Our water quality product group includes tests to detect toxicity in drinking water, industrial process water and wastewater, and tests to detect specific traits in soil and other waste matter for use at environmental remediation projects, hazardous waste operations and other applications.

We sell products and services in the food safety, water quality and antibody market categories through our U.S. direct sales force, a network of over 50 distributors in Canada, Mexico, Latin America, Europe and Asia and our corporate partners. These products and services are sold to a wide range of customers including water utilities, food processors, pharmaceutical, biotechnology and diagnostic companies and major biomedical research centers.

Results of Operations

Three Months Ended September 30, 2008 versus Three Months Ended September 30, 2007

Revenues for the third quarter of 2008 increased 5.0% to $6.9 million, compared to $6.6 million for the same period in 2007. The increase in revenues in the third quarter of 2008 was primarily the result of a 38.2% increase in sales of food pathogen products, a 13.8% increase in sales of water and environmental products and a 3.9% increase in sales of Ag-GMO products when comparing the third quarter of 2008 to the third quarter of 2007. These increases were partially offset by decreased sales of antibody products which decreased by 8.1% when comparing the third quarter of 2008 to the third quarter of 2007 (see discussion of product groups below).

Operating expenses for the third quarter of 2008 increased 25.4% to $8.0 million, compared to $6.4 million for the third quarter of 2007. As described below, this increase is primarily attributable to a 34.0% increase in research and development costs, a 32.9% increase in manufacturing costs and a 21.1% increase in selling, general and administrative costs.

Gross profits (defined as total revenues less manufacturing costs) for the third quarter of 2008 were $3.3 million compared to $3.9 million for the same period in 2007. Gross margins were 48.4% and 59.4% for the third quarters of 2008 and 2007, respectively. The decrease in margins and related increase in manufacturing costs was primarily attributable to increased write-offs for obsolete inventory and additional employee costs in the Company's test kit business, and increased costs of production in the antibody business due to the expansion of the Company's antibody production capabilities, creating an unfavorable overhead absorption rate.

Research and development spending was $969,000, or 14.1% of revenues, in the third quarter of 2008, compared to $723,000, or 11.0% of revenues, in the third quarter of 2007. This increase was primarily due to increased spending and effort on the development of the Company's proprietary phage technology for use in the production of ethanol.

Selling, general and administrative expenses were $3.5 million for the third quarter of 2008, compared to $2.9 million for the same quarter in 2007. The increase is primarily attributable to increased recruiting costs associated with the Company's continued expansion of its sales and marketing efforts.

Gain on disposal of assets of $11,000 was recorded in the third quarter of 2008, relating to the sale and disposal of rental equipment. Loss on disposal of assets of $108,000 was recorded in the third quarter of 2007, relating to the replacement of manufacturing equipment that was no longer fit for use.

The Company recorded net interest income of $35,000 in the third quarter of 2008 compared to $109,000 in the third quarter of 2007. The decrease was primarily due to increased debt and related interest expense during the third quarter of 2008 when compared to the third quarter of 2007, and decreased interest rates received on invested cash during the third quarter of 2008.

As a result of the reduced margins and higher costs discussed above, pre-tax loss totaled ($1.1 million) for the three months ended September 30, 2008 compared to pre-tax income of $275,000 for the same period in 2007.

Income tax expense for the third quarter of 2008 includes approximately $1.6 million in expense for a valuation allowance against deferred tax assets relating to approximately $4.6 million in federal net operating loss carryforwards that will expire in the year 2010. The tax rate without the effect of the additional $1.6 million expense for the three month period ending September 30, 2008 was approximately 39.9%.

Income tax expense for the third quarter of 2007 included an additional expense of $158,000 associated with the reconciliation of the December 2006 tax provision to the actual 2006 tax return filed in the third quarter of 2007. The difference between the 2006 tax provision and the 2006 tax return is primarily due to the amount of research and experimentation credits utilized, and changes in applicable tax rates. The tax rate without the effect of the additional $158,000 expense as described above for the three month period ending September 30, 2007 was approximately 42.5%.

Net loss in the third quarter of 2008 was ($2.2 million), or ($0.11) per diluted share, compared to no net income or loss for the same period in 2007. Diluted shares utilized in these computations were 20.4 million and 20.5 million for the third quarters of 2008 and 2007, respectively.

Product Groups

Antibody Products

Antibody product revenues decreased 8.1% to $3.3 million for the third quarter of 2008, compared to $3.6 million for the same quarter in 2007. The Company recorded an increase of $339,000, or 190.8%, in sales of its custom antibody services utilizing its new Genomic Antibody Technology ™ platform. This increase was offset by a $378,000 decrease in sales of custom monoclonal services, a $188,000 decrease in sales of custom polyclonal services and a decrease of $116,000 in sales of bulk products. The decreases in the monoclonal services and bulk products were primarily the result of decreased orders by customers that had previously accumulated excess inventories. For the third quarter of 2008, antibody revenues were 47.9% of total Company revenues compared to 54.7% in the third quarter of 2007.

Food Safety Products

Food safety revenues increased 26.1% to $2.1 million for the third quarter of 2008, compared to $1.7 million in the third quarter of 2007.

Food pathogen sales (which are a subset of food safety revenues) increased 38.2% to $1.5 million in the third quarter of 2008 as compared to $1.1 million for the third quarter of 2007, due to increased sales of products that detect the three major food pathogens, E. coli, salmonella and listeria.

Ag-GMO product sales (which are a subset of food safety revenues) increased 3.9% to $626,000 for the third quarter of 2008 as compared to $602,000 for the third quarter of 2007. This increase is primarily attributable to increased demand for the Company's testing products in Brazil where the Company has had strong sales efforts since 2000.

Water and Environmental Products

Water and environmental products revenue increased 13.8% to $1.4 million for the third quarter of 2008 as compared to $1.3 million for the third quarter of 2007. This increase is primarily due to increased sales of water testing equipment in China.

Nine Months Ended September 30, 2008 versus Nine Months Ended September 30, 2007

Revenues for the first nine months of 2008 increased 3.5% to $20.6 million, compared to $19.9 million for the same period in 2007. The increase in revenues in the first nine months of 2008 was primarily the result of a 29.6% increase in sales of food safety products when comparing the first nine months of 2008 to the first nine months of 2007 and a 10.6% increase in sales of water and environmental products when comparing the first nine months of 2008 to the first nine months of 2007. These increases were partially offset by a 4.3% decrease in the sale of antibody products when comparing the first nine months of 2008 and 2007 (see discussion of product groups below).

Operating expenses for the first nine months of 2008 increased 24.7% to $23.5 million, compared to $18.8 million for the first nine months of 2007. This increase is primarily attributable to a 29.6% increase in research and development costs, a 24.9% increase in selling, general and administrative costs and a 24.8% increase in manufacturing costs.

Gross profits (defined as total revenues less manufacturing costs) for the first nine months of 2008 were $10.8 million compared to $12.0 million for the same period in 2007. Gross margins were 52.2% and 60.4% for the nine month periods ending September 30, 2008 and 2007, respectively. The decrease in margins and related increase in manufacturing costs was primarily attributable to increased write-offs for obsolete inventory in the Company's test kit business and increased costs of production in the antibody business due to the expansion of the Company's antibody production capabilities, all creating an unfavorable overhead absorption rate.

Research and development spending was $2.8 million, or 13.7% of revenues, in the first nine months of 2008, compared to $2.2 million, or 11.0% of revenues, in the first nine months of 2007. This increase was primarily due to increased spending and effort on development of the Company's proprietary SEQer™ antibodies, which are produced by the Company's Genomic Antibody Technology ™ platform and are being sold through the Company's antibody catalog, and increased spending and effort on development of the Company's proprietary phage technology for use in the production of ethanol.

Selling, general and administrative expenses were $10.8 million for the first nine months of 2008, compared to $8.7 million for the same period in 2007. The increase is primarily due to severance costs for the former Chief Executive Officer of $630,000, and increased costs associated with the Company's continued expansion of its sales and marketing efforts.

Gain on disposal of assets of $11,000 was recorded in the first nine months of 2008, relating to the sale and disposal of rental equipment. Loss on disposal of assets of $108,000 was recorded in the first nine months of 2007, relating to the replacement of manufacturing equipment that was no longer fit for use.

The Company recorded net interest income of $134,000 in the first nine months of 2008 compared to $335,000 in the first nine months of 2007. The decrease was primarily due to increased debt and related interest expense and decreased interest rates received on invested cash during the first nine months of 2008.

As a result of the reduced margins and higher costs discussed above, pre-tax loss totaled ($2.7 million) for the nine months ended September 30, 2008 compared to pre-tax income of $1.4 million for the same period in 2007.

Income tax expense in the first nine months of 2008 includes approximately $1.6 million in expense for a valuation allowance against deferred tax assets relating to approximately $4.6 million in federal net operating loss carryforwards that will expire in the year 2010. The tax rate without the effect of the additional $1.6 million expense for the nine month period ending September 30, 2008 was approximately 35.8%.

Income tax expense in the first nine months of 2007 includes additional expense of approximately $158,000 associated with the reconciliation of the December 2006 tax provision to the actual 2006 tax return filed in the third quarter of 2007. The difference between the 2006 tax provision and the 2006 tax return is primarily due to the amount of federal research and experimentation credits utilized and changes in applicable effective state tax rates. The tax rate without the effect of the additional $158,000 expense as described above for the nine month period ending September 30, 2007 was approximately 40.3%.

Net loss in the first nine months of 2008 was ($3.3 million), or ($0.16) per diluted share, compared to net income of $694,000, or $0.03 per diluted share, for the same period in 2007. Diluted shares utilized in these computations were 20.4 million for the first nine months of 2008 and 20.5 million for the first nine months of 2007.

Product Groups

Antibody Products

Antibody revenues decreased 4.3% to $10.0 million for the first nine months of 2008, compared to $10.5 million for the same period in 2007. The Company recorded increases of $595,000 in sales of its custom antibody services utilizing its new Genomic Antibody Technology ™ platform, but had decreases of $523,000 in sales of custom polyclonal services, $434,000 in sales of bulk products and $198,000 in custom monoclonal services. The decreases in the monoclonal services and bulk products were primarily the result of decreased orders by customers that had previously accumulated excess inventories.

Food Safety Products

Food safety revenues increased 12.4% to $6.4 million for the first nine months of 2008, compared to $5.7 million in the first nine months of 2007.

Food pathogen sales (which are a subset of food safety revenues) increased 29.6% to $4.2 million in the first nine months of 2008 as compared to $3.3 million in the first nine months of 2007, due to increased sales of products that detect the three major food pathogens, E. coli, salmonella and listeria.

Ag-GMO product sales (which are a subset of food safety revenues) decreased 10.1% to $2.2 million, for the first nine months of 2008 as compared to $2.5 million for the first nine months of 2007. This decrease is primarily attributable to the reduction in sales of tests to detect StarlinkTM in grain.

Water and Environmental Products

Water and environmental products revenue increased 10.6% to $4.2 million for the first nine months of 2008 as compared to $3.8 million for the first nine months of 2007. This increase is primarily due to increased sales of water testing equipment in China.

Liquidity and Capital Resources

The net cash used in operating activities of $618,000 for the first nine months of 2008 was primarily the result of the ($3.3 million) net loss recorded for the period and a $260,000 increase in other current assets offset by non-cash charges for depreciation, amortization, deferred income tax provision and share-based compensation expense of $2.1 million. The increase in other current assets was primarily the result of the purchase of insurance for 2008.

Net cash used in investing activities of $687,000 for the first nine months of 2008 was primarily related to the capital expenditures for the period. This compares to net cash used in investing activities of $2.3 million for the first nine months of 2007. The capital expenditures for the first nine months of 2008 were primarily related to purchases of laboratory and manufacturing equipment, and the capital expenditures for 2007 were primarily attributable to the expansion of the Company's antibody production facility in Maine.

Net cash used in financing activities of $403,000 for the first nine months of 2008 was primarily the result of scheduled debt repayments. Net cash provided by financing activities for the first nine months of 2007 of $2.3 million was primarily driven by proceeds from the issuance of a $2.0 million term loan for construction of a new facility at the Company's Maine location and the exercise of stock options which was partially offset by net repayments of outstanding debt.

The Company's working capital, current assets less current liabilities, decreased $3.8 million to $16.2 million at September 30, 2008 from $20.0 million at December 31, 2007, primarily due to changes in classification of $1.2 million of debt from long-term debt to current debt,, reduction in current deferred tax assets of $199,000 and an increase in other current assets as described above. Outstanding debt decreased $458,000 from $2.3 million at December 31, 2007 to $1.8 million at September 30, 2008, due to scheduled repayments.

On May 5, 2000, the Company entered into a financing agreement with a commercial bank which was amended on August 10, 2007 (the "Credit Agreement"). The Credit Agreement provides for up to a $5.0 million revolving line of credit, none of which was outstanding and all of which was available at September 30, 2008. The revolving line of credit bears a variable interest rate of 100 basis points to 225 basis points over the one month London Interbank Offered Rate (LIBOR) depending upon the ratio of the Company's funded debt to EBITDA. The Company's annual effective rate of interest on this line of credit, taking into account the variable interest rate and LIBOR, was approximately 3.47% at September 30, 2008.

On December 13, 2001, the Company received a term loan under the Credit Agreement to finance the construction of new facilities at its Windham, Maine location. This term loan provided for up to $1.5 million in financing, $193,000 of which was outstanding at September 30, 2008, and is repayable over seven years, with principal payments that began on October 1, 2002. The loan bears a variable interest rate of 100 basis points to 275 basis points over the one month LIBOR rate depending upon the ratio of the Company's funded debt to EBITDA. Payments are due monthly, with equal amortization of principal payments plus interest. The Company's annual effective rate of interest on this loan at September 30, 2008 was approximately 3.47%.

On August 21, 2007, the Company received a term loan under the Credit Agreement to finance the construction of new facilities at its Windham, Maine location. This term loan provided for up to $2.0 million in financing, $1.6 million of which was outstanding at September 30, 2008, and is repayable over five years, with principal payments that began on October 1, 2007. The loan bears a fixed interest rate of 5.96% with equal amortization of principal payments plus interest.

Under the Credit Agreement, the Company is required to meet certain quarterly financial covenants that include a ratio of EBITDA to current maturities of debt plus interest and cash paid for taxes greater than 1.50 and a ratio of funded debt to EBITDA not to exceed 3.25. The Company did not meet its financial covenants with respect to its indebtedness at September 30, 2008 and does not expect that it will be able to meet all of its financial covenants under the Credit Agreement for the next twelve months. The Company received a waiver of the financial covenants relating to the above financing from its commercial bank as of September 30, 2008.

As of September 30, 2008, the Company has classified the balance of its long-term obligations under the Credit Agreement of $1.2 million as current debt in the consolidated balance sheet as the Company believes it is probable that there will be a violation of the same covenants within the next twelve months if the covenant terms are not amended. If the Company is unable to obtain a waiver of future debt covenant violations, the Company will be unable to draw upon its line of credit until such violations are cured. As of September 30, 2008, the Company is not required to repay these long-term debt obligations within twelve months and expects to amend its bank Credit Agreement before December 31, 2008 to allow the Company to meet its financial covenants and reclassify these long-term obligations from current to non-current in the consolidated balance sheet.

For the nine months ended September 30, 2008, the Company satisfied all of its cash requirements from cash on-hand. At September 30, 2008, the Company had $1.8 million in debt and stockholders' equity of $34.3 million.

Based upon its cash on-hand and the anticipated sales of current and new products, the Company believes it has, or has access to, sufficient resources to meet its operating requirements through the next twelve months. The Company's ability to meet its long-term capital needs will depend on a number of factors, including compliance with existing and new loan covenants, the success of its current and future products, the focus and direction of its research and development programs, competitive and technological advances, future relationships with corporate partners, government regulation, the Company's marketing and distribution strategy, its successful sale of additional common stock and/or the Company successfully locating and obtaining other financing, and the success of the Company's plan to make future acquisitions. Accordingly, no assurance can be given that the Company will be able to meet the future liquidity requirements that may arise from these inherent and similar uncertainties.

Non-GAAP Financial Measures

The Company presents an EBITDA measure as the Company believes this provides investors and the Company's management with additional information to measure the Company's liquidity. EBITDA measures are not a measure of performance under GAAP, and therefore should not be considered in isolation or as a substitute for net income or cash flows from operations. Additionally, the Company's EBITDA calculations may differ from the EBITDA calculations for other companies. The Company excludes stock compensation expense from its measure of EBITDA.

The calculation of the Company's EBITDA measure (as discussed above), and the reconciliation of the Company's EBITDA measure to net cash provided by or (used in) operating activities for the nine month periods ended September 30, 2008 and 2007 is as follows:

                                                             Nine Months Ended
                                                               September 30,
                                                              2008         2007
                                                               (in thousands)
     Net cash provided by (used in) operating activities   $     (618 )   $   871
     Changes in assets and liabilities:
     Receivables                                                 (241 )       177
     Inventories                                                 (215 )     1,218
     Other current assets                                         260         239
     Other assets                                                  (3 )         4
     Accounts payable                                             (54 )       147
     Accrued expenses                                            (197 )        63
     Deferred revenue                                            (120 )        12
     Other non-current liabilities                                  -        (117 )
     Gain (loss) on disposal of fixed assets                       11         (93 )
     Net change in deferred income tax                           (597 )      (570 )
     Income tax provision (benefit)                               582         733
     Share-based compensation expense                            (533 )      (352 )
     Interest income, net                                        (134 )      (335 )
     EBITDA                                                $   (1,859 )   $ 1,997

Critical Accounting Policies

The preparation of financial statements in accordance with generally accepted accounting principles ("GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses in the consolidated financial . . .