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"). In addition, when used in this quarterly report, 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, 2008.

Background

SDI is a biotechnology company with a core mission of developing, commercializing and marketing innovative and proprietary products, services and solutions that preserve and enhance the quality of human health and wellness.

The Company believes that its competitive position has been enhanced through the combination of talent, technology and resources resulting from the business development activities it has pursued since its inception. The Company has achieved meaningful economies of scale for the products it offers through the utilization of its consolidated facilities in Newark, Delaware for the manufacture of test kits and antibodies, and its facilities located in Windham, Maine and Dallas, Texas for the manufacture of antibodies.

The Company believes that by applying its core competency of creating custom antibodies to assay development, it produces 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. In addition, the Company believes its tests provide high levels of accuracy, reliability and actionability of essential test results as compared to alternative products. 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. The Company believes that an established product base, quality manufacturing expertise, experienced sales and marketing organization, established network of distributors, corporate partner relationships and proven research and development expertise will be critical elements of its potential future success.

In 2008, the Company continued the transition from a fragmented product offering and marketing strategy to becoming a focused organization, with proven, proprietary technologies tied directly to its customers' needs. The transition is most evident in the Genomic Antibody Technology™ (GAT™) initiative and food pathogen detection products, where the Company believes significant progress is being made.

The Company continues to develop and introduce new methods for the detection of food pathogens that deliver a strong competitive advantage to its customers. In 2005, the Company filed a patent for new technology to be used in proprietary enrichments of its food pathogen testing methods. The patent covers technology for increasing the specificity and sensitivity of the Company's immunoassay test methods. The patent also makes claims for the application of the technology in large scale bio-production/bio-fermentation processes, such as those used in the production of amino acids, ethanol, enzymes and other processes using microbiological production methods.

The Company continues to develop multiple channels to market products worldwide through an approach that includes direct sales, inside sales, distributors and agents. The Company increased distribution for its food pathogen products in Europe and Asia where there is growing demand for the Company's product line.

The Company believes it is making progress in most of its business efforts. As the deployment of new initiatives is accelerated, building on the Company's leadership position in food pathogens and expanding its strong positioning in the emerging area of genomic antibodies, the Company anticipates that the revenue lost to market changes in its legacy businesses will be replaced and the Company will develop a stronger, more predictable revenue base.

The Company expects the GAT™ and food pathogen products to be its primary growth drivers in the future, and that the Company's competencies and competitive positions in these two areas are strong.

Results of Operations

Three Months Ended March 31, 2009 versus Three Months Ended March 31, 2008

Revenues for the first quarter of 2009 decreased 4% to $6.9 million, compared to $7.2 million for the same period in 2008. The decrease in revenues in the first quarter of 2009 was primarily the result of a 31% decrease in sales of Ag-GMO products and a 4% decrease in the sale of antibody products when comparing the first quarter of 2009 to the first quarter of 2008. These decreases were partially offset by a 7% increase in sales of food pathogen products and a 2% increase in the sale of water and environmental products, all as described below.

Antibody Products

Antibody revenues decreased 4% to $3.7 million for the first quarter of 2009, compared to $3.8 million for the same quarter in 2008. The Company recorded a significant increase in sales of products utilizing its GAT ™ platform of 47% to $350,000 and an increase of 20% to $1.2 million in sales of its bulk antibody offerings. These increases were offset by decreased sales of custom monoclonal products of 38% to $678,000 and custom polyclonal products of 6% to $1.4 million. These decreased sales are primarily the result of a reduced number of completed monoclonal projects and a reduced number of polyclonal orders received during the three months ended March 31, 2009.

Food Safety Products

Food safety revenues decreased 9% to $2.0 million for the first quarter of 2009 compared to $2.2 million in the first quarter of 2008. Food pathogen sales increased 7% in the first quarter of 2009 as compared to the first quarter of 2008. The Company continues to see revenue gains with its RapidChek® SELECT™ for Salmonella products. Ag-GMO product sales were down $285,000, or 31%, for the first quarter of 2009 as compared to the first quarter of 2008. This decrease is primarily attributable to decreased demand for the Company's testing products in Brazil and reduced demand for products that detect the StarlinkTM trait in grains.

Water and Environmental Products

Water and environmental products revenue was $1.1 million for each of the first quarters of 2009 and 2008.

Gross profits (defined as total revenues less manufacturing costs) for the first quarter of 2009 was $3.8 million compared to $4.0 million for the same period in 2008. Gross margins were 55% and 56% for the first quarters of 2009 and 2008, respectively. The decrease in margins was primarily attributable to decreased levels of production creating a higher cost per unit.

Operating expenses for the first quarter of 2009 increased 3% to $7.5 million, compared to $7.2 million for the first quarter of 2008. This increase was primarily attributable to a 17% increase in selling, general and administrative costs, partially offset by a 29% decrease in research and development costs and a 1% decrease in manufacturing costs, all as described below.

Research and development spending was $663,000, or 10% of net revenues, in the first quarter of 2009, compared to $940,000, or 13% of net revenues, in the first quarter of 2008. This decrease was primarily due to decreased spending and effort on development of the Company's proprietary SEQer™ antibodies, which are produced by the Company's GAT ™ platform and are being sold through the Company's antibody catalog.

Selling, general and administrative expenses were $3.7 million for the first quarter of 2009, compared to $3.2 million for the same quarter in 2008. The increase is primarily associated with severance charges for management changes and the Company's continued expansion of its sales and marketing efforts to strengthen the Company's life sciences position.

The Company recorded net interest income of $5,000 in the first quarter of 2009 compared to $62,000 in the prior year first quarter. The decrease was primarily due to lower interest rates received on decreased levels of invested cash and cash equivalents during the first quarter of 2009.

The Company's effective rate was 2% for the three month period ended March 31, 2009 and approximately 48% for the three month period ended March 31, 2008. This decrease is primarily due to the full valuation allowance placed against U.S. federal and state deferred tax assets as of March 31, 2009.

Net loss in the first quarter of 2009 was $561,000, or $0.03 per diluted share, compared to a net loss of $12,000, or $0.00 per diluted share, for the same period in 2008. Diluted shares utilized in these computations were 20.0 million and 20.4 million for the first quarters of 2009 and 2008, respectively.

Liquidity and Capital Resources

The net cash used in operating activities of $564,000 for the first quarter of 2009 compared to net cash used in operating activities of $68,000 for the first quarter of 2008. The net cash used in operating activities for the first quarter of 2009 was primarily the result of the net loss recorded in the period, and increases in other current assets and deferred revenues and decreases in accrued expenses, accounts payable and inventories. The increase in other current assets was primarily the result of the purchase of insurance for 2009, while the decrease in accrued expenses is primarily attributable to reductions in accrued commissions and salaries.

Net cash used in investing activities of $193,000 for the first quarter of 2009 related to the capital expenditures for the period. This compares to net cash used in investing activities of $325,000 for the first quarter of 2008. The capital expenditures for the first quarter of 2009 were primarily related to computer and electronic equipment. In the first quarter of 2008, the capital expenditures were primarily related to purchases of laboratory and manufacturing equipment.

Net cash used in financing activities of $149,000 and $135,000 for the first quarters of 2009 and 2008, respectively, was primarily the result of scheduled debt repayments.

The Company's working capital, current assets less current liabilities, decreased $117,000 to $14.1 million at March 31, 2009 from $14.2 million at December 31, 2008.

On May 5, 2000, the Company entered into a financing agreement with a commercial bank which was amended on October 1, 2008 (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 March 31, 2009. The revolving line of credit bears a variable interest rate of between 150 basis points and 250 basis points over the one month LIBOR rate 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 3.00% at March 31, 2009.

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 agreement provided for up to $1.5 million in financing, $105,000 of which was outstanding at March 31, 2009, 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 less than the current Prime Interest Rate. Payments are due monthly, with equal amortization of principal payments plus interest. The Company's annual effective rate of interest on this loan at March 31, 2009 was approximately 2.25%.

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 agreement provided for up to $2.0 million in financing, $1.4 million of which was outstanding at March 31, 2009, and is repayable over five years, with principal payments that began on October 1, 2007. The loan bears a fixed interest rate of 5.961% 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, a ratio of funded debt to EBITDA not to exceed 3.25 and a requirement of liquid assets (cash and cash equivalents) to be greater than or equal to $2.5 million at all times.

The Company did not meet its financial covenants with respect to its indebtedness at March 31, 2009 and does not expect that it will be able to meet all of its financial covenants under the Credit Agreement for the next 12 months. The Company received a waiver of the financial covenants relating to the above financing from its commercial bank as of March 31, 2009 and expects it will receive waivers of the financial covenants until such covenants are amended.

As of March 31, 2009, the Company has classified the balance of its long-term obligations under the Credit Agreement of $1.0 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 12 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 March 31, 2009, the Company is not required to repay these long-term debt obligations within 12 months and expects to amend the Credit Agreement before December 31, 2009 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.

As of March 31, 2009, the outstanding balance on all of the Company's commercial bank debt was $1.5 million. This indebtedness is secured by substantially all of the Company's assets.

For the quarter ended March 31, 2009, the Company satisfied all of its cash requirements from cash available and on-hand. At March 31, 2009, the Company had $1.5 million in debt and stockholders' equity of $20.9 million.

Based upon its cash and cash equivalents on hand, credit facilities, current product sales and the anticipated sales of new products, the Company believes it has, or has access to, sufficient resources to meet its operating requirements through the next 12 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 earnings before interest, tax, depreciation and amortization ("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 loss 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 operating activities for the three months ended March 31, 2009 and 2008, respectively, is as follows:

                                          Three Months Ended
                                               March 31,
                                          2009           2008
                                            (in thousands)
Net cash used in operating activities   $    (564 )     $   (68 )
Changes in assets and liabilities:
Receivables                                  (512 )        (545 )
Inventories                                   104          (205 )
Other current assets                          576           633
Other assets                                  (82 )           -
Accounts payable                              269            83
Accrued expenses                              507           774
Deferred revenue                             (300 )         (70 )
Other non-current liabilities                   -            (1 )
Net change in deferred income tax             (12 )         (35 )
Income tax provision                          (12 )         (11 )
Stock compensation expense                   (218 )        (252 )
Interest income, net                           (5 )         (62 )
EBITDA                                  $    (249 )     $   241