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 "SDIX"). 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 SEC including, without limitation, the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

Background

SDIX 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 utilizes its facilities in Newark, Delaware for the manufacture of test kits and antibodies, and its facilities located in Windham, Maine for the manufacture of antibodies.

The Company believes that by applying its core competency of creating custom antibodies, it produces sophisticated diagnostic and reagents that are responsive to customer 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, 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.

The Company's Life Sciences product portfolio includes a full suite of integrated capabilities including antibody and assay design, development and production. These capabilities, combined with our proprietary Genomic Antibody Technology™ ("GAT™"), are being used today to help discover the mechanisms of disease, facilitate the development of new drugs, and provide the means for rapid diagnosis. In 2009, 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 Life Science immuno-solutions initiative and food pathogen detection products, where the Company believes significant progress is being made. In 2011, the Company sold its Water Quality assets as part of its overall strategy to focus on its core Life Science and Food Safety operations. Financial information of the Water Quality division has been separately reclassified within the consolidated financial statements as a discontinued operation. See Note 3 of the Notes to the Consolidated Financial Statements for further information.

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 2009, a patent was issued to the Company 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 Company continues to develop multiple channels to market 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 Life Science and Food Safety 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 June 30, 2012 versus Three Months Ended June 30, 2011

Revenues for the three months ended June 30, 2012 decreased 9% to $5.5 million,
compared to $6.1 million for the same period in 2011. The decrease in revenues
in the second quarter of 2012 was the result of a 2% decrease in sales of Kit
Products and a 12% decrease in the sale of Life Sciences products and services
as discussed below in more detail.

                              Three Months Ended
                                   June 30,                                Percent
                              2012             2011       (Decrease)       Change
                              (in thousands, except percentages)
          Life Sciences   $      3,635        $ 4,153     $      (518 )         (12 %)
          Kit Products           1,857          1,904             (47 )          (2 %)
          Revenues        $      5,492        $ 6,057     $      (565 )          (9 %)

Life Sciences Products and Services

Life Sciences revenues decreased 12% to $3.6 million for the three-month period ended June 30, 2012, compared to $4.2 million for the same period in 2011. This decrease was primarily the result of decreased sales to all of the Company's customer categories, except in-vitro diagnostic. Sales to the Company's in-vitro diagnostic customers increased 0.5% to approximately $2.3 million, sales to biopharma customers decreased 31% to $0.6 million, sales to content/resellers decreased 30% to $0.6 million and sales to academic/government customers decreased 0.5% to $0.1 million. Included in the in-vitro diagnostic sales is $0.1 million recognized pursuant to the Becton Dickinson (BD) Diagnostics multiple-element arrangement as described in Note 1, Revenue Recognition. These decreases were primarily related to a softening biopharmaceutical market.

Kit Products

Kit Products revenues decreased 2% to $1.86 million for the three-month period ended June 30, 2012 as compared to $1.90 million for the same period of 2011. Sales of food pathogen products decreased 1% to $1.60 million for the three months ended June 30, 2012 from $1.62 million for the same period in 2011. This decrease was primarily the result of decreased sales of tests to detect the pathogen E. Coli, as USDA regulations for the testing of this pathogen in beef and beef products have changed, requiring many of the Company's customers to change to a new method for testing (a technology different from the Company's). Ag-GMO product sales decreased 12%, to $0.25 million, in the second quarter of 2012 as compared to the same period of 2011. This decrease was primarily attributable to lower sales of seed testing products in Brazil, where sales have declined over the past few years due to reduced demand for the testing of Genetically Modified Organisms (GMOs).

Gross profit

Gross profit for the three months ended June 30, 2012 was $3.0 million compared to $3.5 million for the same period in 2011. Gross margins were 54% and 58% for the three month periods ended June 30, 2012 and 2011, respectively. The decrease in gross profit and gross margin was primarily attributable to the lower level of sales in the 2012 period.

Research and development

Research and development expenses were $976,000, or 18% of revenues for the three-month period ended June 30, 2012, compared to $842,000, or 14% of revenues, for the three-month period ended June 30, 2011. This increase was primarily the result of increased spending related to the development of the Company's advanced GATTM technology.

Selling, general and administrative

Selling, general and administrative expenses were $3.4 million for the three-month period ended June 30, 2012 and $3.8 million for the three-month period ended June 30, 2011. This decrease was primarily the result of lower levels of personnel and their related cost.

Interest expense, net

The Company had net interest expense of $10,000 for the three-month period ended June 30, 2012 compared to net interest expense of $8,000 for the three-month period ended June 30, 2011. This increase is primarily due to the borrowings against the equipment financing revolving line of credit the Company secured in the three-month period ended June 30, 2012.

Income taxes

The Company recorded no income tax provision for the three-month period ended June 30, 2012 compared to a tax expense of $7,000 for the three-month period ended June 30, 2011. The Company has full valuation allowances placed against U.S. federal and state deferred tax assets.

Loss from continuing operations

Loss from continuing operations for the three-month period ended June 30, 2012 was $1.5 million, or $0.07 per diluted share, compared to a loss from continuing operations of $1.1 million, or $0.05 per diluted share, for the three-month period ended June 30, 2011. Diluted shares utilized in these computations were 20.5 million and 20.4 million for the 2012 and 2011 three month periods, respectively.

Income from discontinued operations

Income from the Company's discontinued operations of its water and environmental assets were $438,000 for the three-month period ended June 30, 2011. Income per share from discontinued operations was $0.02 per diluted share for the three-month period ended June 30, 2011. Diluted shares utilized in this computation were 20.4 million.

Net loss

Net loss was $1.5 million, or $0.07 per diluted share, for the three-month period ended June 30, 2012, compared to a net loss of $657,000, or $0.03 per diluted share, for the same period in 2011. Diluted shares utilized were 20.5 million and 20.4 million for the 2012 and 2011 periods, respectively.

Six Months Ended June 30, 2012 versus Six Months Ended June 30, 2011

Revenues for the six months ended June 30, 2012 decreased 12% to $11.1 million, compared to $12.6 million for the same period in 2011. The decrease in revenues in the first six months of 2012 was the result of an 11% decrease in sales of Kit Products and a 12% decrease in the sale of Life Sciences products and services as discussed below in more detail.

                               Six Months Ended
                                   June 30,                                Percent
                             2012             2011        (Decrease)       Change
                              (in thousands, except percentages)
          Life Sciences   $     7,615       $  8,651     $     (1,036 )         (12 %)
          Kit Products          3,514          3,964             (450 )         (11 %)
          Revenues        $    11,129       $ 12,615     $     (1,486 )         (12 %)

Life Sciences Products and Services

Life Sciences revenues decreased 12% to $7.6 million for the six-month period ended June 30, 2012, compared to $8.7 million for the same period in 2011. This decrease was primarily the result of decreased sales to all of the Company's customer categories, except in-vitro diagnostic. Sales to the Company's in-vitro diagnostic customers increased 3% to approximately $5.0 million, sales to biopharma customers decreased 42% to $1.0 million, sales to content/resellers decreased 22% to $1.3 million and sales to academic/government customers decreased 13% to $0.3 million. Included in the in-vitro diagnostic sales is $1.0 million recognized pursuant to the Becton Dickinson (BD) Diagnostics multiple-element arrangement as described in Note 1, Revenue Recognition. These decreases were primarily related to the timing of IVD sales and a softening biopharmaceutical market.

Kit Products

Kit Products revenues decreased 11% to $3.5 million for the six months ended June 30, 2012 as compared to $4.0 million for the same period of 2011. Sales of food pathogen products decreased 10% to $3.1 million for the six months ended June 30, 2012 from $3.4 million for the six-month period ended June 30, 2011. This decrease was primarily the result of decreased sales of tests to detect the pathogen E. Coli, as USDA regulations for the testing of this pathogen in beef and beef products have changed, requiring many of the Company's customers to change to a new method for testing (a technology different from the Company's). Ag-GMO product sales decreased 21%, to $0.4 million, in the first six months of 2012 as compared to the same period of 2011. This decrease was primarily attributable to lower sales of seed testing products in Brazil, where sales have declined over the past few years due to reduced demand for the testing of Genetically Modified Organisms (GMOs).

Gross profit

Gross profit for the six months ended June 30, 2012 was $6.2 million compared to $7.2 million for the same period in 2011. Gross margins were 55% and 57% for the six-month periods ended June 30, 2012 and 2011, respectively. The decrease in gross profit and gross margin was primarily attributable to the lower level of sales in the 2012 period.

Research and development

Research and development expenses were $2.1 million, or 19% of revenues, for the six-month period ended June 30, 2012, compared to $1.7 million, or 14% of revenues for the six-month period ended June 30, 2011. This increase was primarily the result of increased spending related to the development of the Company's advanced GATTM technology.

Selling, general and administrative

Selling, general and administrative expenses were $6.7 million for the six-month period ended June 30, 2012 and $7.6 million for the six-month period ended June 30, 2011. This decrease was primarily the result of lower levels of personnel and their related cost.

Interest expense, net

The Company had net interest expense of $17,000 for both the six-month periods ended June 30, 2012 and June 30, 2011.

Income taxes

The Company recorded no income tax provision for the six-month period ended June 30, 2012 compared to a tax expense of $2,000 for the six month period ended June 30, 2011. The Company has full valuation allowances placed against U.S. federal and state deferred tax assets.

Loss from continuing operations

Loss from continuing operations for the six-month period ended June 30, 2012 was $2.7 million, or $0.13 per diluted share, compared to a loss from continuing operations of $2.1 million, or $0.10 per diluted share, for the six-month period ended June 30, 2011. Diluted shares utilized in these computations were 20.5 million and 20.4 million for the 2012 and 2011 six month periods, respectively.

Income from discontinued operations

Income from the Company's discontinued operations of its water and environmental assets were $826,000 for the six-month period ended June 30, 2011. Income per share from discontinued operations was $0.04 per diluted share for the six-month period ended June 30, 2011. Diluted shares utilized in this computation were 20.4 million.

Net loss

Net loss was $2.7 million, or $0.13 per diluted share, for the six-month period ended June 30, 2012, compared to a net loss of $1.3 million, or $0.06 per diluted share, for the same period in 2011. Diluted shares utilized were 20.5 million and 20.4 million for the 2012 and 2011 periods, respectively.

Liquidity and Capital Resources

The net cash used in operating activities was $1.9 million for the first six months of 2012 compared to net cash used in operating activities of $164,000 for the first six months of 2011. The net cash used in operating activities for the 2012 period was primarily the result of the net loss incurred and an increase in inventories, partially offset by an increase in accounts payable and deferred revenue. The net cash used in operating activities for the 2011 period was primarily the result of the net loss incurred for the period, partially offset by an increase in accrued expenses.

Net cash used in investing activities of $1.3 million for the first six months of 2012 related to the capital expenditures for the period. This compares to net cash used in investing activities of $445,000 for the first six months of 2011. The capital expenditures for the 2012 period were primarily related to purchases of manufacturing and laboratory equipment, as well as leasehold improvements. The capital expenditures for the 2011 period were primarily related to leasehold improvements and computer equipment.

Net cash used in financing activities of $1,000 for the first six months of 2012 was attributable to a reduction in the Company's restricted cash requirement offset by scheduled debt repayments.. Net cash provided by financing activities of $71,000 for the first six months of 2011 was the result of a reduction in the Company's restricted cash requirement, proceeds for the exercise of stock options and payments into the Company's Employee Stock Purchase Plan, offset by scheduled debt repayments. The Company's working capital (current assets less current liabilities) was $11.7 million at June 30, 2012 compared to $14.9 million at December 31, 2011.

On May 5, 2000, the Company entered into a financing agreement with a commercial bank which was amended on August 12, 2009 (as amended, the "Credit Agreement").

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 million in financing, $100,000 of which was outstanding at June 30, 2012, 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.

This indebtedness is secured by $100,000 in restricted cash as required by the Credit Agreement.

On March 26, 2012, the Company entered into a Master Equipment Lease agreement with a commercial bank. The agreement is for a $500,000 revolving line of credit to purchase equipment. The equipment purchased has a distinct schedule under the agreement and provides for specific terms of payment related to that particular equipment lease. For accounting purposes, the leases are considered capital leases and accordingly are recorded as debt and amortized with an imputed interest rate according to the terms of the applicable equipment lease. All leases carry a one dollar buyout at lease end.

To date, the Company has borrowed $271,000 against this Master Lease agreement, which includes three separate leases, of which $263,000 is outstanding as of June 30, 2012. Each of three leases contains a 60 month term with an imputed interest rate of approximately 4.3%.

The Company has certain financial covenants to meet related to this Master Equipment Lease, including a debt coverage ratio of not less than 1.25 to 1 based upon a trailing 12 months basis, tangible net worth of not less than $15.0 million, minimum liquidity of $2.0 million and a requirement to maintain its primary banking accounts with the Commercial Bank. As of June 30, 2012, the Company was in compliance with all applicable loan covenants.

For the six months ended June 30, 2012, the Company satisfied all of its cash requirements from cash available and on-hand, and the above noted Master Equipment Lease agreement. At June 30, 2012, the Company had $363,000 of debt and $17.7 million of stockholders' equity.

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 at least the next 12 months. In reaching this conclusion, the Company has taken into account its expectation of increased capital expenditures in 2012 with respect to certain renovations and modifications to its facilities in Newark, Delaware. These renovations are designed to provide for larger and improved R&D laboratory space to accommodate the GATTM technology development efforts and also to modernize the animal facility and ensure that biosecurity measures are aligned with current industry practices and all for the Company to minimize and ameliorate the effects of animal diseases.

The Company's ability to meet its long-term capital needs will depend on a number of factors, including compliance with 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.