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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One)þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005
 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number: 000-50786 STRATAGENE CORPORATION  Delaware
    
    33-0683641(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)11011 North Torrey Pines Road, La Jolla, CA
    
    92037(Address of principal executive offices)
    
    (Zip Code)
 (858) 535-5400
(Registrants telephone number, including area code) No Change
(Former name, former address and former fiscal year, if changed since last report) 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 (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date. Class
    
    Outstanding at May 12, 2005Common Stock, $0.0001 Par Value
    
    22,050,566




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STRATAGENE CORPORATION Quarterly Report on Form 10-Q
Table of Contents PagePart I. Financial InformationItem 1.
Financial Statements
    
    
    3Consolidated Balance Sheets as of March 31, 2005 (unaudited) and December 31, 2004
    
    
    3Consolidated Income Statements for the Three Months Ended March 31, 2005 (unaudited) and 2004 (unaudited)
    
    
    4Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 (unaudited) and 2004 (unaudited)
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    7Item 2.
Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    16Item 3.
Quantitative and Qualitative Disclosures about Market Risk
    
    
    35Item 4.
Controls and Procedures
    
    
    36Part II. Other Information
    
    
    38Item 1.
Legal Proceedings
    
    
    38Item 6.
Exhibits
    
    
    38Signatures
    
    
    39EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  Note: Items 2, 3, 4 and 5 of Part II are omitted because they are not applicable. 2




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PART I. FINANCIAL INFORMATION 
 ITEM I. FINANCIAL STATEMENTS STRATAGENE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 March 31,
    
    
    December 31,2005
    
    
    2004(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    3,921,443
    
    
    $
    4,890,458Marketable debt securities
    
    
    65,209
    
    
    
    197,125Cash  restricted related to bond indenture
    
    
    745,012
    
    
    
    582,995Accounts receivable, less allowance for doubtful
accounts and sales returns of $576,545 and
$766,772 at March 31, 2005 and December 31,
2004, respectively
    
    
    12,124,686
    
    
    
    11,059,464Income taxes receivable
    
    
    
    
    
    
    269,861Inventories
    
    
    13,552,178
    
    
    
    12,986,910Deferred income tax assets
    
    
    1,969,990
    
    
    
    2,002,013Prepaid expenses and other current assets
    
    
    2,247,680
    
    
    
    1,713,729Total current assets
    
    
    34,626,198
    
    
    
    33,702,555Property and equipment, net
    
    
    11,832,368
    
    
    
    12,111,957Other assets
    
    
    614,732
    
    
    
    541,091Deferred income tax assets
    
    
    213,735
    
    
    
    217,102Goodwill
    
    
    27,234,214
    
    
    
    27,234,214Intangible assets
    
    
    6,511,902
    
    
    
    6,524,781Total assets
    
    $
    81,033,149
    
    
    $
    80,331,700LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    4,632,785
    
    
    $
    4,129,171Accrued expenses and other liabilities
    
    
    9,408,627
    
    
    
    9,877,253Current portion of long-term debt
    
    
    735,000
    
    
    
    735,000Deferred revenue, current
    
    
    1,093,658
    
    
    
    1,062,288Income taxes payable
    
    
    1,172,287
    
    
    
    Total current liabilities
    
    
    17,042,357
    
    
    
    15,803,712Deferred revenue
    
    
    338,769
    
    
    
    395,881Long-term debt, less current portion
    
    
    5,218,410
    
    
    
    8,971,923Other liabilities
    
    
    302,914
    
    
    
    Total liabilities
    
    
    22,902,450
    
    
    
    25,171,516Commitments and contingencies (Note 8)Stockholders equity:Preferred stock, $0.0001 par value; 4,000,000
shares authorized; no shares issued and
outstanding at March 31, 2005 and December 31,
2004
    
    
    
    
    
    
    Common stock, $0.0001 par value; 50,000,000
shares authorized; 22,048,965 and 22,029,430
shares issued and outstanding at March 31, 2005
and December 31, 2004, respectively
    
    
    2,205
    
    
    
    2,203Additional paid-in capital
    
    
    53,039,436
    
    
    
    52,880,192Unearned stock-based compensation
    
    
    (289,234
    )
    
    
    (420,677
    )Retained earnings
    
    
    6,450,103
    
    
    
    3,514,811Accumulated other comprehensive loss
    
    
    (1,071,811
    )
    
    
    (816,345
    )Total stockholders equity
    
    
    58,130,699
    
    
    
    55,160,184Total liabilities and stockholders equity
    
    $
    81,033,149
    
    
    $
    80,331,700
 See accompanying notes to unaudited consolidated financial statements. 3




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STRATAGENE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED INCOME STATEMENTS
(unaudited)
 Three Months EndedMarch 31,2005
    
    
    2004Revenues
    
    $
    24,600,040
    
    
    $
    19,422,022Costs and expenses:Cost of products sold
    
    
    8,466,028
    
    
    
    5,925,585Research and development
    
    
    2,888,610
    
    
    
    2,520,613Selling and marketing
    
    
    4,992,706
    
    
    
    4,054,463General and administrative
    
    
    4,106,387
    
    
    
    3,093,867Impairment of long-lived assets
    
    
    20,025
    
    
    
    51,238Total costs and expenses
    
    
    20,473,756
    
    
    
    15,645,766Income from operations
    
    
    4,126,284
    
    
    
    3,776,256Other income and expenses:Loss on foreign currency transactions
    
    
    (113,850
    )
    
    
    (129,301
    )Equity in loss of joint venture
    
    
    
    
    
    
    (24,214
    )Other income, net
    
    
    532,707
    
    
    
    84,762Interest expense
    
    
    (99,043
    )
    
    
    (693,773
    )Interest income
    
    
    5,121
    
    
    
    67,478Total other income (expense)
    
    
    324,935
    
    
    
    (695,048
    )Income before income taxes
    
    
    4,451,219
    
    
    
    3,081,208Income tax expense
    
    
    (1,515,927
    )
    
    
    (1,007,296
    )Net income
    
    $
    2,935,292
    
    
    $
    2,073,912Earnings per share:Basic
    
    $
    0.13
    
    
    $
    0.13Diluted
    
    $
    0.13
    
    
    $
    0.13Weighted average shares:Basic
    
    
    22,031,472
    
    
    
    15,632,668Diluted
    
    
    22,130,834
    
    
    
    15,632,668
 See accompanying notes to unaudited consolidated financial statements. 4




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STRATAGENE CORPORATION AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 Three Months EndedMarch 31,2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    2,935,292
    
    
    $
    2,073,912Adjustments to reconcile net income to net cash provided by operating activities:Equity in (income) loss of joint venture
    
    
    
    
    
    
    24,214Depreciation and amortization
    
    
    955,513
    
    
    
    629,668Impairment of long-lived assets
    
    
    20,025
    
    
    
    51,238Stock-based compensation
    
    
    179,460
    
    
    
    41,155Bad debt expense
    
    
    (53,176
    )
    
    
    101,952Excess and obsolete inventory expense
    
    
    115,784
    
    
    
    (46,573
    )Loss on disposal of assets
    
    
    3,095
    
    
    
    1,107Interest accrued on notes receivable from stockholders
    
    
    
    
    
    
    (47,741
    )Accretion of interest on long-term debt
    
    
    (3,513
    )
    
    
    509,787Deferred income taxes
    
    
    16,761
    
    
    
    24,165Changes in assets and liabilities:Foreign currency exchange contracts
    
    
    
    
    
    
    (173,421
    )Accounts receivable
    
    
    (1,203,684
    )
    
    
    (521,899
    )Inventories
    
    
    (781,562
    )
    
    
    (218,590
    )Prepaid expenses and other current assets
    
    
    (554,759
    )
    
    
    (580,617
    )Due from related party
    
    
    
    
    
    
    (19,557
    )Other assets
    
    
    (80,411
    )
    
    
    138,041Accounts payable
    
    
    633,897
    
    
    
    (756,581
    )Accrued expenses and other liabilities
    
    
    (287,438
    )
    
    
    950,789Deferred revenue
    
    
    (19,654
    )
    
    
    (208,560
    )Other liabilities
    
    
    302,914
    
    
    
    Income taxes payable
    
    
    1,268,617
    
    
    
    541,649Net cash provided by operating activities
    
    
    3,447,161
    
    
    
    2,514,138Cash flows from investing activities:Proceeds from maturities of marketable debt securities
    
    
    130,000
    
    
    
    Purchases of property and equipment
    
    
    (391,582
    )
    
    
    (166,499
    )Additions to intangible assets
    
    
    (320,898
    )
    
    
    (283,435
    )Changes in restricted cash
    
    
    (162,679
    )
    
    
    (215,999
    )Net cash used in investing activities
    
    
    (745,159
    )
    
    
    (665,933
    )
 (Continued) 5




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STRATAGENE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
 Three Months EndedMarch 31,2005
    
    
    2004Cash flows from financing activities:Principal payments on long-term debt
    
    
    
    
    
    
    (14,944,645
    )Issuance of long-term debt
    
    
    
    
    
    
    6,000,000Borrowings under line of credit
    
    
    
    
    
    
    8,128,773Payments under line of credit
    
    
    (3,750,000
    )
    
    
    Proceeds from issuance of common stock
    
    
    95,983
    
    
    
    Net cash used in financing activities
    
    
    (3,654,017
    )
    
    
    (815,872
    )Effects of foreign currency exchange rates on cash
    
    
    (17,000
    )
    
    
    30,367Net increase (decrease) in cash
    
    
    (969,015
    )
    
    
    1,062,700Cash at beginning of period
    
    
    4,890,458
    
    
    
    2,003,762Cash at end of period
    
    $
    3,921,443
    
    
    $
    3,066,462Supplemental disclosure of cash flow information:Cash paid during the period for:Interest
    
    $
    75,678
    
    
    $
    55,963Income taxes
    
    $
    46,684
    
    
    $
    443,963
 (Concluded) See accompanying notes to unaudited consolidated financial statements. 6




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STRATAGENE CORPORATION AND SUBSIDIARIES 
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005 1. Basis of Presentation The consolidated financial statements of Stratagene Corporation and its subsidiaries
(Stratagene or the Company) for the three months ended March 31, 2005 and 2004 are unaudited.
These financial statements include all adjustments that, in the opinion of management, are
necessary to present fairly the consolidated financial position of the Company as of March 31, 2005
and the consolidated results of operations and cash flows of the Company for the three months ended
March 31, 2005 and 2004. The financial information of the Company has been presented on a consolidated basis, and
includes the results of operations of Hycor Biomedical Inc. and subsidiaries (Hycor) since Hycor
was acquired by the Company on June 2, 2004. The financial information also includes the results of
operations of BioCrest Holdings, LLC (BCH), whose assets were acquired by the Company on June 2,
2004. Prior to the acquisition, BCH was under common control with Stratagene, and substantially
all of the BCH membership units were held by certain Stratagene shareholders. The acquisition of
the BCH assets has been presented as a change in reporting entity. Accordingly, the financial
statements of Stratagene and BCH are presented on a consolidated basis for all periods. Intercompany balances and transactions have been eliminated as appropriate in the
consolidation of Stratagene. The preparation of financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and disclosures made in the accompanying
notes. Actual results could differ from those estimates. These statements have been prepared pursuant to the rules and regulations of the Securities
and Exchange Commission (SEC) and do not include all the information and note disclosures
required by accounting principles generally accepted in the United States of America for complete
financial statements but reflect all adjustments (consisting only of normal recurring accruals)
necessary for the fair presentation of the financial position, results of operations and cash flows
for the periods and dates presented. These unaudited consolidated financial statements should be
read in conjunction with the consolidated financial statements and related notes included in the
Companys Annual Report on Form 10-K for the year ended December 31, 2004. The results of operations for any interim period are not necessarily indicative of results to
be expected for the full year. 7




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2. Proforma Financial Information The results of operations of Hycor have been included in the accompanying consolidated
financial statements of Stratagene from the date of acquisition. However, the following unaudited
pro forma information assumes that the June 2, 2004 Hycor merger occurred on January 1, 2004.
These unaudited pro forma results have been prepared for comparative purposes only and are not
indicative of the results of operations that would have actually resulted had the acquisition been
in effect as of the periods indicated above, or of future results of operations. The unaudited pro
forma results for the three months ended March 31, 2004 are as follows: Three Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004(pro forma)Revenues
    
    $
    24,600,040
    
    
    $
    24,890,844Net income
    
    $
    2,935,292
    
    
    $
    2,779,653Earnings per share:Basic
    
    $
    0.13
    
    
    $
    0.13Diluted
    
    $
    0.13
    
    
    $
    0.12Weighted average shares:Basic
    
    
    22,031,472
    
    
    
    21,827,069Diluted
    
    
    22,130,834
    
    
    
    22,309,340
 The unaudited pro forma information presented above the three months ended March 31, 2004 has
been adjusted for charges for material, nonrecurring items that include the following:  
    removing interest income on shareholder loans that were paid off upon the closing of the merger;
    removing interest expense on subordinated debt that converted to common stock upon the closing of the merger;
    recording amortization expense on acquired other intangible assets;
    recording amortization expense on unearned stock-based compensation for assumed stock options;
    reducing the CEOs salary pursuant to a new employment agreement effective on the merger date;
    removing Hycors merger related costs incurred in the periods presented; and
    recording the tax provision adjustment to the pro forma statement of operations at the statutory rate of 36%. 3. Earnings Per Share (EPS) Basic EPS is based on the weighted-average number of shares outstanding during the periods,
while diluted EPS additionally includes the dilutive effects of the Companys outstanding options
computed using the treasury stock method. The number of shares used in computing EPS is as
follows: Three Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004Weighted average shares:Basic
    
    
    22,031,472
    
    
    
    15,632,668Effect of dilutive common stock options
    
    
    99,362
    
    
    
    Diluted
    
    
    22,130,834
    
    
    
    15,632,668
 Options outstanding totaling 2,691,728 and 1,368,994 for the three month periods ended March
31, 2005 and 2004, respectively, were excluded from the calculations of earnings per common share,
as their effect would have been antidilutive. 8




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4. Accounting for Stock-Based Compensation The Company accounts for its stock-based compensation in accordance with the provisions of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,as
amended, and Financial Accounting Standards Board (FASB) Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation. Pro forma information regarding net income is required by Statement of Financial Accounting
Standards (SFAS) No. 123, Accounting for Stock-based Compensation, and has been determined as if
the Company had accounted for its employee stock options under the fair value method of SFAS No.
123. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through
the use of option pricing models, even though such models were developed to estimate the fair value
of freely tradable, fully transferable options without vesting restrictions, which significantly
differ from the Companys stock option awards. The value for Stratagene employee stock options was
estimated at the dates of grant using the minimum value method of SFAS No. 123 from the inception
date of the applicable stock option plan through June 2, 2004 and fair value for all option grants
made subsequent to that date using the Black-Scholes pricing model. Fair value for Hycor employee
stock options assumed by Stratagene in the Hycor merger was estimated at the dates of grant using
the Black-Scholes pricing model for all option grants. For options granted that have multiple cliff
vesting periods, the Company amortizes compensation cost using the graded vesting method prescribed
by FASB Interpretation No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock
Option and Award Plans. The following weighted average assumptions were used for the three month
periods ended March 31, 2005 and for the full year ended December 31, 2004, respectively: 2005
    
    
    2004Risk free interest rate
    
    
    4.0
    %
    
    
    4.0
    %Dividend yield
    
    
    0
    %
    
    
    0
    %Volatility factor
    
    
    45
    %
    
    
    45
    %Expected life (in years)
    
    6 years
    
    6 yearsResulting average fair value
    
    $
    2.25
    
    
    $
    3.69
 If the computed fair values of the stock options granted in 2004 and 2003 had been amortized
to expense over the vesting period of the awards, pro forma net income would have been as follows: Three Months Ended March 31,2005
    
    
    2004Net income as reported
    
    $
    2,935,292
    
    
    $
    2,073,912Stock-based employee compensation
expense included in reported net
income, net of related tax effects
    
    
    
    
    
    
    35,765Stock-based compensation expense
determined under SFAS No. 123 for
all awards, net of related tax
effects
    
    
    (2,099,119
    )
    
    
    (1,255
    )Pro forma net income
    
    $
    836,173
    
    
    $
    2,108,422Earnings per common share:Basic  as reported
    
    $
    0.13
    
    
    $
    0.13Basic  pro forma
    
    $
    0.04
    
    
    $
    0.13Diluted  as reported
    
    $
    0.13
    
    
    $
    0.13Diluted  pro forma
    
    $
    0.04
    
    
    $
    0.13
 The acceleration of certain outstanding employee stock options in the first quarter of 2005
impacted the proforma stock-based compensation expense determined under SFAS No. 123 presented in
the table above. On March 31, 2005, the Compensation Committee of the Board of Directors of the
Company accelerated the vesting of certain unvested non-qualified stock options previously awarded
to the executive officers and other employees under the Companys Amended and Restated Year 2000
Stock Option Plan that had an exercise price greater than or equal to $8.05, the closing price of
the Companys common stock on the date preceding the Compensation Committees action. Options to
purchase approximately 1.2 million shares of common stock (of which approximately 905,000 shares
are subject to options held by executive officers) were subject to this acceleration. Options held
by non-employee directors and advisory board members and incentive stock options were not
included in the acceleration. 9




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Because these options had exercise prices at or in excess of the fair market value of the
Companys common stock at the time they were accelerated, and were not fully achieving their
original objectives of incentive compensation and employee retention, the Company believes that the
acceleration had a positive effect on employee morale, retention and perception of option value.
The acceleration will eliminate any future compensation expense the Company would otherwise
recognize in its income statement with respect to these options with the implementation of SFAS No.
123(R), Share-Based Payment, which becomes effective for the
Companys first quarterly reporting period in 2006. The future expense that is eliminated
beginning in 2006 as a result of the acceleration of the vesting of these options is approximately
$1.6 million, or approximately $1.0 million net of tax, of which approximately $1.2 million, or
$775,000 net of tax, is attributable to options held by executive officers. Charges
for options granted to non-employees have been determined in
accordance with SFAS No. 123 and Emerging Issues Task Force (EITF) No. 96-18, Accounting for Equity Instruments that are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, as
the estimated fair value of the consideration received or the estimated fair value of the equity
instruments issued, whichever is more reliably measured. The fair value for these options is based
on the Black-Scholes pricing model using the assumptions described above. The Company recognized
$48,017 and $5,390 of stock-based compensation expense for the three months ended March 31, 2005
and 2004, respectively. The expense was recorded in research and development expense and the total
deferred charges for options granted to non-employees are periodically re-measured as the
underlying options vest and are included in additional paid-in capital in the financial statements. 5. Balance Sheet Information Inventories Inventories are stated at the lower of cost or market. Cost is determined on a first-in,
first-out basis. Inventories consist of the following: March 31,
    
    
    December 31,2005
    
    
    2004Raw materials and supplies
    
    $
    5,240,293
    
    
    $
    5,710,213Work-in-process
    
    
    3,738,485
    
    
    
    3,067,593Finished goods
    
    
    4,573,400
    
    
    
    4,209,104Total
    
    $
    13,552,178
    
    
    $
    12,986,910
 Intangible Assets and Goodwill The following sets forth the Companys intangible assets by major asset class: March 31, 2005
    
    
    December 31, 2004Useful Life
    
    
    
    
    
    
    Accumulated
    
    
    Net Book
    
    
    
    
    
    
    Accumulated
    
    
    Net Book(Years)
    
    
    Gross
    
    
    Amortization
    
    
    Value
    
    
    Gross
    
    
    Amortization
    
    
    ValueIntangible assets subject to
amortization:Amortizable patents and other
    
    2  7 years
    
    $
    7,603,981
    
    
    $
    3,559,296
    
    
    $
    4,044,685
    
    
    $
    7,303,757
    
    
    $
    3,324,128
    
    
    $
    3,979,629Amortizable intangible assets
    
    1  5 years
    
    $
    1,189,000
    
    
    $
    296,783
    
    
    $
    892,217
    
    
    $
    1,189,000
    
    
    $
    218,848
    
    
    $
    970,152Intangible assets not subject to
amortization:Non-amortizable intangible assets
    
    
    
    
    
    $
    1,575,000
    
    
    $
    
    
    
    $
    1,575,000
    
    
    $
    1,575,000
    
    
    $
    
    
    
    $
    1,575,000Goodwill
    
    
    
    
    
    $
    27,234,214
    
    
    $
    
    
    
    $
    27,234,214
    
    
    $
    27,234,214
    
    
    $
    
    
    
    $
    27,234,214$
    37,602,195
    
    
    $
    3,856,079
    
    
    $
    33,746,116
    
    
    $
    37,301,971
    
    
    $
    3,542,976
    
    
    $
    33,758,995
 Amortizable patents and other includes costs incurred in connection with patent
applications, which consist principally of legal fees. Amortizable intangible assets,
non-amortizable intangible assets and goodwill were established in connection with the merger with
Hycor. Amortization expense totaled approximately $313,000 and $102,000 for the three months ended
March 31, 2005 and 2004, respectively. 10




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##### Table of Contents



Accrued Expenses and Other Liabilities Accrued expenses and other liabilities consist of the following: March 31,
    
    
    December 31,2005
    
    
    2004Accrued compensation
    
    $
    2,243,396
    
    
    $
    3,008,605Accrued royalties
    
    
    5,399,113
    
    
    
    4,825,246Warranty
    
    
    264,922
    
    
    
    333,277Other accrued expenses and liabilities
    
    
    1,501,196
    
    
    
    1,710,125Total
    
    $
    9,408,627
    
    
    $
    9,877,253
 6. Stockholders Equity The following table summarizes equity transactions during the three months ended March 31, 2005: Additional
    
    
    Unearned
    
    
    
    
    
    
    Accumulated Other
    
    
    TotalCommon Stock
    
    
    Paid-in
    
    
    Stock-based
    
    
    Retained
    
    
    Comprehensive
    
    
    StockholdersShares
    
    
    Amount
    
    
    Capital
    
    
    Compensation
    
    
    Earnings
    
    
    Loss
    
    
    EquityBalance as of January 1, 2005
    
    
    22,029,430
    
    
    $
    2,203
    
    
    $
    52,880,192
    
    
    $
    (420,677
    )
    
    $
    3,514,811
    
    
    $
    (816,345
    )
    
    $
    55,160,184Amortization of unvested
options acquired in the
Hycor merger
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131,443
    
    
    
    
    
    
    
    
    
    
    
    131,443Common stock issued for
employee stock purchase plan
    
    
    11,222
    
    
    
    1
    
    
    
    73,952
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    73,953Common stock issued upon
exercise of stock options
    
    
    8,313
    
    
    
    1
    
    
    
    22,029
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    22,030Tax benefit received from
the exercise of stock
options
    
    
    
    
    
    
    
    
    
    
    15,246
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,246Compensation
expense for non-employee stock options
    
    
    
    
    
    
    
    
    
    
    48,017
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    48,017Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,935,292
    
    
    
    
    
    
    
    2,935,292Foreign currency translation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (254,982
    )
    
    
    (254,982
    )Unrealized gain on securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (484
    )
    
    
    (484
    )Balance as
of March 31, 2005
    
    
    22,048,965
    
    
    $
    2,205
    
    
    $
    53,039,436
    
    
    $
    (289,234
    )
    
    $
    6,450,103
    
    
    $
    (1,071,811
    )
    
    $
    58,130,699
 7. Comprehensive Income Components of comprehensive income, net of income taxes, were as follows: Three Months EndedMarch 31,
    
    
    March 31,2005
    
    
    2004Net income
    
    $
    2,935,292
    
    
    $
    2,073,912Foreign currency translation loss
    
    
    (254,982
    )
    
    
    (38,886
    )Unrealized loss on securities
    
    
    (484
    )
    
    
    Comprehensive income, net of tax
    
    $
    2,679,826
    
    
    $
    2,035,026
 8. Commitments and Contingencies Royalty Payments Accrued expenses and other liabilities at March 31, 2005 and December 31,
2004 include $4.8 million and $4.1 million, respectively, of accrued royalties due to an unrelated
third party license holder for estimated royalties due from the second quarter of 2003 through the
respective balance sheet date. The Company has accrued royalties under this patent license
agreement based on an estimate of the amounts payable in accordance with the terms of the patent
license agreement. The Companys calculations of royalty payments are subject to review by the
license holder. Beginning in the second half of 2003, such royalty payments have been withheld by
the Company while the Company evaluates a possible overpayment of royalties paid in prior periods.
However, no assurances can be made that the Company will recover any of the overpayments.
Stratagenes financial position or 11




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results of operations could be materially affected if the
parties subsequently determine that the royalty calculation differs significantly
from the amounts recorded by Stratagene. The patent underlying this royalty obligation expired
in the United States in March 2005. The corresponding foreign patents will expire in 2006 and 2007.
Following the expiration of these PCR process patents, Stratagene will no longer be required to pay
royalties on future product sales related to such patents. Accordingly, Stratagene expects that
the expiration of the subject United States patent in March 2005 will result in an approximately
$300,000 per quarter reduction in royalty expense beginning in the second quarter of 2005. In
addition, upon the expiration of the corresponding foreign patents, Stratagene expects an
additional $300,000 reduction in royalty expense beginning in the second quarter of 2006. The
Company anticipates that this decrease in royalty expense will be partially offset by decreases in
the average unit selling price of products using the patented technology following the expiration
of the patents. Legal Stratagene is a party to litigation in the ordinary course of business. Due to the
uncertainties inherent in litigation, no assurances can be given as to the outcome of these
proceedings. If any of these matters were resolved in a manner unfavorable to Stratagene, its
business, financial condition and results of operations could be materially harmed. Additionally,
favorable outcomes or gain contingencies that may result from these matters, if any, are not
recognized until they are realized. Information on the most significant of these matters follows. Invitrogen Corporation In June 2000, Stratagene was sued by Invitrogen Corporation (formerly Life Technologies, Inc.)
in the United States District Court for the District of Maryland. The complaint alleges that
Stratagene willfully infringed United States patent no. 6,063,608 (and United States patent nos.
5,244,797 and 5,405,776) for making, using and selling products derived from, using or containing
RNase H minus reverse transcriptase enzymes. Invitrogens motion for a preliminary injunction was
denied and the case was stayed pending a trial in a related action involving Invitrogen and a third
party regarding the same patents. Invitrogen appealed the denial of an injunction and the stay to
the Federal Circuit Court of Appeals. In February 2002, the Federal Circuit Court of Appeals
affirmed the district courts decision. In September 2003, Invitrogen filed a consent to judgment
in the related action that the asserted patents were invalid. Accordingly, the case against
Stratagene remains administratively stayed pending Invitrogens appeal with respect to the related
matter. In addition, in March 2001, Stratagene was sued by Invitrogen in the United States District
Court for the Western District of Texas. Invitrogen alleges (1) that Stratagene willfully infringed
United States patent no. 4,981,797 for making, using and selling competent E. colicell products
and (2) damages of up to approximately $22.0 million. In November 2001, the district court granted
Stratagenes motion for summary judgment, finding that the 797 patent was not infringed by
Stratagene. Invitrogen appealed the judgment to the Federal Circuit Court of Appeals which, in May
2003, reversed the district courts decision in part and remanded the case for further proceedings.
In January 2004, in response to a pending summary judgment motion, the district court ruled that
Invitrogens 797 patent was invalid under 35 U.S.C. § 102(b). More specifically, the district
court found that Invitrogen had used the patented process claimed in the 797 patent for commercial
purposes for more than one year prior to the filing date of the patent. Having found the 797
patent invalid, the district court indicated there was no need for a trial. Invitrogen is currently
appealing the district courts ruling. Oral argument before the Federal Circuit Court of Appeals
occurred on May 2, 2005, and the parties have not yet received the courts ruling. In November 2001, Stratagene filed a complaint in the United States District Court for the
District of Maryland charging Invitrogen with willful infringement and inducing others to infringe
United States patent no. 5,556,772 for making, using, selling and offering for sale certain
polymerase blend products. Stratagene seeks a permanent injunction against continued infringement
as well as monetary damages (compensatory and enhanced) and recovery of its attorneys fees and
costs. Given the nature of patent litigation, at the present time Stratagene is unable to quantify
the amount of remuneration it will ultimately seek in this proceeding or the likelihood of
recovering any portion of such remuneration once quantified. No trial date is currently set for
this case. Takara Bio In November 2002, Stratagene filed a complaint in the United States District Court for the
District of Maryland charging Takara Bio with willful infringement and inducing others to infringe
United States patent no. 5,556,772 for making, using, selling and offering for sale certain
polymerase blend products. Stratagene seeks a permanent injunction, monetary damages (compensatory
and enhanced) and recovery of its attorneys fees and costs. Given the nature of patent litigation,
at the present time Stratagene is unable to quantify the amount of remuneration it will ultimately
seek in this proceeding or the likelihood of recovering any portion of such remuneration once
quantified. 12




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Takara filed a counterclaim in a separate action in the United States District Court
for the Southern District of California. By its counterclaim, Takara seeks joint ownership of
Stratagenes 772 patent. In June 2003, Stratagene successfully moved to transfer the California
action to Maryland. In August 2003, the Maryland district court denied Takaras motion to dismiss
or transfer the complaint, and the cases have been consolidated for pretrial and trial. The parties
entered into a joint stipulation, effective as of March 24, 2005, to stay the proceedings to
continue to pursue settlement of this action. No trial date is currently set for this case. Third Wave Technologies In September 2004, Stratagene was sued by Third Wave Technologies, Inc. in the United States
District Court for the Western District of Wisconsin. The complaint alleges that Stratagene
infringes United States patent nos. 6,348,314 and 6,090,543, and has induced or contributed to
infringement of the patents-in-suit, by making, using, importing, offering for sale or selling
assays employing cleavage of nucleic acids. Third Wave seeks a preliminary and permanent
injunction, monetary damages (compensatory and enhanced), and recovery of its attorneys fees and
costs. In October 2004, Stratagene filed its answer to the complaint responding that it does not
infringe a valid or enforceable claim of either patent. Stratagene has also asserted affirmative
defenses, including invalidity and unenforceability, and counterclaims of invalidity and
non-infringement. Stratagene is seeking an award of its fees and costs incurred in defending itself
in this action. Trial is currently scheduled for August 2005. On May 6, 2005, Stratagene filed a complaint in the United States District Court for the
District of Delaware charging Third Wave Technologies with willful infringement and inducing others
to infringe United States patent nos. 6,528,254 and 6,548,250 for making, using, selling and
offering for sale certain of its Invader® products. Stratagene seeks a permanent
injunction against continued infringement as well as monetary damages (compensatory and enhanced)
and recovery of its attorneys fees and costs. Given the nature of patent litigation, at the
present time Stratagene is unable to quantify the amount of remuneration it will ultimately seek in
this proceeding or the likelihood of recovering any portion of such remuneration once quantified. Applera Corporation In November 2004, Stratagene received notice of a patent infringement suit filed by Applera
Corporation against it and other parties in the United States District Court for the District of
Connecticut for alleged infringement of U.S. patent no. 6,814,934. The Stratagene products alleged
to infringe are the Mx4000 and Mx3000P instruments and certain related reagents. In December 2004,
Stratagene filed its answer to the complaint responding that it does not infringe, directly or
indirectly, any valid and enforceable claim of the 934 patent and asserting related counterclaims
of invalidity and non-infringement. An estimate of the possible loss or range of loss cannot be
made at this time and Stratagene is unable to determine whether the outcome of the litigation could
have a material impact on its results of operations or financial condition in any future period.
This case is currently scheduled to be placed on the Courts trial ready list in April 2006. Ariadne Genomics In March 2005, the Company filed a demand for arbitration against Ariadne Genomics for
declaratory relief and damages relating to the Exclusive Marketing and Distribution Agreement (the
Agreement) between the parties. In particular, Stratagene seeks to confirm that it holds the
exclusive right to market, sell and distribute the software products covered by the Agreement and
all upgrades thereof in any country or territory in the world, except Japan, for the duration of
the term of the Agreement. Further, Stratagene seeks to confirm that it is the party entitled to
ownership and use of the trademark Pathway Assist or, alternatively, that neither party may use
that name. The matter is currently pending before the American Arbitration Association in San
Diego, California. Other Legal Matters Pursuant to the terms of a litigation settlement in 2002, Stratagene is entitled to receive
35,290 shares of a European company. Stratagene received 11,763 shares in August 2004, 11,764
shares in September 2004 and the final 11,763 shares in March 2005. These shares were sold and
converted into cash upon receipt, resulting in a gain in other income of approximately $527,000
during the quarter ended March 31, 2005 and $664,000 during the quarter ended September 30, 2004. 13




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9. New Accounting Pronouncements In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which will be effective
for the Companys first quarterly reporting period in 2006. SFAS No. 123R replaces SFAS No. 123,
Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees. The new standard requires that the compensation cost relating to share-based
payments be recognized in financial statements at fair value. As such, reporting employee stock
options under the intrinsic value-based method prescribed by APB No. 25 will no longer be allowed.
The Company has historically elected to use the intrinsic value method and has not recognized
expense for employee stock options granted. The Company has not yet determined the impact that
adopting SFAS No. 123R will have on the financial results of the Company in future periods. In December 2004, the FASB staff issued FASB Staff Position (FSP) SFAS No. 109-1,
Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of 2004,to provide
guidance on the application of SFAS No. 109 to the provision within the American Jobs Creation Act
of 2004 (the Act) that provides tax relief to U.S. domestic manufacturers. The FSP states that
the manufacturers deduction provided for under the Act should be accounted for as a special
deduction in accordance with SFAS No. 109 and not as a tax rate reduction. A special deduction is
accounted for by recording the benefit of the deduction in the year in which it can be taken in the
Companys tax return, and not by adjusting deferred tax assets and liabilities in the period of the
Acts enactment (which would have been done if the deduction on qualified production activities
were treated as a change in enacted tax rates). The proposed FSP also reminds companies that the
special deduction should be considered by an enterprise in (a) measuring deferred taxes when the
enterprise is subject to graduated tax rates and (b) assessing whether a valuation allowance is
necessary as required by SFAS No. 109. The FSP is effective upon issuance. In accordance with the
FSP, the Company will record the benefit, if any, of the tax deduction in the year in which the
deduction becomes available. In December 2004, the FASB staff issued FSP FAS No. 109-2, Accounting and Disclosure Guidance
for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,to
provide accounting and disclosure guidance for the repatriation provisions included in the Act. The
Act introduced a special limited-time dividends received deduction on the repatriation of certain
foreign earnings to a U.S. taxpayer. As a result, an issue has arisen as to whether an enterprise
should be allowed additional time beyond the financial reporting period in which the Act was
enacted to evaluate the effects of the Act on its plan for reinvestment or repatriation of foreign
earnings for purposes of applying SFAS No. 109. The FSP is effective upon issuance. The Company has
not yet completed its evaluation of this aspect of the Act and will complete its review in
connection with the preparation of its 2004 corporate tax returns. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin
(SAB) No. 107 to provide public companies additional guidance in applying the provisions of SFAS
No. 123(R). Among other things, the SAB describes the staffs expectations in determining the
assumptions that underlie the fair value estimates and discusses the
interaction of SFAS No. 123(R)
with certain existing staff guidance. SAB No. 107 should be applied upon the adoption of SFAS No.
123(R). 14




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##### Table of Contents



10. Segment Information The Company operates in two business segments: research supplies and medical diagnostics. The
segment information provided for the three months ended March 31, 2004 includes only research
supplies segment information, as the Company only established a separate medical diagnostics
reporting segment in connection with the Hycor merger on June 2, 2004. Three Months Ended
    
    
    Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Research
    
    
    Medical
    
    


    
    
    Research
    
    
    MedicalSupplies
    
    
    Diagnostics
    
    
    Total
    
    
    Supplies
    
    
    Diagnostics
    
    
    TotalRevenues from external customers
    
    $
    18,911,120
    
    
    $
    5,688,920
    
    
    $
    24,600,040
    
    
    $
    19,422,022
    
    
    $
    
    
    
    $
    19,422,022Income before income taxes
    
    $
    3,055,127
    
    
    $
    1,396,092
    
    
    $
    4,451,219
    
    
    $
    3,081,208
    
    
    $
    
    
    
    $
    3,081,208
 At March 31, 2005 and December 31, 2004, total assets for each business segment were as
follows: March 31, 2005
    
    
    December 31, 2004Research
    
    
    Medical
    
    
    
    
    
    Research
    
    
    MedicalSupplies
    
    
    Diagnostics
    
    
    Total
    
    
    Supplies
    
    
    Diagnostics
    
    
    TotalTotal assets
    
    $
    39,143,554
    
    
    $
    41,889,595
    
    
    $
    81,033,149
    
    
    $
    38,202,779
    
    
    $
    42,128,921
    
    
    $
    80,331,700
 15




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations The following information should be read in conjunction with the financial statements and the
related notes included in Item 1 of Part I of this Quarterly Report onForm 10-Qand with the
financial statements and related notes included in the Companys Annual Report onForm 10-Kfor the
year ended December 31, 2004. The financial information for Stratagene includes the accounts and
balances of Stratagene Corporation and subsidiaries on a consolidated basis, and includes the
results of operations of Hycor Biomedical Inc. and subsidiaries since Stratagenes acquisition of
Hycor on June 2, 2004. This Managements Discussion and Analysis of Financial Condition and Results of Operations
and other sections of this Quarterly Report onForm 10-Qcontain forward-looking statements and
include assumptions concerning the Companys operations, future results and prospects. These
forward-looking statements are based on current expectations and are subject to a number of risks,
uncertainties and other factors. The Companys actual results could differ materially from those
expressed in or implied by these forward-looking statements as a result of various factors,
including those set forth below under the caption Factors that May Affect Future Results. Overview Stratagene develops and manufactures biological products and instruments designed to improve
the speed and accuracy of life sciences research and medical diagnosis. Stratagene markets its
products to researchers at academic and government institutions and pharmaceutical, biotechnology
and industrial companies, in the U.S. and internationally. These researchers use Stratagenes
products to identify genes and proteins, study how cells are regulated by genes and proteins,
determine the molecular mechanisms of health and disease, search for new drug therapies, develop
diagnostic tests, and test the safety of compounds used in food and pharmaceuticals. Stratagene engages in business activity in two operating segments: Research Supplies and
Medical Diagnostics. The Company has marketed and sold its Research Supplies products for over 20
years, while the Medical Diagnostics products are a new addition to Stratagenes product portfolio
as a result of the merger with Hycor Biomedical Inc. in June 2004. Merger with Hycor On June 2, 2004, Stratagene acquired all of the outstanding shares of Hycor Biomedical Inc.
through a merger of a wholly owned subsidiary of Stratagene with Hycor, with Hycor continuing as a
wholly owned subsidiary of Stratagene. Pursuant to the merger, Hycors stockholders received 0.6158
of a share of Stratagene common stock in exchange for each share of Hycor common stock, plus cash
for any fractional shares. The merger has been recognized as a tax-free reorganization. Stratagene
filed a registration statement on Form S-4 (No. 333-109420) and related amendments in connection
with the transaction, which registration statement was declared effective by the Securities and
Exchange Commission on April 29, 2004. Stratagene incurred merger-related costs of approximately
$1.7 million, which were capitalized as a component of the purchase price. BCH Asset Acquisition Concurrently with the closing of the Hycor merger, Stratagene acquired substantially all of
the assets of BioCrest Holdings, LLC, or BCH, including BCHs interests in its subsidiaries. In exchange, Stratagene forgave
all of the outstanding intercompany indebtedness owed by BCH and its subsidiaries to Stratagene of
approximately $5.4 million and assumed all of the other outstanding liabilities of BCH and its
subsidiaries of approximately $0.8 million. Because Stratagene and BCH are under common control,
with substantially all of the BCH membership units held by certain Stratagene shareholders, the
acquisition of BCH was recorded on a historical cost basis. As such, there was no adjustment of
BCHs assets and liabilities to fair value and no goodwill resulting from the purchase. As of and
for the year ended December 31, 2004, Stratagenes financial statements are presented on a
consolidated basis, which represents a change in reporting entity under Accounting Principles Board
Opinion 20, Accounting Changes. Previously combined statements are now presented on a consolidated
basis as a result of the transaction. There is no change to income for previous periods presented
on a combined basis. For income tax purposes, this transaction is considered a taxable pooling. The
financial statements reflect net deferred tax assets of $875,000 for differences between the tax
and book bases of assets and liabilities acquired by Stratagene. 16




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##### Table of Contents



Prior to the acquisition date, Stratagene presented its financial statements on a combined
basis with BCH. BCH was a limited liability company treated as a partnership for income tax
purposes; therefore, any related income tax obligations were the responsibility of the members of
BCH. As a result, the operations of BCH did not reflect a provision for income taxes in the
combined financial statements. Beginning on June 2, 2004, the consolidated results of Stratagene,
which includes the results of BCH, includes a provision for income taxes. As part of the acquisition of BCH, Stratagene acquired BCHs interests in its subsidiaries,
which include Phenogenex, LLC, or Phenogenex, Iobion Informatics, LLC and subsidiaries, which the
Company refers to collectively as Iobion, and an investment in a joint venture consisting of a
49% interest in a limited partnership that operates a research lab. The investment in a joint
venture is accounted for under the equity method. At the time of the acquisition, Stratagene owned 100% of Phenogenex and approximately 78% of
Iobion. The remaining 22% interest in Iobion was held by two individuals, one of which is now an
employee of Iobion and the other is a consultant to the Company. In October 2004, the Company
purchased the remaining 22% outstanding membership interests in Iobion owned by these individuals.
As a result of the purchase of these minority interests, Stratagene now owns 100% of Iobion. Total
cash consideration of $330,000 was paid and was recorded to intangible assets based on the fair
value of the assets and liabilities acquired. Basis of Presentation The financial information of the Company has been presented on a consolidated basis, and
includes the results of operations of Hycor Biomedical Inc. and subsidiaries (Hycor) since Hycor
was acquired by the Company on June 2, 2004. The financial information also includes the results of
operations of BCH, whose assets were acquired by the Company on June 2,
2004. Prior to the acquisition, BCH was under common control with Stratagene, and substantially
all of the BCH membership units were held by certain Stratagene shareholders. The acquisition of
the BCH assets has been presented as a change in reporting entity. Accordingly, the financial
statements of Stratagene and BCH are presented on a consolidated basis for all periods.
Intercompany balances and transactions have been eliminated as appropriate in the consolidation of
Stratagene. The results of operations for any interim period are not necessarily indicative of results to
be expected for the full year. Critical Accounting Policies and Estimates The Companys consolidated financial statements are prepared in accordance with accounting
principles generally accepted in the United States of America and management is required to make
certain estimates, judgments and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of revenues and
expenses during the periods presented. The significant accounting policies that the Company
believes are the most critical to aid in fully understanding and evaluating its reported financial
results include the following: Use of Estimates The preparation of financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and disclosures made in the accompanying
notes. Actual results could differ from those estimates. Revenue Recognition Revenue from research supplies, diagnostic and basic instrumentation product sales is
recognized under the provisions of Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition,
which is generally when products are shipped, title has transferred and risk of loss has passed. In
accordance with Statement of Position, or SOP, No. 97-2, Software Revenue Recognition, as amended
by SOP No. 98-9, for instrumentation products where software is a key component, revenue is
recognized when persuasive evidence of an arrangement exists, delivery has occurred, the sales
price is fixed or determinable and collectibility is probable. Generally, these criteria are met at
the time product is shipped and title has transferred. When contractual acceptance clauses exist,
revenue is recognized upon 17




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##### Table of Contents



satisfaction of such clauses. Contract research service revenues are
earned and recognized in accordance with contract provisions. Government grant revenues related to
research activities are recognized when earned, generally as related research activities occur.
Amounts received in advance of performance or acceptance are recorded as deferred revenue. The following table summarizes the types of deferred revenue and the timing of when that
revenue is recognized: Type of deferred revenue
    
    When recognizedExtended warranty or maintenance
agreements
    
    Recognized over the term of the contract, generally 12
months. In
most cases, these contracts were sold at the time of product
purchase and the recognition of revenue begins after the
warranty
period, which is generally one year.License agreements
    
    Recognized over the term of the agreement, generally 12
months.
 The following table provides the percentage of the ending balance in deferred revenue that
each type of deferred revenue represents as of December 31, 2004: Type of deferred revenue
    
    2004Extended warranty, installation or maintenance agreement
    
    
    49
    %License agreements
    
    
    51
    %Total deferred revenue
    
    
    100
    %
 Accounts Receivable Stratagene performs ongoing credit evaluations of its customers and adjusts credit limits
based upon payment history and the customers current creditworthiness. Stratagene regularly
monitors collections and payments from customers and maintains a provision for estimated credit
losses based upon historical experience and any specific customer collection issues that have been
identified. Stratagenes credit losses have historically been within expectations and the
provisions established. Inventories Inventories are valued at the lower of the actual cost to purchase and/or manufacture the
inventory or the current estimated market value of the inventory. Stratagene regularly reviews
inventory quantities on hand and records a provision for excess and obsolete inventory on
specifically identified items based primarily on an estimated forecast of product demand and
production requirements. Stratagenes losses from disposal of excess or obsolete inventory have
historically been within expectations and the provisions established. However, Stratagenes
estimates of future product demand may prove to be inaccurate, in which case Stratagene may have
understated or overstated the provision required for excess and obsolete inventory. In addition,
rapid technological change or new product development could result in an increase in the quantity
of obsolete inventory on hand. In the future, if Stratagenes inventory is determined to be
overvalued, it would be required to recognize such costs in its cost of products sold at the time
of such determination. Likewise, if Stratagenes inventory is determined to be undervalued, it may
have over-reported its cost of products sold in previous periods and would be required to recognize
such additional operating income at the time of sale. Additionally, Stratagenes manufacturing costs and inventory carrying costs are dependent on
managements accurate estimates of customer demand for Stratagenes products. A significant
increase in the demand for Stratagenes products could result in a short-term increase in the cost
of inventory purchases, while a significant decrease in demand could result in an increase in the
amount of excess inventory quantities on hand and increase the expense of storing and maintaining
the inventory until it is sold. As a result, although management attempts to maximize the accuracy
of its forecasts of future product demand, any significant unanticipated changes in demand or
technological developments could have a significant impact on the value of Stratagenes inventory
and its reported operating results. 18




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Deferred Taxes Stratagenes deferred tax assets relate primarily to prior operating losses that are available
to offset future taxable income and tax credits that are available to offset future income taxes.
Deferred taxes are also recognized for differences between the financial statement carrying amounts
and the tax basis of assets and liabilities. Stratagene evaluates a variety of factors in
determining the amount of deferred income tax assets to be recognized pursuant to Statement of
Financial Accounting Standards, or SFAS, No. 109, Accounting for Income Taxes. Long-lived Assets The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 142,
Goodwill and Intangibles,and SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets.These Statements require that long-lived assets and certain identifiable intangible assets
be reviewed annually for impairment or whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of the asset to the future net undiscounted
cash flows expected to be generated by the asset. With the acquisition of Hycor in the second
quarter of 2004, Stratagene has substantial amortizable and non-amortizable long-lived assets
(including goodwill) that are reviewed for impairment quarterly and when there is an indication
that the carrying value of an asset may not be recoverable. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the carrying amount of
the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell. Royalties Stratagene enters into license agreements in the ordinary course of its business, which
require royalty payments based on specified product sales. These agreements cover the majority of
Stratagenes products. Since mid-2003, Stratagene has withheld payments to a license holder while
Stratagene evaluates a possible overpayment in the royalties paid in prior periods. Stratagene has
continued to record the estimated quarterly royalty payable under the patent license agreement and
reports this amount to the license holder. Management believes the royalty payments accrued are
determined in accordance with the patent license agreement. However, the Companys calculations of
royalty payments are subject to review by the license holder. Therefore, Stratagenes financial
position or results of operations could be materially affected if the license holder later
determines that the royalty calculation differs significantly from the amounts recorded by
Stratagene. As of March 31, 2005, the amount of accrued and unpaid royalties related to this patent
license agreement was $4.8 million. The patent underlying this royalty obligation expired in the
United States in March 2005. The corresponding foreign patents will expire in 2006 and 2007.
Following the expiration of these PCR process patents, Stratagene will no longer be required to pay
royalties on future product sales related to such patents. Accordingly, Stratagene expects that
the expiration of the subject United States patent in March 2005 will result in an approximately
$300,000 per quarter reduction in royalty expense beginning in the second quarter of 2005. In
addition, upon the expiration of the corresponding foreign patents, Stratagene expects an
additional $300,000 reduction in royalty expense beginning in the second quarter of 2006. The
Company anticipates that this decrease in royalty expense will be partially offset by decreases in
the average unit selling price of products using the patented technology following the expiration
of the patents. Warranties Stratagene warrants certain equipment against defects in workmanship or materials for a period
of one year from the date of purchase. Upon shipment of equipment sold that includes a warranty,
Stratagene establishes, as part of cost of products sold, a provision for the expected costs of
such warranty. While Stratagenes warranty costs have historically not been significant, Stratagene
cannot guarantee that it will continue to experience the same warranty return and repair rates that
it has in the past. A significant increase in product return and repair rates could have a material
adverse impact on operating results for the period or periods in which such items materialize. Research and Development Stratagene focuses its research and development efforts on developing products that use
innovative technologies in both the Research Supplies and Medical Diagnostics product lines.
Research and development costs are expensed as incurred. For the three months ended March 31, 2005
and for fiscal year 2004, Stratagenes research and 19




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development expenses totaled approximately $2.9
million and $10.8 million, respectively, and Stratagene intends to spend between 11% and 14% of its
revenues on research and development activities for at least the next few years. Stratagenes numerous research and development initiatives are generally ongoing. Some of the
efforts are for new product technologies, while others are designed to support an existing product
or products relating to one of Stratagenes more than 2,500 stock keeping units, which cover
approximately 75 existing product categories. In addition, the funds used by Stratagene in its
research and development activities are allocated among the various technologies and products in
which Stratagene is currently involved and are not concentrated to one specific product or product
line. Stratagene does not provide forward-looking estimates of costs and time to complete any of its
individual ongoing research and development projects because none of such projects are material to
the Company on an individual basis. In addition, any such estimates would be subject to a number of
risks and uncertainties, including Stratagenes ability to predict the outcome of complex research,
competition from other entities of which Stratagene may become aware in future periods, predictions
of market potential from products that may be derived from Stratagenes research and development
efforts and Stratagenes ability to recruit and retain personnel with the necessary knowledge and
skills to perform the required research activities. Results of Operations Three months ended March 31, 2005 compared to three months ended March 31, 2004 Revenues For the three months ended March 31, 2005, revenue increased $5.2 million, or 26.7%, compared
to the three months ended March 31, 2004. This increase was primarily attributable to the Company
recording three months of Hycors diagnostics product sales of $5.7 million for the three months
ended March 31, 2005. This increase was offset by declines in research supplies product sales of
approximately $0.5 million for the three months ended March 31, 2005 when compared to the same
period in 2004 due to declines in sales of older technology products of $1.2 million, or 8%, offset
by growth in QPCR products of $0.7 million, or 15%. In addition, for the three months ended March
31, 2004, there were $0.5 million more of backordered products shipped than for the same period in
2005. Sales during the three months ended March 31, 2005 were also affected by the weakening
dollar resulting in a positive foreign exchange impact to foreign sales of 4.5% and a 1.2% increase
to total worldwide revenue for the three months ended March 31, 2005 when compared to the three
months ended March 31, 2004. There were no significant changes to price or volume during the three
months ended March 31, 2005 compared to the same period in 2004. Stratagene expects that future
revenue will depend on a number of factors, including the market acceptance of new products,
competitive conditions, currency fluctuations and the continued funding of customer research
budgets. Stratagenes operating results have fluctuated in the past and may continue to fluctuate in
the future. In particular, Stratagene has historically seen slower sales in the fourth quarter as a
result of reduced purchases by academic and research institutions as well as the closing of such
facilities during the holiday period. Conversely, Stratagenes sales in the first quarter have
historically been higher than other quarters due to increased sales by academic and research
institutions. Therefore, the results of operations for any interim period are not necessarily
indicative of results to be expected for the full year. Gross Profit Gross profit increased $2.6 million, or 19.5%, for the three months ended March 31, 2005
compared to the same period in 2004 due to inclusion of Hycors results of operations in the first
quarter of 2005. As a percentage of sales, gross profit decreased 3.9% from 69.5% for the three
months ended March 31, 2004 to 65.6% for the three months ended March 31, 2005 due to the inclusion
of Hycors lower margin medical diagnostic products. The decrease was also attributable to higher
royalty expense for research supplies as a result of increased sales of QPCR and software products
for the three months ended March 31, 2005 as compared to the same period in 2004. Research and Development Expenses Research and development expenses increased $0.3 million, or 14.6%, for the three months ended
March 31, 20




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2005 compared to the same period in 2004. The increase in spending was primarily due to
approximately $0.4 million of Hycors medical diagnostic research and development efforts for the
three months ended March 31, 2005. As a percentage of product sales, research and development
expenses decreased from 13.0% for the three months ended March 31, 2004 to 11.7% for the three
months ended March 31, 2005. This decrease in research and development expense as a percentage of
sales is primarily the result of including revenue from the sale of medical diagnostic products for
the three months ended March 31, 2005. Selling and Marketing Expenses Selling and marketing expenses increased $0.9 million, or 23.1%, for the three months ended
March 31, 2005 compared to the same period in 2004. The increase in spending was due to the Company
recording three months of Hycor sales and marketing expenses of approximately $0.9 million.
However, as a percentage of total revenue, selling and marketing expenses decreased slightly from
20.9% for the three months ended March 31, 2004 to 20.3% for the three months ended March 31, 2005.
As a result of the merger with Hycor, Stratagene recorded amortizable intangible assets related to
trade names and customer contracts. These intangible assets are being amortized to sales and
marketing expense over various periods ranging from one to five years beginning in June of 2004.
The amortization expense included in sales and marketing was approximately $0.1 million for the
three months ended March 31, 2005. General and Administrative Expenses General and administrative expenses increased by $1.0 million, or 32.7%, for the three months
ended March 31, 2005 compared to the same period in 2004. As a percentage of total revenue,
general and administrative expenses increased from 15.9% for the three months ended March 31, 2004
to 16.7% for the three months ended March 31, 2005. The increased spending is primarily due to
$0.2 million of expenses related to increased legal fees associated with patent litigation,
approximately $0.3 million of expense for additional costs related to public company oversight and
three months of general and administrative expenses related to the Hycor operations of $0.6
million, which includes approximately $0.1 million for the amortization of patents and non-cash
stock compensation charges related to the unvested stock options assumed in the merger with Hycor.
These increases were offset by $0.1 million of decreases in other general and administrative
spending. Total Other Income (Expense), Net Total other income, net of expense, increased by $1.0 million, or 146.8%, for the three months
ended March 31, 2005 compared to the same period in 2004. This increase was primarily due to a
reduction in interest expense of $0.6 million for the three months ended March 31, 2005 resulting
from the repayment of long-term debt obligations. Also contributing to the net increase in other income was a gain of $0.5 million as a result
of a litigation settlement in 2002. Pursuant to the terms of the settlement, Stratagene received
the final 11,763 shares in March 2005. These shares were sold and converted into cash upon receipt,
resulting in a gain of approximately $527,000 in other income during the quarter ended March 31,
2005. Income Taxes Stratagene recorded $1.5 million in tax expense for the three months ended March 31, 2005,
which is approximately 34.1% of pre-tax income as compared to 32.7% for the three months ended
March 31, 2004. Stratagene recognizes state research and development and other credits when they
are generated. Excess credits for mature operating entities are recognized and will be used to
offset future taxable income as management believes it is more likely than not that the credits
will be realized. Liquidity and Capital Resources Stratagenes liquidity requirements have historically consisted of research and development
expenses, sales and marketing expenses, debt service, capital expenditures, working capital and
general corporate purposes. These expenses have been funded primarily through cash from operations,
supplemented with borrowings under credit facilities and other debt instruments. 21




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Stratagene generated net cash from operating activities of $3.5 million and $2.5 million for
the three months ended March 31, 2005 and 2004, respectively. Stratagene used $0.7 million of net
cash in its investing activities for each of the three months ended March 31, 2005 and 2004.
Capital expenditures and additions to patents for the three months ended March 31, 2005 totaled
$0.4 million and $0.3 million, respectively, as compared to $0.2 million and $0.3 million for the
three months ended March 31, 2004, respectively. For fiscal 2005, Stratagene currently anticipates
capital spending on property and equipment to be in the range of $1.5 million to $2.0 million. Stratagene used $3.7 million and $0.8 million in net cash for financing activities for the
three months ended March 31, 2005 and 2004, respectively, which included the repayment of $3.8
million and $14.9 million in debt, respectively. The $14.9 million repayment of debt for the three
months ended March 31, 2004 was offset by borrowings under the
Companys credit facilities of $14.1 million. Based on managements review of Stratagenes accounts receivables, an allowance for doubtful
accounts is accrued. However, Stratagene does not write off individual accounts receivable until
substantially all avenues of legal recourse to collect the outstanding amount have been exhausted.
The actual write-off for the three months ended March 31, 2005 was minimal and the allowance
decreased by approximately $0.2 million. This decrease in expected uncollectible accounts was due
in part to continued collection efforts. No significant change to future liquidity is anticipated. Gross accounts receivable used cash of $1.2 million and $0.5 million for the three months
ended March 31, 2005 and 2004, respectively, due primarily to increased instrumentation sales
during the first quarter of each year. Gross
inventory used cash of $0.8 million and $0.2 million for
the three months ended March 31, 2005 and 2004, respectively, due to supporting ongoing business requirements. Stratagene had cash, cash equivalents and restricted cash totaling $4.7 million and $5.7
million at March 31, 2005 and December 31, 2004, respectively, and working capital of $17.6 million
and $17.9 million at March 31, 2005 and December 31, 2004, respectively. As of March 31, 2005, BioCrest Manufacturing, L.P., a consolidated subsidiary of Stratagene,
had approximately $6.0 million in total debt. This debt included approximately $1.2 million under a
$9.0 million reducing revolving line of credit and $4.8 million in industrial revenue bonds. The obligations of BioCrest Manufacturing under the reducing revolving line of credit have
been guaranteed by Stratagene and each of its wholly owned domestic subsidiaries. The obligation is
also generally secured by substantially all of the personal property assets of Stratagene and each
of its wholly owned domestic subsidiaries, as well as liens on the real property and improvements
related to Stratagenes Texas manufacturing facility. Borrowings under the reducing revolving line of credit bear interest at a variable rate equal
to the one-month LIBOR rate plus 2.55% and matures in January 2007. The reducing revolving line of
credit includes customary but significant restrictions on the incurrence of additional debt, the
payment of dividends, acquisitions and capital expenditures above stated limits. The reducing
revolving line of credit also contains restrictive covenants requiring the Company to maintain
certain financial ratios, including minimum debt service coverage ratios, fixed charge coverage
ratios and tangible net worth. As of March 31, 2005, the Company was in compliance with all of
these covenants. The industrial revenue bonds are secured by land, building and equipment acquired in Bastrop
County, Texas with the proceeds from the issuance of the bonds. The average interest rate on the
industrial revenue bonds was 2.0% for the three months ended March 31, 2005 and was 1.44% for
fiscal 2004. Under the instrument governing the industrial revenue bonds, Stratagene was required
to make sinking fund payments of $870,000 per year through April 2004 and $735,000 in April 2005,
and is required to make sinking fund payments of $240,000 per year through April 2021, and then
$175,000 in April 2022 when the bonds mature. Stratagene leases certain facilities and equipment under noncancelable operating leases, with
equipment leases expiring through January 2007 and facility leases for the Companys headquarters
in La Jolla and its offices in 22




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Garden Grove, California, Canada, the Netherlands, Germany, Scotland
and Japan expiring on various dates between September 30, 2005 and September 30, 2008. Stratagene has entered into employment agreements with certain of its officers which expire
from June 2006 to June 2007 and with salary ranges from approximately $181,000 to $450,000. These
agreements generally provide for severance benefits if the officer is terminated by Stratagene
other than for cause, as defined in the employment agreements. In addition, in the normal course of operations, Stratagene enters into purchase obligations
with various vendors and suppliers of various key raw materials and other goods and services
through purchase orders or other documentation. Such obligations are generally outstanding for
periods of less than one year and are settled by cash payments upon delivery of goods and services.
At December 31, 2004, the purchase commitments covered by these various key raw materials and other
goods and services aggregate approximately $3,130,000. The following table summarizes the approximate future minimum payments under the above
contractual obligations at December 31, 2004: Payment Due by PeriodLess than
    
    
    1-3
    
    
    4-5
    
    
    After 5Contractual Obligations
    
    Total
    
    
    1 Year
    
    
    Years
    
    
    Years
    
    
    YearsOperating leases
    
    $
    6,687,753
    
    
    $
    2,107,937
    
    
    $
    4,579,816
    
    
    
    
    
    
    
    Principal on long-term debt
    
    
    9,706,923
    
    
    
    735,000
    
    
    
    5,676,923
    
    
    $
    480,000
    
    
    $
    2,815,000Employment agreements
    
    
    1,358,753
    
    
    
    630,835
    
    
    
    727,918
    
    
    
    
    
    
    
    Other purchase commitments
    
    
    3,130,000
    
    
    
    3,130,000
    
    
    
    
    
    
    
    
    
    
    
    Total contractual obligations
    
    $
    20,883,429
    
    
    $
    6,603,772
    
    
    $
    10,984,657
    
    
    $
    480,000
    
    
    $
    2,815,000
 Off-Balance Sheet Arrangements At March 31, 2005 and December 31, 2004, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often referred to as structured
finance, variable interest or special purpose entities, which would have been established for the
purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited
purposes. In addition, the Company does not engage in trading activities involving non-exchange
traded contracts. As such, the Company is not materially exposed to any financing, liquidity,
market or credit risk that could arise if it had engaged in such relationships. Other Commitments and Contingencies In connection with the closing of the Hycor merger, Stratagene entered into a new employment
agreement with the Chief Executive Officer, or the CEO, of the Company, pursuant to which, among
other things, the CEOs base annual salary was reduced from $1.1 million to $450,000, and the CEO
was granted an option to purchase 738,960 shares of Stratagene common stock at an exercise price of
$9.34 per share. The agreement provides for the CEOs base salary to be reviewed on at least an
annual basis by the compensation committee of the board of directors, which may also increase the
CEOs base salary from time to time in its discretion. It is anticipated that if the Company
establishes any general bonus program for senior executives based upon the attainment of
established goals, the CEO will be entitled to participate in such program on a basis at least
comparable to other senior executives. The CEO may also receive bonuses at the discretion of the
board of directors upon the recommendation of the compensation committee. The new employment
agreement has an initial term of three years and is subject to successive one year renewals unless
either party provides a notice of non-renewal at least 30 days prior to the termination of the then
current term. New Accounting Pronouncements Information regarding recent accounting pronouncements is contained in Note 9 to the
Consolidated Financial Statements for the period ended March 31, 2005, which note is incorporated
herein by this reference and is included as part of Item 1. Financial Statements, to this Form
10-Q. 23




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Cautionary Note Regarding Forward-Looking Statements Some of the statements in this Quarterly Report on Form 10-Q, including, but not limited to,
this Managements Discussion and Analysis of Financial Condition and Results of Operations, are
forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are
therefore entitled to the protection of the safe harbor provisions of these laws. Stratagene
generally identifies forward-looking statements in this Quarterly Report by using words like
believes, intends, targets, expects, estimates, may, should, plans, projects,
contemplates, anticipates, predicts or similar expressions. You can also identify
forward-looking statements by discussions of strategies, plans or intentions. These statements
involve known and unknown risks, uncertainties and other factors that may cause the Companys
actual results, levels of activity, performance or achievements to be materially different from any
future results, levels of activity, performance or achievements expressed or implied by these
forward-looking statements. These factors include the absence of a public market for the Stratagene
common stock prior to the Hycor merger, Stratagenes ability to introduce new products and the
acceptance of these products by the marketplace, competition, the inability to sell products as a
result of the termination of license agreements, fluctuations in operating results, dependence on
key employees, Stratagenes substantial indebtedness, future capital requirements, the possibility
of unproductive research and development projects, ability to manage growth, price volatility of
Stratagenes common stock, the impact of future sales of common stock on Stratagenes stock price
and potential declines in research and development budgets or funding. For more information about
the risks faced by the Company, please see Factors that May Affect Future Results included in the
Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and the discussion
set forth below under the caption Factors that May Affect Future Results. Although Stratagene believes that the expectations reflected in its forward-looking statements
are reasonable, Stratagene cannot guarantee future results, events, levels of activity, performance
or achievement. Stratagene undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future events or otherwise,
unless required by law. Factors that May Affect Future Results It is important to carefully consider the following risks, together with other matters
described in this Form 10-Q or in other documents referred to in this Form 10-Q in evaluating
Stratagenes business and prospects. If any of the following risks occur, Stratagenes business,
financial condition or operating results could be harmed. In such case, the trading price of
Stratagenes common stock could decline. The risks described below are not the only risks
Stratagene faces. Additional risks not presently known to Stratagene or that Stratagene currently
deems immaterial may also impair business operations. Stratagenes future success depends on the timely introduction of new products and the
acceptance of these new products in the marketplace. Rapid technological change and frequent new product introductions are typical for the markets
Stratagene serves. Stratagenes future success will depend in large part on continuous, timely
development and introduction of new products that address evolving market requirements. Stratagene believes successful new product introductions provide a significant competitive
advantage because customers make an investment of time in selecting and learning to use new
products, and are reluctant to switch thereafter. To the extent that Stratagene fails to introduce
new and innovative products, it may lose market share to its competitors, which may be difficult to
regain. Any inability, for technological or other reasons, to successfully develop and introduce
new products could materially damage Stratagenes business. In the past Stratagene has experienced, and is likely to experience in the future, delays in
the development and introduction of products. Stratagene cannot assure you that it will keep pace
with the rapid rate of change in life sciences or medical diagnostic research, or that its new
products will adequately meet the requirements of the marketplace or achieve market acceptance.
Some of the factors affecting market acceptance of new products include:  
    availability, quality and price relative to competitive products;
    the timing of introduction of the product relative to competitive products; 24




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
    customers opinions of the products utility;
    citation of the product in published research; and
    general trends in life sciences and medical diagnostics research. The markets for Stratagenes products are extremely competitive and subject to rapid
technological change and if Stratagene fails to compete effectively, its business may suffer. The markets for Stratagenes products are highly competitive. Stratagene competes with many
other suppliers of life sciences research products and medical diagnostics products. Many of
Stratagenes competitors have greater financial, operational and sales and marketing resources and
more experience in research and development than it does. These and other companies may have
developed or could in the future develop new technologies that compete with Stratagenes products
or even render Stratagenes products obsolete. Competition in Stratagenes markets is primarily
driven by:  
    product performance, features and reliability;
    price;
    timing of product introductions;
    ability to develop, maintain and protect proprietary products and technologies;
    sales and distribution capabilities;
    technical support and service; and
    breadth of product line. If a competitor develops or acquires superior technology or cost-effective alternatives to
Stratagenes products, Stratagenes business, financial condition and results of operations could
be materially adversely affected. Stratagenes competitors have in the past and may in the future compete by lowering prices.
Stratagene may respond by lowering its prices, which could reduce revenues and profits. Conversely,
failure to anticipate and respond to price competition may damage Stratagenes market share. In
addition, Stratagene must continually adapt to new marketing and distribution trends in order to
compete effectively. Stratagene believes that customers in its markets display a significant amount of loyalty to
their initial supplier of a particular product. Therefore, it may be difficult to make sales to
customers who have previously purchased products from Stratagenes competitors. To the extent
Stratagene is unable to be the first to develop and supply new products, its competitive position
may suffer. If Stratagenes existing license agreements are terminated, Stratagene may be prevented from
selling some of its products. Approximately 50% of Stratagenes revenue in 2004 came from products sold pursuant to license
agreements. If Stratagene loses the rights to a patented technology, it may be forced to stop
selling some of its products or redesign its products and may lose significant sources of revenues.
In addition, potential competitors could license technologies that Stratagene fails to license. The
loss of a significant license could have a material adverse effect on Stratagenes business. Stratagenes significant licenses include a license from Hoffman La Roche and Roche Molecular
Systems, Inc., which we refer to collectively as Roche, which includes rights to use PCR and Taq
polymerase in its research efforts and rights to manufacture, promote and sell products for PCR for
the research field of use, and a license from Applied Biosystems, which grants rights to promote
and sell thermal cyclers and temperature cycling instruments as authorized thermal cyclers for the
automated performance of PCR for the research field of use. Each of these license 25




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agreements
terminates upon the expiration of the last to expire underlying patent in each agreement. The
agreement with Roche is subject to early termination in the event of the bankruptcy or insolvency
of Stratagene. Roche may also terminate the agreement (1) for cause or (2) if a third party which is licensed
by Roche to manufacture products for use in PCR-based human diagnostics testing acquires more than
50% of the voting stock of the Stratagene subsidiary party to the agreement. Since mid-2003,
Stratagene has withheld royalty payments to Roche under this license agreement while it evaluates a
possible overpayment in the royalties paid in prior periods. Stratagene has continued to record the
estimated quarterly royalty payable under the patent license agreement and reports this amount to
Roche. Management believes that the royalties calculated and accrued are determined in accordance
with the terms of the patent license agreement. However, Stratagenes calculations of the royalties
are subject to review by Roche. Stratagenes financial position or results of operations could be
materially affected if the parties determine that the royalty calculation differs significantly
from the amounts recorded by Stratagene. Additionally, there can be no assurances that
Stratagene will recover any overpayment in royalties paid in prior periods. The PCR process
patents underlying this royalty obligation expired in the United States in March of 2005. The
corresponding foreign patents will expire in 2006 and 2007. Upon the expiration of the patents,
Stratagene will no longer be required to pay royalties on future product sales related to these PCR
process patents. The agreement with Applied Biosystems is subject to early termination in the event
that all claims of the underlying patents in the agreement are unenforceable or invalid. Applied
Biosystems may also terminate the license agreement (1) for cause, (2) upon a change in control of
the Stratagene subsidiary party to the license agreement or (3) in the event of the bankruptcy or
insolvency of Stratagene. Stratagene does not anticipate that either of these license agreements
will terminate in the near future. Stratagenes licenses also typically subject it to various commercialization, sublicensing and
other obligations. If Stratagene fails to comply with these requirements, it could lose important
rights under a license, such as the right to exclusivity in a specified market. In some cases,
Stratagene could also lose all rights under a license. In addition, the licensor could lose patent
protection for a number of reasons, including invalidity of the licensed patent. Stratagene
typically does not receive significant indemnification from a licensor against third party claims
of intellectual property infringement. Because Stratagenes quarterly revenue and operating results may vary significantly in future
periods, its stock price may decline. Stratagenes operating results have fluctuated in the past and may continue to fluctuate in
the future. In particular, Stratagene has historically seen slower sales in the fourth quarter as a
result of reduced purchases by academic and research institutions as well as the closing of such
facilities during the holiday period. Stratagenes revenues are unpredictable and may also
fluctuate due to changes in demand for its products, delays in development and introduction of new
products and new product introductions by Stratagenes competitors. A high proportion of
Stratagenes costs are fixed, due in part to significant research and development costs. Thus,
small declines in revenue could disproportionately affect operating results in a quarter and the
price of the Stratagene common stock may decline. Moreover, a variety of factors may affect
Stratagenes ability to make accurate forecasts regarding its operating results. Because of these
factors, Stratagenes operating results in one or more future quarters may fail to meet the
expectations of securities analysts or investors, which could also cause its stock price to
decline. Stratagenes founder, chairman of its board of directors, chief executive officer and
president exerts considerable control over it. As of March 31, 2005, Joseph A. Sorge, M.D., the founder, chairman of the board of directors,
chief executive officer and president of Stratagene, beneficially owned approximately 62% of
Stratagenes outstanding common stock. As a result, Dr. Sorge controls all matters requiring
approval of its stockholders, including the election of directors and the approval of mergers or
other business combinations. Such a concentration of ownership may have the effect of delaying or
preventing transactions resulting in a change of control of Stratagene, including transactions
where stockholders might otherwise receive a premium for their shares over then current market
prices. Stratagene depends substantially on key employees, and the loss of the services of any of its
key employees or the failure to hire qualified employees could seriously damage Stratagenes
business. To a large degree, Stratagene is dependent on its founder, chairman of its board of directors,
chief executive officer and president, Joseph A. Sorge, M.D. Dr. Sorge has significant expertise in
the life sciences research market 26




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and has been instrumental in establishing and executing
Stratagenes business plan. The loss of Dr. Sorges services could have a material adverse effect
on Stratagenes business. Dr. Sorge has an existing employment agreement with Stratagene which
expires in June 2007, subject to automatic one year renewals unless either party provides timely
notice of non-renewal. Because Stratagenes products and services are highly technical in nature, only highly
qualified and trained scientists have the necessary skills to develop and market Stratagenes
products and provide Stratagenes services. As such, Stratagenes future success also will depend
in large part on the continued service of its key scientific and management personnel, including
research and development, customer service, marketing and sales staffs. Stratagene faces intense
competition for these professionals from its competitors, its customers and other companies
throughout its industry. Stratagene does not generally enter into employment agreements requiring
these employees to continue in its employment for any period of time. Any failure on Stratagenes
part to hire, train and retain a sufficient number of qualified professionals could seriously
damage its business. Stratagenes indebtedness could limit its ability to operate its business, obtain additional
financing and pursue other business opportunities. As of March 31, 2005, Stratagene had approximately $6.0 million of outstanding indebtedness,
including approximately $1.2 million of borrowings under its reducing revolving line of credit and
approximately $4.8 million in principal amount of industrial revenue bonds. Stratagenes
indebtedness could have negative consequences for Stratagene, including the following:  
    Stratagene will need a substantial portion of its cash flow to pay the principal and
interest on its indebtedness, including indebtedness it may incur in the future;
    payments of Stratagenes indebtedness will reduce the funds that would otherwise be
available for its operations and future business opportunities;
    Stratagene may have greater relative debt burdens than its competitors, which may place
Stratagene at a competitive disadvantage;
    Stratagenes debt level may make it more vulnerable than its competitors to a downturn in
its business or the economy generally; and
    there would be a material adverse effect on Stratagenes business and financial condition
if Stratagene is unable to service its indebtedness or obtain additional financing. Stratagene may not have financing for future capital requirements, which may prevent it from
addressing gaps in its product offerings or improving its technology. Although historically Stratagenes cash flow from operations has been sufficient to satisfy
working capital, capital expenditure and research and development requirements, in the future
Stratagene may need to incur additional debt or issue equity in order to fund these requirements as
well as to make acquisitions and other investments. Stratagenes senior credit facility restricts
the Companys ability to incur new debt. If Stratagene cannot obtain additional debt or equity
financing on acceptable terms or is limited with respect to incurring additional debt or issuing
equity, Stratagene may be unable to address gaps in its product offerings or improve its
technology, particularly through strategic acquisitions or investments. 27




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Stratagene may need to raise substantial amounts of money to fund a variety of future
activities integral to the development of its business, including but not limited to the following:  
    for research and development to successfully develop additional products;
    to file and prosecute patent applications and defend and assert patents to protect its technology;
    to retain qualified employees, particularly in light of intense competition for qualified scientists;
    to manufacture additional products itself or through third parties; and
    to acquire new technologies, products or companies. If Stratagene raises funds through the issuance of debt or equity, any debt securities or
preferred stock issued will have rights, preferences and privileges senior to those of holders of
the Stratagene common stock in the event of a liquidation. The terms of the debt securities may
impose restrictions on Stratagenes operations. If Stratagene raises funds through the issuance of
equity, this issuance would dilute the ownership interest of existing stockholders in Stratagene.
Stratagene expects to fund future acquisitions in part by issuing additional equity. If the price
of Stratagenes equity is low or volatile, it may not be able to acquire other companies. Inability to secure and maintain intellectual property protection for its products and
technologies could adversely affect Stratagenes ability to compete. Stratagenes success depends to a significant degree upon its ability to develop, maintain and
protect proprietary products and technologies. Stratagene files patent applications in the United
States and selectively in foreign countries as part of its strategy to protect its proprietary
products and technologies. However, patents provide only limited protection of Stratagenes
intellectual property. The assertion of patent protection involves complex legal and factual
determinations and is therefore uncertain and expensive. Stratagene cannot assure you that patents
will be granted with respect to any of its patent applications, that the scope of any of its issued
patents will be sufficiently broad to offer meaningful protection or that Stratagene will develop
additional proprietary technologies that are patentable. Stratagenes issued patents or patents
licensed to it could be successfully challenged, invalidated or circumvented so that Stratagenes
patent rights would not create an effective competitive barrier. The loss of a significant patent
or the failure of a patent to issue from a pending patent application that Stratagene considers
significant could have a material adverse effect on Stratagenes business. The laws governing the scope of patent coverage in the United States and abroad continue to
evolve, particularly in the life sciences area. The laws of some foreign countries may not protect
Stratagenes intellectual property rights to the same extent as United States laws. Stratagene
holds patents only in selected countries. Therefore, third parties can make, use and sell products
covered by its patents in some countries in which Stratagene does not have patent protection. Stratagene gives its customers the right to use some of its products under label licenses that
are for research purposes only. These licenses could be contested and no assurances can be given
that Stratagene would either be aware of an unauthorized use or be able to enforce these
restrictions in a cost-effective manner. Stratagene attempts to protect its trade secrets by entering into confidentiality agreements
with employees, consultants and third parties. However, these agreements might be breached and, if
they are, there may not be an adequate remedy available to Stratagene. Also, Stratagenes trade
secrets might become known to a third party through means other than by breach of its
confidentiality agreements, or they could be independently developed by Stratagenes competitors.
If Stratagenes trade secrets become known, its business and competitive position could be
adversely affected. Intellectual property litigation could seriously harm Stratagenes business. Litigation involving patents and other intellectual property rights is pervasive in the
biotechnology industry. Stratagene is aware that patents have been applied for and in some cases
issued to others claiming technologies that are closely related to its own technology. As a result,
Stratagene periodically receives notices of potential infringement of patents held by others.
Although Stratagene has generally been successful in resolving these types of claims, it may not be
able to do so in the future. While Stratagene takes steps to avoid infringing the patents of other 28




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parties, Stratagene cannot assure investors that it will not be found to infringe these patents or
other proprietary rights of third parties. In the event of an intellectual property dispute, Stratagene may become involved in litigation
or arbitration. Litigation could involve proceedings in court as well as in the United States
Patent and Trademark Office or the International Trade Commission. Intellectual property litigation can be extremely expensive and may divert managements time
and resources away from Stratagenes operations. Moreover, the outcome of any such litigation is
inherently uncertain. Even a successful outcome may take years to achieve and the costs associated
with such litigation, in terms of dollars spent and diversion of management time and resources,
could seriously harm its business. Stratagene has been involved in patent disputes with third parties, a number of which remain
unresolved. For example, Stratagene is involved in litigation with Invitrogen Corporation regarding
patents relating to specified reverse transcriptase enzymes and certain competent cell products.
Stratagene is also involved in litigation with Third Wave Technologies regarding patents relating
to certain assays for detection of nucleic acids. Stratagene is also involved in litigation with
Applera Corporation regarding a patent relating to real-time PCR instrumentation and certain
related reagents. Stratagene is also involved in litigation with Invitrogen Corporation and Takara
Bio regarding one of Stratagenes patents relating to polymerase blend products. As part of the
patent infringement claims in these matters, the litigants are seeking monetary damages, injunctive
relief and attorneys fees. At the present time, Stratagene is unable to quantify the probability
or extent of any potential monetary recovery or exposure with respect to these matters. If a third party claims an intellectual property right to technology Stratagene uses,
Stratagene may be forced to discontinue an important product or product line, alter its products
and processes, pay license fees, pay damages for past infringement or cease certain activities.
Under these circumstances, Stratagene may attempt to obtain a license to this intellectual
property, but it may not be able to do so on commercially reasonable terms, or at all. Stratagene may spend resources on research and development projects without being able to
achieve an adequate return, if any, on its investment. It is important for Stratagene to continue to invest heavily in research and development.
However, because Stratagene competes in a relatively new and constantly evolving market, it may
pursue research and development projects that do not result in viable commercial products. In
addition, Stratagene has in the past, and may in the future, terminate research efforts in a
particular area after it has made substantial initial funding commitments in that area. Any failure
to translate research and development expenditures into successful new product introductions could
have an adverse effect on Stratagenes business. If Stratagene fails to manage its growth effectively, its business could suffer. A significant portion of Stratagenes historical revenue growth is attributable to internal
product development. Stratagene, being one of the smaller companies in its industry, is
particularly dependent on internal invention and product development to replace older products in
its product line. Stratagenes ability to achieve its expansion objectives and to manage its growth
effectively depends upon a variety of factors, including Stratagenes ability to internally develop
products, to attract and retain skilled employees, to successfully position and market its products
and to identify and acquire technologies and intellectual property rights from third parties. In
addition, Stratagene faces significant challenges and risks in building and managing its sales
team, including managing geographically dispersed sales efforts and adequately training its sales
people in the use and benefits of its products. To accommodate its growth and compete effectively,
Stratagene will be required to improve its information systems, create additional procedures and
controls and expand, train, motivate and manage its work force. Stratagenes future success will
depend in part on the ability of current and future management personnel to operate effectively,
both independently and as a group. Stratagene cannot be certain that its personnel, systems,
procedures and controls will be adequate to support its future operations. If Stratagene is unable to implement and maintain effective internal control over financial
reporting, its stock price could be adversely affected. Item 308 of Regulation S-K promulgated under Section 404 of the Sarbanes-Oxley Act of 2002
requires that public companies annually evaluate the effectiveness of their internal control over
financial reporting as of the end of each fiscal year, and include a management report assessing
the effectiveness of such internal control over financial reporting in all annual reports. Item
308 of Regulation S-K also requires that the independent accountants of public companies attest to,
and report on, managements assessment of its internal control over financial reporting. The
initial compliance date with respect to these requirements depends on whether a company is an
accelerated filer as determined by Rule 12b-2 of the Exchange Act. An accelerated filer must
begin to comply with the rules regarding managements report on internal control over financial
reporting for its first fiscal year ending on or after November 15, 2004, and a non-accelerated
filer must begin to comply with these requirements for its first fiscal year ending on or after
July 15, 2006. Accelerated filer status is measured as of the end of each fiscal year and is
determined in part on whether the aggregate market value of the common equity of a company held by
non-affiliates of such company is $75.0 million or more measured as of the last business day of the
companys most recently completed second fiscal quarter. As disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2004,
Stratagene was not an accelerated filer as of December 31, 2004. Accordingly, Stratagene was not
subject to the rules regarding managements report on internal control over financial reporting for
the fiscal year ended December 31, 2004. However, Stratagene will not be able to determine if it
will be subject to the rules regarding managements report on internal control over financial
reporting for the fiscal year ending December 31, 2005 until
June 30, 2005. Notwithstanding the
question as to whether Stratagene will be subject to the rules regarding managements report on
internal control over financial reporting for fiscal 2005, Stratagene is currently making concerted
efforts to prepare itself to be able to comply with such requirements. These efforts include
documenting, evaluating the design and testing the effectiveness of Stratagenes internal control
over financial reporting. During this process, Stratagene expects to make improvements in the
design and operation of its internal control over financial reporting, including further
formalization of policies and procedures, improved segregation of duties and additional monitoring
of controls. Stratagenes management, including the CEO and CFO, does not expect that Stratagenes internal
control over financial reporting will prevent all error and all fraud. A control system, no matter
how well designed and operated, can provide only reasonable, not absolute, assurance that the
control systems objectives will be met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of fraud, if any,
within Stratagene have been, or will be detected. These inherent limitations include the realities
that judgments in decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Controls can also be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The design of any
system of controls is based in part on certain assumptions about the likelihood of future events,
and Stratagene cannot assure you that any design will succeed in achieving its stated goals under
all potential future conditions. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies or procedures. Because of the
inherent limitations in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected. Stratagene cannot assure you that it or its independent registered public accounting firm will
not identify a material weakness in Stratagenes internal control over financial reporting. A
material weakness in Stratagenes internal control over financial reporting would require
management and its independent registered public accounting firm to evaluate Stratagenes internal
control over financial reporting as ineffective. If Stratagenes internal control over financial
reporting is not considered adequate, Stratagene may experience a loss of public confidence, which
could have an adverse effect on its business and its stock price. The price of the Stratagene common stock is expected to be volatile. The market price of the Stratagene common stock may be subject to significant fluctuations.
These fluctuations may occur, among other reasons, in response to:  
    quarterly fluctuations in Stratagenes operating and earnings per share results; 29




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
    technological innovations or new product introductions by Stratagene or its competitors;
    delays in the development and introduction of new products;
    disputes concerning patents, licenses or other proprietary rights;
    changes in earnings estimates by equity and market research analysts;
    sales of common stock by existing stockholders;
    loss of key personnel; and
    securities class actions or other litigation affecting Stratagene or other companies in its industry. Any failure to meet analysts expectations could have an adverse effect on the market price
for the Stratagene common stock. In addition, the stock market is subject to extreme price and
volume fluctuations. This volatility has had a significant effect on the market prices of
securities issued by many companies for reasons unrelated to the operating performance of these
companies. In the past, following periods of volatility in the market price of a companys
securities, securities class action litigation has often been instituted against that company. If
similar litigation were instituted against Stratagene, it could result in substantial costs and a
diversion of Stratagenes managements attention and resources, which could have an adverse effect
on its business, financial condition and results of operations. In addition, Stratagene cannot
predict the extent to which investors interest in the Company will lead to a liquid trading market
in the Stratagene common stock. Future sales of currently outstanding shares of Stratagene common stock could adversely affect
Stratagenes stock price. As of March 31, 2005, Stratagene had approximately 22.0 million shares of common stock
outstanding. Of this amount, the 5,015,453 shares issued to the former Hycor stockholders in the
merger transaction with Hycor are freely tradable under the Securities Act, except for any shares
held by affiliates of Stratagene or Hycor, as the case may be, which may be sold from time to time
in accordance with the requirements of Rule 144 or Rule 145 of the Securities Act. In addition,
Stratagene has entered into a registration rights agreement with Dr. Sorge and certain of his
affiliates pursuant to which, at the request of Dr. Sorge and subject to specified conditions,
Stratagene will file a registration statement under the Securities Act covering 2,000,000 shares of
Stratagene common stock held by Dr. Sorge and specified trusts and partnerships controlled by Dr.
Sorge. Dr. Sorge and such trusts and partnerships are also entitled to register the remaining
approximately 11.3 million shares of Stratagene common stock held by them in specified situations.
The shares held by Dr. Sorge and such trusts and partnerships and the remaining shares of
Stratagene common stock held by the other stockholders of Stratagene prior to the Hycor merger may
also be sold from time to time in the public market subject to the requirements of Rule 144 under
the Securities Act. The sale by Stratagenes current stockholders of a substantial number of
shares, or the expectation that such sales may occur, could significantly reduce the market price
of the Stratagene common stock. Stratagene has also registered the shares of common stock that it may issue from time to time
under its employee benefits plans. As a result, these shares can be freely sold in the public
market upon issuance, subject to restrictions under the securities laws. If any of the Companys
stockholders cause a large number of securities to be sold in the public market, the sales could
reduce the trading price of the Stratagene common stock. These sales also could impede Stratagenes
ability to raise future capital. Reductions in research and development budgets or government funding may impact Stratagenes
sales. Fluctuations in the research and development budgets of Stratagenes customers could have a
significant effect on the demand for its products. Research and development budgets fluctuate due
to changes in available resources, spending priorities and institutional budgetary policies.
Stratagenes business could be seriously damaged by any significant decrease in research and
development expenditures by pharmaceutical and biotechnology companies, academic institutions or
government and private laboratories. A substantial portion of Stratagenes sales have been to researchers at universities,
government laboratories and private foundations whose funding is dependent upon grants from
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National Institutes of Health. Although Stratagene
is not aware of any impending reductions in governmental grants, government funding of research and
development is subject to the political process and as a result the amount of available funding may
decrease. Stratagenes sales may be adversely affected if its customers delay purchases as a result
of uncertainties surrounding the approval of government budget proposals. A reduction in government
funding for the National Institutes of Health or other government research agencies could seriously
damage Stratagenes business. In recent years, the pharmaceutical and biotechnology industries have undergone substantial
consolidation. Further mergers or corporate consolidations in these industries could cause
Stratagene to lose existing customers and potential future customers. Pharmaceutical and
biotechnology companies have generally raised little money in the past few years, and some are low
on funds. Some of these companies have begun to reduce their research and development budgets in
recent years. It is possible that these biotechnology and pharmaceutical companies will continue to
reduce spending on research and development in the future and some companies may go out of business
entirely. In addition, health care reform and other changes in the regulatory environment affecting
these industries could have an adverse impact on research and development expenditures by
pharmaceutical and biotechnology companies, which would negatively impact Stratagenes business. Stratagenes academic customers generally receive funds from approved grants at particular
times of the year, as determined by the government. Grants have in the past been frozen for
extended periods or have otherwise become unavailable to various institutions
without advance notice. The timing of the receipt of grant funds affects the timing of
purchase decisions by Stratagenes customers and, as a result, can cause fluctuations in its sales
and operating results. Failure to license new technologies could impair Stratagenes new product development. In order to meet the needs of its customers, Stratagene must develop a broad spectrum of
products. To build a product line, it is sometimes advantageous or necessary to license
technologies from third parties. Approximately 50% of Stratagenes revenues for 2004 were
attributable to products manufactured or sold under licenses from third parties. As a result,
Stratagene believes its ability to license new technologies from third parties is and will continue
to be important to its ability to offer new products. From time to time, Stratagene is notified or becomes aware of patents held by third parties
that are related to technologies Stratagene is selling or may sell in the future. After a review of
these patents, Stratagene may attempt to obtain a license for these technologies from these third
parties. Stratagene can give no assurances that it will be able to negotiate such licenses on
commercially reasonable terms, or at all. Stratagenes ability to gain access to technologies needed for new products and services
depends in part on its ability to convince inventors that it can successfully commercialize their
inventions. Stratagene can give no assurances that it will be able to continue to identify new
technologies developed by others or that it will be able to negotiate appropriate licenses on
commercially reasonable terms, or at all. Stratagene may acquire other businesses or form joint ventures that could decrease its
profitability, dilute your ownership in Stratagene, increase its debt or cause Stratagene to incur
significant expense. As part of Stratagenes business strategy, it intends to pursue acquisitions of other
complementary businesses and technology licensing arrangements. Stratagene also intends to pursue
strategic alliances that leverage its core technology and industry experience to expand its product
offerings and geographic presence. Stratagene has limited experience with respect to acquiring
other companies and limited experience with respect to the formation of collaborations, strategic
alliances and joint ventures. If Stratagene were to make any acquisitions, it may not be able to
integrate these acquisitions successfully into its existing business and Stratagene could assume
unknown or contingent liabilities. Any future acquisitions by Stratagene also could result in large
and immediate write-offs or the incurrence of debt and contingent liabilities, any of which could
harm Stratagenes operating results. Integration of an acquired company also may require management
resources that otherwise would be available for ongoing development of Stratagenes existing
business. Stratagene may not identify or complete these transactions in a timely manner, on a
cost-effective basis, or at all, and Stratagene may not realize the anticipated benefits of any
acquisition, technology license or strategic alliance. 31




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Changes in distribution and purchasing methods by Stratagenes customers may force it to use
more expensive marketing and distribution channels. A number of Stratagenes customers have developed purchasing initiatives to reduce the number
of vendors they purchase from in order to lower their supply costs. In some cases, these customers
have established agreements with large distributors, which include discounts and the distributors
direct involvement with the purchasing process. These activities may force Stratagene to supply
these large distributors with its products at a discount to continue to reach its customers. For
similar reasons, many of Stratagenes larger customers, including the government, have requested
and may in the future request special pricing arrangements, including blanket purchase agreements.
To date, Stratagene does not believe that these special pricing arrangements have had a material
effect on either sales revenues or margins. However, in the future these agreements may limit
Stratagenes pricing flexibility, which could adversely impact its business, financial condition
and results of operations. In addition, if Stratagene loses one or more of its distributors and
cannot arrange suitable alternatives, its business could be adversely affected. Several of Stratagenes customers have requested that Stratagene sell its products through
third party, e-commerce web sites. While this trend does not seem to be growing, offering its
products through these web sites generally requires Stratagene to agree to offer volume-related
discounts and pay commissions on the sales made through these web sites to these third party
e-commerce providers. Consequently, margins on sales made through these third party web sites would
generally be lower than those on sales made through traditional channels. Stratagenes business may
be harmed as a result of these web sites or other sales methods that may be developed in the
future. Stratagene relies on third party manufacturers for raw materials and product components. Stratagene relies on third party manufacturers to supply many of its raw materials and product
components. Some of these components are only available from a single supplier or a limited group
of suppliers, either because the market for these components is too small to support multiple
suppliers or because the components are protected by patents, in which case there may only be a
single supplier for the covered components. Stratagenes reliance on outside vendors generally, and
a sole supplier or a limited group of suppliers in particular, involves several risks, including:  
    an inability to obtain an adequate supply of required components due to manufacturing
capacity constraints, the discontinuance of a product by a third-party manufacturer, an
acquisition of the manufacturer by one of Stratagenes competitors or other supply
constraints;
    delays and long lead times in receiving materials from vendors; and
    reduced control over quality and pricing of components. If a sole source third party supplier were to go out of business, Stratagene might be unable
to find a replacement for such source or it might take Stratagene several months to be able to make
the substance or component internally. If a sole source third party supplier were to be acquired by
a competitor, that competitor may elect not to sell to Stratagene in the future. Adverse developments affecting Stratagenes international operations or foreign currency
fluctuations could harm its results from operations. Including sales made by Stratagenes subsidiaries and distributors, its products are currently
marketed in over 45 countries throughout the world. Measured in U.S. dollars, Stratagenes product
sales outside the United States for the three months ended March 31, 2005 and for fiscal 2004
represented 33% and 27% of its total sales, respectively. In addition, approximately 10% and 12% of
its total sales for the three months ended March 31, 2005 and for fiscal 2004, respectively, were
for products exported from the United States. Stratagene expects that international sales will
continue to account for a significant percentage of its revenues for the foreseeable future, in
part because Stratagene intends to expand its international operations. There are a number of risks
arising from Stratagenes international business, including:  
    difficulties and costs associated with staffing and managing foreign operations;
    unexpected changes in regulatory requirements; 32




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
    the difficulties of compliance with a wide variety of foreign laws and regulations;
    more limited protection for intellectual property rights in some countries;
    changes in Stratagenes international distribution network and direct sales force;
    potential trade restrictions and exchange controls;
    import and export licensing requirements;
    longer accounts receivable collection cycles in certain foreign countries; and
    potential increased costs associated with overlapping tax structures. A significant portion of Stratagenes business is conducted in currencies other than the U.S.
dollar, which is its reporting currency. Stratagene recognizes foreign currency gains or losses
arising from its operations in the period incurred. As a result, currency fluctuations among the
U.S. dollar and the currencies in which Stratagene does business could adversely affect its results
of operations. Stratagene cannot predict the effects of exchange rate fluctuations upon its future
operating results because of the number of currencies involved, the variability of currency
exposures and the potential volatility of currency exchange rates. Stratagene engages in foreign
currency exchange hedging transactions to manage its foreign currency exposure, but it cannot
assure you that its strategies will adequately protect its operating results from the effects of
exchange rate fluctuations. Stratagenes activities involve hazardous materials and may subject it to costly environmental
liability. Stratagene uses hazardous materials, including phenol, chloroform and ethanol, and radioactive
isotopes in connection with its research and development activities, as well as in its
manufacturing processes and in evaluating the performance of various products. Stratagene is
subject to federal, state and local laws and regulations governing the use, manufacture, storage,
handling and disposal of these materials and specified waste products. The risk of accidental
contamination of property or injury to individuals from these materials cannot be completely
eliminated. In the event of such an accident, Stratagene could be liable for any damages that
result, which could have a material adverse effect on its business, financial condition and results
of operations. Stratagene carries insurance for contamination resulting from the use of hazardous
materials with $25,000 limitations per incident with respect to pollution clean-up and removal and
radioactive contamination. Additionally, any accident could partially or completely shut down
Stratagenes research and manufacturing facilities and operations. Stratagene may also have to
incur substantial costs to comply with current or future environmental laws and regulations. Interruptions in its manufacturing operations could adversely impact Stratagenes ability to
effectively operate its business. Stratagene maintains manufacturing facilities in San Diego, California, Garden Grove,
California and in the Austin, Texas area. Damage to these facilities due to fire, earthquake or
other natural disaster, power loss, unauthorized entry or other events could cause an interruption
in the production of Stratagenes products. Stratagene does not have or plan to obtain earthquake
insurance. In late 1999 and early 2000 Stratagene opened a manufacturing facility outside of
Austin, Texas and moved over 100 jobs to that location. During the transition process, Stratagene
lost some key personnel who were important to certain manufacturing processes. As a result,
Stratagene was unable to manufacture certain products for a period of three to six months. Many of
the customers who wanted to purchase the affected products during this period switched to other
suppliers and Stratagene found it difficult to reacquire these customers once it was able to
manufacture the products again. Accordingly, Stratagene believes that a prolonged interruption in
its manufacturing operations could have a material adverse impact on Stratagenes ability to
effectively operate its business. If its biological products and instruments are not properly produced or manufactured,
Stratagene could incur substantial unexpected expenses, experience product returns and suffer
damage to its brand and reputation. Stratagenes biological products and instruments are complex and may be improperly produced or
manufactured. In the past, Stratagene has voluntarily recalled several of its products. In each
case, the problem was identified by 33




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Stratagene and corrected. If Stratagenes products need to be
recalled, it could experience decreased sales and loss of customers and market share. In addition,
a recall would divert managerial and financial resources and could harm Stratagenes reputation
with customers. If Stratagenes access to necessary tissue samples is restricted or ethical concerns
surrounding the use of genetic information become widespread, its business could suffer. Stratagene requires access to human and other tissue samples and other biological materials to
continue to develop its products. Stratagene competes with many other companies for these materials
and may not be able to obtain or maintain access to these materials on acceptable terms, or at all.
In addition, genetic testing has raised ethical issues regarding confidentiality and the
appropriate use of the resulting information. Governmental regulation in the United States and
foreign countries could limit access to, or use of, human and other tissue samples or restrict the
use of, or regulate, genetic testing. If Stratagene loses access to sufficient numbers or sources
of tissue samples, or if tighter restrictions are imposed on Stratagenes customers use of the
information generated from tissue samples, its business could suffer. Anti-takeover provisions of Stratagenes certificate of incorporation and bylaws and
provisions of Delaware law could delay or prevent a change of control that you may favor. Provisions of Stratagenes amended and restated certificate of incorporation and amended and
restated bylaws may discourage, delay or prevent a merger or other change of control that
stockholders may consider favorable or may impede the ability of the holders of Stratagenes common
stock to change Stratagenes management. The provisions of Stratagenes amended and restated
certificate of incorporation and amended and restated bylaws, among other things, authorize
Stratagenes board of directors to issue preferred stock in one or more series, without stockholder
approval. Because Stratagene has not chosen to be exempt from Section 203 of the Delaware General
Corporation Law, this provision could also delay or prevent a change of control that you favor.
Section 203 provides that, subject to limited exceptions, persons that acquire, or are affiliated
with a person that acquires, more than 15 percent of the outstanding voting stock of a Delaware
corporation shall not engage in any business combination with that corporation, including by
merger, consolidation or acquisition of additional shares, for a three-year period following the
date on which that person or its affiliate crosses the 15 percent ownership threshold. Additionally, because Dr. Sorge owns approximately 62% of the Companys outstanding common
stock, he controls all matters requiring approval of Stratagenes stockholders. As a result, among
other things, Dr. Sorge must approve any merger or other business combination related to
Stratagene. 34




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Item 3. Quantitative and Qualitative Disclosures about Market Risk Stratagenes financial instruments include cash and cash equivalents, investments and
long-term debt. At March 31, 2005, the carrying values of its financial instruments approximated
their fair values based on current market prices and rates. Foreign Currency Translation/Transaction The accounts of foreign subsidiaries and affiliates of Stratagene are measured using the local
currency as the functional currency. For these operations, assets and liabilities are translated
into U.S. dollars at period-end exchange rates, and income and expense
accounts are translated at average monthly exchange rates. Net translation gains or losses are
excluded from net income and reflected in accumulated other comprehensive income (loss) in the
accompanying consolidated balance sheets. Stratagenes international sales expose it to foreign currency risk in the ordinary course of
its business. Approximately 33% and 27% of Stratagenes revenue for the three months ended March
31, 2005 and 2004, respectively, was generated by its foreign subsidiaries. The foreign
subsidiaries sell products in various local currencies that are collected at future dates and
purchase raw materials and finished goods in both U.S. dollars and local currencies. Accordingly,
Stratagene is exposed to transaction gains and losses that could result from changes in foreign
currency exchange rates. Realized gains and losses from foreign currency transactions are included
in operations as incurred. For financial reporting purposes, the foreign subsidiaries income statements are translated
from the local currency into U.S. dollars at the exchange rates in effect during the reporting
period. When the local currency strengthens compared to the U.S. dollar, there is a positive effect
on the foreign subsidiaries sales as reported in Stratagenes consolidated financial statements.
Conversely, when the U.S. dollar strengthens, there is a negative effect. For the three months
ended March 31, 2005, the net impact to Stratagenes reported sales from the effect of exchange
rate fluctuations was an increase of approximately $0.2 million when compared to the exchange rates
for 35




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the three months ended March 31, 2004. For the three months ended March 31, 2005, the net
impact to Stratagenes reported operating expenses from the effect of exchange rate fluctuations
was an increase of approximately $0.2 million when compared to rates for
the three months ended
March 31, 2004. Derivative Financial Instruments As part of distributing its products, Stratagene regularly enters into intercompany
transactions with its foreign subsidiaries. Stratagenes currency exposures vary, but are primarily
concentrated in the Euro, British Pound, Swiss Franc and Japanese Yen. Prior to 2005, Stratagene
entered into derivative instruments to mitigate foreign currency risk on its European revenues,
however, such derivative instruments did not qualify for hedge accounting under the provisions of
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities,as amended.
Accordingly, both unrealized and realized gains or losses resulting from changes in fair value were
recognized as incurred in gain (loss) on foreign currency transactions in the current period income
statement. Stratagene managed its foreign currency exposure over a maximum of 12 months. All futures
contracts entered into for fiscal year 2004 were settled by year end,
and the Company has no
pending futures contracts currently outstanding. Fair Value of Financial Instruments The carrying amounts of cash, marketable securities, restricted cash, foreign currency
exchange contracts, accounts receivable, prepaid expenses and other current assets, accounts
payable, accrued expenses, other current liabilities, and lines of credit are considered to be
representative of their respective fair values because of the short-term nature of these financial
instruments. The carrying amount of the long-term debt is a reasonable estimate of fair value, as
the loans have terms based on market rates. Interest Rates Stratagenes cash and cash equivalents are generally invested in money market accounts and
short-term debt instruments of highly rated credit issuers. Stratagene limits the amount of credit
exposure to any one issuer and seeks to improve the safety and likelihood of preservation of its
invested funds by limiting default risk and market risk. Based on the Companys short-term
investment portfolio at March 31, 2005, the Company believes that a 10% rise or fall in interest
rates would have had no material impact on its financial statements. The following table shows the average interest rate for the three months ended March 31, 2005
for each of Stratagenes long-term debt obligations: Average Interest Rate forthe Three Months EndedLong-term Debt Obligations
    
    March 31, 2005Reducing revolving line of credit
    
    
    5.2
    %Industrial revenue bonds
    
    
    2.0
    %
 Stratagenes interest income on long-term investments is dependent on the interest rate
attributable primarily to the debt securities purchased by Stratagene. Since Stratagene generally
holds these securities to maturity, changes in interest rates are not expected to have a material
impact on the value of Stratagenes portfolio. 
 Item 4. Controls and Procedures The Company maintains disclosure controls and procedures that are designed to ensure that
information required to be disclosed in the reports filed by the Company pursuant to the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the Securities and Exchange Commission, and that such
information is accumulated and communicated to management, including the Companys Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving the desired control objectives, and in reaching a reasonable
level of assurance, management necessarily was required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures. 36




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The Company carried out an evaluation, under the supervision and with the participation of
management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the Companys disclosure controls and procedures as of the end of
the period covered by this quarterly report. Based on the foregoing, the Companys Chief Executive
Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures
were effective at the reasonable assurance level. Changes in Internal Control There were no changes in the Companys internal control over financial reporting during the
Companys first fiscal quarter that materially affected, or are reasonably likely to materially
affect, the Companys internal control over financial reporting. Item 308 of Regulation S-K promulgated under Section 404 of the Sarbanes-Oxley Act of 2002
requires that public companies annually evaluate the effectiveness of their internal control over
financial reporting as of the end of each fiscal year, and include a management report assessing
the effectiveness of such internal control over financial reporting in all annual reports. Item
308 of Regulation S-K also requires that the independent accountants of public companies attest to,
and report on, managements assessment of its internal control over financial reporting. The
initial compliance date with respect to these requirements depends on whether a company is an
accelerated filer as determined by Rule 12b-2 of the Exchange Act. An accelerated filer must
begin to comply with the rules regarding managements report on internal control over financial
reporting for its first fiscal year ending on or after November 15, 2004, and a non-accelerated
filer must begin to comply with these requirements for its first fiscal year ending on or after
July 15, 2006. Accelerated filer status is measured as of the end of each fiscal year and is
determined in part on whether the aggregate market value of the common equity of a company held by
non-affiliates of such company is $75.0 million or more measured as of the last business day of the
companys most recently completed second fiscal quarter. As disclosed in its Annual Report on Form 10-K for the fiscal year ended December 31, 2004,
Stratagene was not an accelerated filer as of December 31, 2004. However, Stratagene will not be
able to determine if it will be subject to the rules regarding managements report on internal
control over financial reporting for the fiscal year ending December 31, 2005 until June 30, 2005.
If the aggregate market value of Stratagenes common stock held by non-affiliates of Stratagene as
of June 30, 2005 is equal to or greater than $75.0 million, then Stratagene will become an
accelerated filer effective as of December 31, 2005 and will be required to comply with the rules
regarding managements report on internal control over financial reporting for fiscal 2005.
Conversely, if the aggregate market value of Stratagenes common stock held by non-affiliates of
Stratagene as of June 30, 2005 is less than $75.0 million, then Stratagene will continue to be a
non-accelerated filer for fiscal 2005 and will not be required to comply with the rules regarding
managements report on internal control over financial reporting until December 30, 2006. Notwithstanding the question as to whether Stratagene will be subject to the rules regarding
managements report on internal control over financial reporting for fiscal 2005, Stratagene is
currently making concerted efforts to prepare itself to be able to comply with such requirements.
These efforts include documenting, evaluating the design and testing the effectiveness of
Stratagenes internal control over financial reporting. During this process, Stratagene expects to
make improvements in the design and operation of its internal control over financial reporting,
including further formalization of policies and procedures, improved segregation of duties and
additional monitoring of controls. 37




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PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings Information regarding legal proceedings is contained in Note 8 to the Consolidated Financial
Statements for the period ended March 31, 2005, which note is incorporated herein by this reference
and is included as part of Item 1. Financial Statements, to this Form 10-Q. 
 Item 6. Exhibits ExhibitNumber
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.**32.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002.**
   **
    These certifications are being furnished solely to accompany this quarterly
report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be
incorporated by reference into any filing of the Company, whether made before or after
the date hereof, regardless of any general incorporation language in such filing. 38




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized. STRATAGENE CORPORATION Date: May 12, 2005
    By:

/s/        Joseph A. Sorge, M.D.Joseph A. Sorge, M.D.Chairman of the Board and Chief Executive Officer
(Principal Executive Officer) Date: May 12, 2005
    By:
    /s/        Reginald P. JonesReginald P. JonesSenior Vice President and Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer) 39