UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
DC 20549
 ______________
  FORM
10-Q
  x
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
  For
the Quarterly Period Ended September 30, 2008
  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 Number000-22400
  STRATEGIC
DIAGNOSTICS INC.
 (Exact
name of Registrant as specified in its charter)
 ______________
  Delaware
              56-1581761(State
      or other jurisdiction of
              (I.R.S.
      employerincorporation
      or organization)
              identification
      no.)111
      Pencader Drive
              Newark,
      Delaware19702(Address
      of principal executive offices)
              (Zip
      Code)
  Registrant’s
telephone number, including area code: (302) 456-6789
 ______________
  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:
      x
              No:
      o
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer,” “accelerated filer,” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):
  Large
      accelerated filer o
              Accelerated
      filer oNon-accelerated
      filer o
              Smaller
      reporting company x(Do
      not check if a smaller reporting company)
  Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
  Yes:
      o
              No:
      x
  As of
November 10, 2008, there were 20,496,361 outstanding shares of the Registrant’s
common stock, par value $.01 per share.
  
  STRATEGIC
DIAGNOSTICS INC.
  INDEX
  Item
                PagePART
      I FINANCIAL INFORMATIONITEM
      1. Financial Statements (Unaudited)Consolidated
      Balance Sheets – September 30, 2008 and December 31, 2007
                2Consolidated
      Statements of Operations – Three and nine months ended September 30, 2008
      and 2007
                3Consolidated
      Statements of Cash Flows – Nine months ended September 30, 2008 and
      2007
                4Notes
      to Consolidated Interim Financial Statements
                5ITEM
      2. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                12ITEM
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                19ITEM
      4. Controls and Procedures
                20PART
      II OTHER INFORMATION
                21ITEM
      1A. Risk Factors
                21ITEM
      6. Exhibits
                21SIGNATURES
                22
  1
 PART
I. – FINANCIAL INFORMATION
  ITEM
1. FINANCIAL STATEMENTS
  STRATEGIC
DIAGNOSTICS INC. AND SUBSIDIARIES
  CONSOLIDATED
BALANCE SHEETS
 (in
thousands, except share and per share data)
 (unaudited)
  September
      30,
                
                
                December
      31,2008
                
                
                2007ASSETSCurrent
      Assets :Cash
      and cash equivalents
                
                $
                11,177
                
                
                $
                12,988Receivables,
      net
                
                
                3,869
                
                
                
                4,110Inventories
                
                
                3,989
                
                
                
                4,204Deferred
      tax asset
                
                
                1,002
                
                
                
                1,201Other
      current assets
                
                
                781
                
                
                
                521Total
      current assets
                
                
                20,818
                
                
                
                23,024Property
      and equipment, net
                
                
                5,353
                
                
                
                5,481Other
      assets
                
                
                4
                
                
                
                7Deferred
      tax asset
                
                
                7,034
                
                
                
                7,389Goodwill
                
                
                4,158
                
                
                
                4,201Intangible
      assets, net
                
                
                1,668
                
                
                
                1,847Total
      assets
                
                $
                39,035
                
                
                $
                41,949LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      Liabilities :Current
      portion of long-term debt
                
                $
                1,793
                
                
                $
                611Accounts
      payable
                
                
                623
                
                
                
                569Accrued
      expenses
                
                
                2,058
                
                
                
                1,866Deferred
      revenue
                
                
                125
                
                
                
                5Total
      current liabilities
                
                
                4,599
                
                
                
                3,051Long-term
      debt
                
                
                -
                
                
                
                1,640Other
      non-current liabilities
                
                
                130
                
                
                
                130Total
      non-current liabilities
                
                
                130
                
                
                
                1,770Stockholders'
      Equity:Preferred
      stock, $.01 par value, 20,920,648 shares authorized,no
      shares issued or outstanding
                
                
                -
                
                
                
                -Common
      stock, $.01 par value, 35,000,000 shares authorized,20,496,361
      and 20,410,540 issued and outstandingat
      September 30, 2008 and December 31, 2007, respectively
                
                
                205
                
                
                
                205Additional
      paid-in capital
                
                
                40,186
                
                
                
                39,594Accumulated
      deficit
                
                
                (6,141
                )
                
                
                (2,830
                )Cumulative
      translation adjustments
                
                
                56
                
                
                
                159Total
      stockholders' equity
                
                
                34,306
                
                
                
                37,128Total
      liabilities and stockholders' equity
                
                $
                39,035
                
                
                $
                41,949The
      accompanying notes are an integral part of these
    statements.
 2
  STRATEGIC
DIAGNOSTICS INC. AND SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF OPERATIONS
 (in
thousands, except share and per share data)
 (unaudited)
  Three
      Months
                
                
                Nine
      MonthsEnded
      September 30,
                
                
                Ended
      September 30,2008
                
                
                2007
                
                
                2008
                
                
                2007Revenues
                
                $
                6,892
                
                
                $
                6,564
                
                
                $
                20,631
                
                
                $
                19,936OPERATING
      EXPENSES:Manufacturing
                
                
                3,555
                
                
                
                2,667
                
                
                
                9,861
                
                
                
                7,891Research
      and development
                
                
                969
                
                
                
                723
                
                
                
                2,830
                
                
                
                2,184Selling,
      general and administrative
                
                
                3,513
                
                
                
                2,900
                
                
                
                10,814
                
                
                
                8,661(Gain)
      loss on disposal of assets
                
                
                (11
                )
                
                
                108
                
                
                
                (11
                )
                
                
                108Total
      operating expenses
                
                
                8,026
                
                
                
                6,398
                
                
                
                23,494
                
                
                
                18,844Operating
      income (loss)
                
                
                (1,134
                )
                
                
                166
                
                
                
                (2,863
                )
                
                
                1,092Interest
      income, net
                
                
                35
                
                
                
                109
                
                
                
                134
                
                
                
                335Income
      (loss) before taxes
                
                
                (1,099
                )
                
                
                275
                
                
                
                (2,729
                )
                
                
                1,427Income
      tax expense
                
                
                1,119
                
                
                
                275
                
                
                
                582
                
                
                
                733Net
      income (loss)
                
                $
                (2,218
                )
                
                $
                -
                
                
                $
                (3,311
                )
                
                $
                694Basic
      net income (loss) per share
                
                $
                (0.11
                )
                
                $
                -
                
                
                $
                (0.16
                )
                
                $
                0.03Shares
      used in computing basicnet
      income (loss) per share
                
                
                20,395,339
                
                
                
                20,360,125
                
                
                
                20,386,811
                
                
                
                20,301,521Diluted
      net income (loss) per share
                
                $
                (0.11
                )
                
                $
                -
                
                
                $
                (0.16
                )
                
                $
                0.03Shares
      used in computing dilutednet
      income (loss) per share
                
                
                20,395,339
                
                
                
                20,542,294
                
                
                
                20,386,811
                
                
                
                20,489,776The
      accompanying notes are an integral part of these
statements
 3
  STRATEGIC
DIAGNOSTICS INC. AND SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF CASH FLOWS
 (in
thousands)
 (unaudited)
  Nine
      MonthsEnded
      September 30,2008
                
                
                2007Cash
      Flows from Operating Activities :Net
      income (loss)
                
                $
                (3,311
                )
                
                $
                694Adjustments
      to reconcile net income (loss) to netcash
      provided by (used in) operating activities :Depreciation
      and amortization
                
                
                1,004
                
                
                
                905Share-based
      compensation expense
                
                
                533
                
                
                
                352Deferred
      income tax provision
                
                
                597
                
                
                
                570(Gain)
      loss on disposal of fixed assets
                
                
                (11
                )
                
                
                93(Increase)
      decrease in :Receivables
                
                
                241
                
                
                
                (177
                )Inventories
                
                
                215
                
                
                
                (1,218
                )Other
      current assets
                
                
                (260
                )
                
                
                (239
                )Other
      assets
                
                
                3
                
                
                
                (4
                )Increase
      (decrease) in :Accounts
      payable
                
                
                54
                
                
                
                (147
                )Accrued
      expenses
                
                
                197
                
                
                
                (63
                )Deferred
      revenue
                
                
                120
                
                
                
                (12
                )Other
      non-current liabilities
                
                
                -
                
                
                
                117Net
      cash provided by (used in) operating activities
                
                
                (618
                )
                
                
                871Cash
      Flows from Investing Activities :Purchase
      of property and equipment
                
                
                (702
                )
                
                
                (2,264
                )Proceeds
      from sale / disposal of assets
                
                
                15
                
                
                
                -Net
      cash used in investing activities
                
                
                (687
                )
                
                
                (2,264
                )Cash
      Flows from Financing Activities :Proceeds
      from exercise of incentive stock options
                
                
                -
                
                
                
                470Proceeds
      from employee stock purchase plan
                
                
                55
                
                
                
                22Proceeds
      from issuance of long and short-term debt
                
                
                -
                
                
                
                2,000Repayments
      on financing obligations
                
                
                (458
                )
                
                
                (158
                )Net
      cash provided by (used in) financing activities
                
                
                (403
                )
                
                
                2,334Effect
      of exchange rate changes on cash
                
                
                (103
                )
                
                
                38Net
      increase (decrease) in Cash and Cash Equivalents
                
                
                (1,811
                )
                
                
                979Cash
      and Cash Equivalents, Beginning of Period
                
                
                12,988
                
                
                
                10,892Cash
      and Cash Equivalents, End of Period
                
                $
                11,177
                
                
                $
                11,871Supplemental
      Cash Flow Disclosure :Cash
      paid for taxes
                
                
                10
                
                
                
                148Cash
      paid for interest
                
                
                90
                
                
                
                41The
      accompanying notes are an integral part of these
statements
 4
  STRATEGIC
DIAGNOSTICS INC. AND SUBSIDIARIES
  NOTES
TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
 (in
thousands, except share and per share data)
 (unaudited)
  1.
              DESCRIPTION
      OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
  POLICIES
  Business
  Strategic
Diagnostics Inc. and its subsidiaries (the “Company”) develop, manufacture and
market antibody products and analytical test kits to a diverse customer base,
across multiple industrial and human health markets. By applying its core
competencies of creating custom antibodies and assay development, the Company
produces unique, sophisticated diagnostic testing and reagent systems that are
responsive to customer diagnostic and information needs. Customers benefit with
quantifiable “return on investment” by reducing time, labor and/or material
costs. This is accomplished while increasing accuracy, reliability and
actionability of essential test results. The Company is focused on sustaining
this competitive advantage by leveraging its expertise in immunology,
proteomics, bio-luminescence and other bio-reactive technologies to continue its
successful customer-focused research and development efforts.
  Basis of Presentation and
Interim Financial Statements
  The
accompanying unaudited consolidated interim financial statements of the Company
have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”) regarding interim financial
reporting. Accordingly, they do not include all the information and footnotes
required by U.S. generally accepted accounting principles for complete financial
statements and should be read in conjunction with the Company’s Annual Report on
Form 10-K for the fiscal year ended December 31, 2007. In the opinion of
management, the accompanying consolidated interim financial statements include
all adjustments (all of which are of a normal recurring nature) necessary for a
fair presentation of the results of operations.  The interim operating
results are not necessarily indicative of the results to be expected for an
entire year.
  Revenue
Recognition
  Revenues
composed of sales of immunoassay-based test kits and certain antibodies and
immunochemical reagents are recognized upon the shipment of the product and
transfer of title, or when related services are provided. Revenues associated
with such products or services are recognized when persuasive evidence of an
order exists, shipment of product has occurred or services have been provided,
the price is fixed and determinable and collectibility is reasonably assured.
Management is required to make judgments based on actual experience about
whether or not collectibility is reasonably assured.
  The
Company enters into contracts related to the production of custom antibodies,
which provide for the performance of defined tasks for a fixed price, with
delivery of the product upon completion of production. The standard time to
complete a project is typically longer than 30 days but less than 12 months, and
effort is expended over the life of the project. Revenues related to sales of
custom antibody projects are recognized when a project’s specifications have
been met and the related materials have been shipped.
  Fees
associated with products and services added on to a custom antibody project
subsequent to delivery of the initial project are billed monthly and recognized
as revenue as the services and other deliverables are provided.
  Use of
Estimates
  The
preparation of the consolidated interim financial statements requires management
of the Company to make a number of estimates and assumptions relating to the
reported amount of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the consolidated interim financial statements, and
the reported amounts of revenues and expenses during the period. These estimates
include those made in connection with assessing the valuation of accounts
receivable, inventories and deferred tax assets. Actual results could differ
from these estimates.
 
 5
 
 New Accounting
Pronouncements
  In
November 2007, the Emerging Issues Task Force (“EITF”) of the Financial
Accounting Standards Board (“FASB”) reached a consensus on Issue No.
07-1,"Accounting for Collaborative Arrangements" ("EITF No. 07-1"). EITF No.
07-1 defines a collaborative arrangement as a contractual arrangement in which
the parties are: (1) active participants to the arrangement; and (2) exposed to
significant risks and rewards that depend upon the commercial success of the
endeavor. The issue also addresses the appropriate income statement presentation
for activities and payments between the participants in a collaborative
arrangement as well as for costs incurred and revenue generated from
transactions with third parties. EITF No. 07-1 is effective for the Company for
the reporting period beginning January 1, 2009. The Company is in the process of
evaluating the impact of the adoption of EITF No. 07-1 on its consolidated
financial statements.
  In
December 2007, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. No. 141(Revised), “Business Combinations” (“SFAS No. 141(R)”),
which replaces SFAS No. 141, “Business Combinations,” and requires an
acquirer to recognize the assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at the acquisition date, measured at
their fair values as of that date, with limited exceptions. This statement also
requires the acquirer in a business combination achieved in stages to recognize
the identifiable assets and liabilities, as well as the noncontrolling interest
in the acquiree, at the full amounts of their fair values. SFAS No. 141(R)
makes various other amendments to authoritative literature intended to provide
additional guidance or to confirm the guidance in that literature to that
provided in this statement. This statement applies prospectively to business
combinations for which the acquisition date is on or after the beginning of the
first annual reporting period beginning on or after December 15,
2008.  SFAS No. 141(R)’s impact on accounting for business
combinations is dependent upon future acquisitions the Company may
make.
 
 In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests
in Consolidated Financial Statements — An Amendment of ARB No. 51” (“SFAS
No. 160”). SFAS No. 160 amends Accounting Research Bulletin No. 51 to
establish accounting and reporting standards for the noncontrolling interest in
a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 requires
consolidated net income to be reported at amounts that include the amounts
attributable to both the parent and the noncontrolling interest. The standard
also requires disclosure on the face of the consolidated statement of income, of
the amounts of consolidated net income attributable to the parent and to the
noncontrolling interest. In addition, this standard establishes a single method
of accounting for changes in a parent’s ownership interest in a subsidiary that
do not result in deconsolidation and requires that a parent recognize a gain or
loss in net income when a subsidiary is deconsolidated. SFAS No. 160 also
includes expanded disclosure requirements regarding the interests of the parent
and its noncontrolling interest. SFAS No. 160 becomes effective for fiscal
periods beginning after December 15, 2008. As the Company currently does
not have a noncontrolling interest in a subsidiary, the effect of SFAS No. 160,
if any, will be dependent on changes in the Company’s corporate
structure.
  In April
2008, the FASB issued FASB Staff Position No. FAS 142-3, “Determination of the
Useful Life of Intangible Assets” (“FSP 142-3”).  FSP 142-3 amends the
factors an entity should consider in developing renewal or extension assumptions
used in determining the useful life of recognized intangible assets under SFAS
No. 142, “Goodwill and Other Intangible Assets”.  This new guidance
applies prospectively to intangible assets that are acquired individually or
with a group of other assets in business combinations and asset
acquisitions.  FSP 142-3 is effective for financial statements issued
for fiscal years and interim periods beginning after December 15,
2008.  FSP 142-3’s impact on the Company is dependent upon future
acquisitions the Company may make.
  6
  Comprehensive Income
(Loss)
  Comprehensive
income (loss) consists of the following for each period:
  Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30,
                
                
                September
      30,2008
                
                
                2007
                
                
                2008
                
                
                2007Net
      income (loss)
                
                $
                (2,218
                )
                
                $
                -
                
                
                $
                (3,311
                )
                
                $
                694Currency
      translation adjustment
                
                
                (106
                )
                
                
                71
                
                
                
                (103
                )
                
                
                38Total
      comprehensive income (loss)
                
                $
                (2,324
                )
                
                $
                71
                
                
                $
                (3,414
                )
                
                $
                732
 2.
              BASIC
      AND DILUTED INCOME (LOSS) PER SHARE
  Basic
earnings (loss) per share (EPS) is computed by dividing net income (loss)
available for common stockholders by the weighted-average number of common
shares outstanding during the period. Diluted EPS is similar to basic EPS,
except that the dilutive effect of converting or exercising all potentially
dilutive securities is also included in the denominator. The Company’s
calculation of diluted EPS includes the dilutive effect of exercising stock
options into common shares.  For the three and nine month periods
ended September 30, 2008, the effect of converting stock options into 1,925 and
54,040 common share equivalents, respectively, was excluded because it was
antidilutive.
  Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30,
                
                
                September
      30,2008
                
                
                2007
                
                
                2008
                
                
                2007Weighted
      avg. common shares outstanding
                
                
                20,395,339
                
                
                
                20,360,125
                
                
                
                20,386,811
                
                
                
                20,301,521Shares
      used in computing basicnet
      income per share
                
                
                20,395,339
                
                
                
                20,360,125
                
                
                
                20,386,811
                
                
                
                20,301,521Stock
      options
                
                
                -
                
                
                
                182,169
                
                
                
                -
                
                
                
                188,255Shares
      used in computing dilutednet
      income per share
                
                
                20,395,339
                
                
                
                20,542,294
                
                
                
                20,386,811
                
                
                
                20,489,776
  3.
              SHARE-BASED
      COMPENSATION
  The
Company has a stock incentive plan (the “2000 Plan”), which authorizes the
granting of incentive and nonqualified stock options and restricted stock units.
Under the 2000 Plan, executives, key employees and outside directors receive
awards of options to purchase common stock or restricted stock. Incentive stock
options are granted at not less than 100% of fair market value at the date of
grant (110% for stockholders owning more than 10% of the Company’s common
stock). Nonqualified stock options are granted at not less than 85% of fair
market value at the date of grant. A maximum of 4,000,000 shares of common stock
are issuable under the 2000 Plan. Stock options granted under the 2000 Plan have
a maximum contractual term of 10 years. The 2000 Plan provides for accelerated
vesting if there is a change of control (as defined in the 2000
Plan).
  7
  The
Company also has an Employee Stock Purchase Plan (the “ESPP”). The ESPP allows
eligible full-time employees to purchase shares of common stock at 90 percent of
the lower of the fair market value of a share of common stock on the first or
last day of the quarter. Eligible employees are provided the opportunity to
acquire Company common stock during each quarter. No more than 661,157 shares of
common stock may be issued under the ESPP. Such stock may be unissued shares or
treasury shares of the Company or may be outstanding shares purchased in the
open market or otherwise on behalf of the ESPP. Under SFAS 123R, “Share-Based
Payment,” the Company’s ESPP is compensatory. Therefore, the Company is required
to recognize compensation expense related to the discount from market value of
shares sold under the ESPP.
  Certain
additional options have been granted outside the 2000 Plan. These options
generally follow the provisions of the 2000 Plan.  The Company issues
new shares to satisfy option exercises, the vesting of restricted stock units
and shares purchased under the ESPP.
  Share-based
compensation expense recorded in the three and nine month periods ended
September 30, 2008 and 2007 is summarized as follows:
  Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30,
                
                
                September
      30,2008
                
                
                2007
                
                
                2008
                
                
                2007Stock
      options
                
                $
                70
                
                
                $
                78
                
                
                $
                295
                
                
                $
                208Employee
      stock purchase plan
                
                
                2
                
                
                
                2
                
                
                
                6
                
                
                
                6Restricted
      stock units
                
                
                61
                
                
                
                54
                
                
                
                232
                
                
                
                138Total
      share-based compensation expense
                
                $
                133
                
                
                $
                134
                
                
                $
                533
                
                
                $
                352
  The
deferred income tax benefit related to share-based compensation expense for the
nine month periods ended September 30, 2008 and 2007 was $133 and $103,
respectively.  Share-based compensation expense is a component of
selling, general and administrative expense, and is recorded as a non-cash
expense in the operating activities section of the Company’s Consolidated
Statement of Cash Flows.
  The
intrinsic value of options exercised during the nine month periods ended
September 30, 2008 and 2007 was $0 and $240, respectively.  Proceeds
received from the exercise of stock options and from employee payments into the
ESPP totaled $0 and $55, respectively, in the nine month period ended September
30, 2008 and $470 and $22, respectively, in the nine month period ended
September 30, 2007. These amounts are recorded in the cash flows from financing
activities section of the Company’s Consolidated Statement of Cash
Flows.
  Information
with respect to the activity of outstanding stock options granted under the 2000
Plan and options granted separately from the 2000 Plan for the nine months ended
September 30, 2008 is summarized as follows:
 
 Weighted
                
                AggregateNumber
                
                
                
                
                
                
                
                
                Average
      Remaining
                
                Instrinsicof
      Shares
                
                
                Price
      Range
                
                Contractual
      term
                
                ValueBalance,
      December 31, 2007
                
                
                1,251,620
                
                
                $
                2.50
                
                -
                
                $
                6.94Granted
                
                
                274,420
                
                
                $
                2.44
                
                -
                
                $
                4.60Cancelled
      / Forfeited
                
                
                (106,068
                )
                
                $
                3.05
                
                -
                
                $
                5.50Balance,
      September 30, 2008
                
                
                1,419,972
                
                
                $
                2.44
                
                -
                
                $
                6.94
                
                5.6
      years
                
                $
                -Vested
      and excercisable atSeptember
      30, 2008
                
                
                1,152,616
                
                
                $
                2.50
                
                -
                
                $
                6.94
                
                4.8
      years
                
                $
                -Expected
      to vest as ofSeptember
      30, 2008
                
                
                1,400,158
                
                
                $
                2.44
                
                -
                
                $
                6.94
                
                5.6
      years
                
                $
                -
  8
  During
the nine month period ended September 30, 2008, there were 274,420 options
granted with a weighted average grant date fair value, based on a Black-Scholes
calculation, of $2.06 per share.  The assumptions used in the
Black-Scholes model are as follows, based upon a weighted average: dividend
yield 0%, expected volatility 48.5%, risk-free interest rate 3.15% and an
expected life of 5.6 years.  The Company uses the Simplified Method
for determining the expected life of the options granted which is computed using
the sum of the average vesting period and the contractual life of the option and
dividing by 2, for all periods presented.
  The
following table provides additional information about the Company’s stock
options outstanding and exercisable at September 30, 2008:
  Options
      Outstanding
                
                
                Options
      ExercisableWeighted
      Average
                
                
                
                
                
                Wtd.
      AverageRange
      of
                
                
                Number
      of
                
                
                Remaining
                
                Exercise
                
                
                Number
      of
                
                
                ExerciseExercise
      Prices
                
                
                Shares
                
                
                Contractual
      Life
                
                Price
                
                
                Shares
                
                
                Price$
                2.44
                
                -
                
                $
                2.88
                
                
                
                158,400
                
                
                2.6Years
                
                $
                2.73
                
                
                
                155,700
                
                
                $
                2.74$
                3.05
                
                -
                
                $
                3.57
                
                
                
                286,400
                
                
                5.7Years
                
                $
                3.34
                
                
                
                246,400
                
                
                $
                3.32$
                3.69
                
                -
                
                $
                6.94
                
                
                
                975,172
                
                
                6.1Years
                
                $
                4.13
                
                
                
                750,516
                
                
                $
                4.10$
                2.44
                
                -
                
                $
                6.94
                
                
                
                1,419,972
                
                
                5.6Years
                
                $
                3.81
                
                
                
                1,152,616
                
                
                $
                3.75
  A summary
of the status of the Company’s unvested restricted stock units (RSU) as of
December 31, 2007 and changes during the nine month period ended September 30,
2008 is presented below.
  Weighted
      AverageGrant
      Date
                
                
                AggregateShares
                
                
                Fair
      Value
                
                
                Intrinsic
      ValueNon-vested
      RSU's at December 31, 2007
                
                
                96,116
                
                
                $
                4.39Granted
                
                
                78,590
                
                
                $
                4.51Vested
                
                
                (23,194
                )
                
                $
                4.13Cancelled
      / forfeited
                
                
                (11,212
                )
                
                $
                4.55Non-vested
      RSU's at September 30, 2008
                
                
                140,300
                
                
                $
                4.49
                
                
                $
                227Expected
      to vest at September 30, 2008
                
                
                130,182
                
                
                $
                4.50
                
                
                $
                221
  Restricted
stock units granted are generally scheduled to vest over periods of two to four
years. The cost of the grant is charged to operations over the vesting period.
The total unamortized fair value of non-vested restricted stock units that are
expected to vest at September 30, 2008 was $359 with a weighted average
remaining term of 1.8 years.
  9
 
 4.
              INVENTORIES
  The
Company’s inventories are valued at the lower of cost or market. For inventories
that consist primarily of test kit components, bulk serum and antibody products,
cost is determined using the first in, first out method. For inventories that
consist of costs associated with the production of custom antibodies, cost is
determined using the specific identification method. At September 30, 2008 and
December 31, 2007, inventories consisted of the following:
  September
      30,
                
                
                December
      31,2008
                
                
                2007Raw
      materials
                
                $
                1,462
                
                
                $
                1,354Work
      in progress
                
                
                848
                
                
                
                903Finished
      goods
                
                
                1,679
                
                
                
                1,947Inventories
                
                $
                3,989
                
                
                $
                4,204
 
 5.
              GOODWILL
      AND INTANGIBLE ASSETS
  At
September 30, 2008 and December 31, 2007, intangible assets consisted of the
following:
  September
      30,
                
                
                December
      31,2008
                
                
                2007
                
                
                LivesGoodwill
                
                $
                4,731
                
                
                $
                4,774
                
                
                N/ALess
      - accumulated amortization
                
                
                (573
                )
                
                
                (573
                )Net
      goodwill
                
                $
                4,158
                
                
                $
                4,201September
      30,
                
                
                December
      31,2008
                
                
                2007
                
                
                LivesIntangible
      assets
                
                
                3,134
                
                
                
                3,134
                
                
                2-20Less
      - accumulated amortization
                
                
                (1,466
                )
                
                
                (1,287
                )Net
      intangible assets
                
                $
                1,668
                
                
                $
                1,847
  6.
              DEBT
  On May 5,
2000, the Company entered into a financing agreement with a commercial bank
which was amended on August 10, 2007 (the “Credit Agreement”).  The
Credit Agreement provides for up to a $5,000 revolving line of credit, none of
which was outstanding and all of which was available at September 30,
2008.  The revolving line of credit bears a variable interest rate of
100 basis points to 225 basis points over the one month London Interbank Offered
Rate (LIBOR) depending upon the ratio of the Company’s funded debt to
EBITDA.  The Company’s annual effective rate of interest on this line
of credit, taking into account the variable interest rate and LIBOR, was
approximately 3.47% at September 30, 2008.
  On
December 13, 2001, the Company received a term loan under the Credit Agreement
to finance the construction of new facilities at its Windham, Maine location.
This term loan provided for up to $1,500 in financing, $193 of which was
outstanding at September 30, 2008, and is repayable over seven years, with
principal payments that began on October 1, 2002. The loan bears a variable
interest rate of 100 basis points to 275 basis points over the one month LIBOR
rate depending upon the ratio of the Company’s funded debt to EBITDA. Payments
are due monthly, with equal amortization of principal payments plus interest.
The Company’s annual effective rate of interest on this loan at September 30,
2008 was approximately 3.47%.
  10
  On August
21, 2007, the Company received a term loan under the Credit Agreement to finance
the construction of new facilities at its Windham, Maine location. This term
loan provided for up to $2,000 in financing, $1,600 of which was outstanding at
September 30, 2008, and is repayable over five years, with principal payments
that began on October 1, 2007. The loan bears a fixed interest rate of 5.96%
with equal amortization of principal payments plus interest.
  Under the
Credit Agreement, the Company is required to meet certain quarterly financial
covenants that include a ratio of EBITDA to current maturities of debt plus
interest and cash paid for taxes greater than 1.50 and a ratio of funded debt to
EBITDA not to exceed 3.25.  The Company did not meet its financial
covenants with respect to its indebtedness at September 30, 2008 and does not
expect that it will be able to meet all of its financial covenants under the
Credit Agreement for the next twelve months.  The Company received a
waiver of the financial covenants relating to the above financing from its
commercial bank as of September 30, 2008.
  As of
September 30, 2008, the Company has classified the balance of its long-term
obligations under the Credit Agreement of $1,200 as current debt in the
consolidated balance sheet as the Company believes it is probable that there
will be a violation of the same covenants within the next twelve months if the
covenant terms are not amended.  If the Company is unable to obtain a
waiver of future debt covenant violations, the Company will be unable to draw
upon its line of credit until such violations are cured.  As of
September 30, 2008, the Company is not required to repay these long-term debt
obligations within twelve months and expects to amend the Credit Agreement
before December 31, 2008 to allow the Company to meet its financial covenants
and reclassify these long-term obligations from current to non-current in the
consolidated balance sheet.
  As of
September 30, 2008, the outstanding balance on all of the Company’s
commercial bank debt was $1,793. This indebtedness is secured by substantially
all of the Company’s assets.
  7.
              INCOME
      TAXES
 
 The
Company is subject to U.S. federal and United Kingdom income tax, as well as
income taxes of numerous state jurisdictions.  The Company recognizes
interest and penalties related to uncertain tax positions in income tax
expense.  Upon adoption of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement 109” and at
September 30, 2008, the Company had no interest or penalties accrued related to
uncertain tax positions, due to available net operating loss
carryforwards.
 
 As of
January 1, 2008, the Company provided a liability for approximately $580 of
unrecognized tax benefits, of which $513 would impact the Company’s effective
tax rate if recognized.  For the nine months ended September 30, 2008,
unrecognized tax benefits increased $18 to $598, of which approximately $530
would impact the Company’s effective tax rate if recognized.
  For
federal purposes, post-1993 tax years remain open to examination as a result of
earlier net operating losses being utilized in recent years.  For
state purposes, the statute of limitations remains open in a similar manner for
states that have generated net operating losses.
  In
accordance with SFAS 109, “Accounting for Income Taxes”, the Company evaluates
its deferred tax assets quarterly to determine if a valuation allowance is
required to offset the carrying value of future tax benefits.  Due to
the significant losses incurred by the Company through September 30, 2008 and
the timing of when certain tax net operating loss carryforwards expire, the
Company determined that it was more likely than not that approximately $4,582 of
federal net operating loss carryforwards (NOLs), would expire unused in the year
2010.  As a result of this determination, the Company has recorded a
valuation allowance of approximately $1,558 against the deferred tax asset
attributable to these NOLs.  This valuation allowance was charged to
income tax expense for the three and nine month periods ending September 30,
2008.  After recording these valuation allowances, the Company has net
deferred tax assets of approximately $8.0 million as of September 30,
2008.  Management believes it is more likely than not that based upon
its projections of future taxable income including available tax planning
strategies, the Company will generate sufficient future taxable income to
realize the benefits of the net deferred tax assets existing at September 30,
2008.
 
 11
  Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
  Forward-Looking
Statements
  This Form
10-Q contains certain forward-looking statements reflecting the current
expectations of Strategic Diagnostics Inc. and its subsidiaries (the “Company”
or “SDI”). These statements include, among others, statements regarding: the
Company’s intentions with respect to future spending on research and
development; the development, market acceptance and sales of tests for
food-borne pathogens and related growth media; the size and nature of demand in
the markets for the Company’s products and related effects on operating results;
the need for water quality and toxicity tests; approval and validation by third
parties of the Company’s food pathogen tests; the performance of the Company’s
testing products; sales of the Company’s antibodies; timing of new product
introductions and other information that may be predictive of future operating
results; the Company’s ability to reduce operating expenses; and the Company’s
ability to improve operating results thus enabling it to meet future loan
covenants. In addition, when used in this Form 10-Q, the words “anticipate,”
“enable,” “estimate,” “intend,” “expect,” “believe,” “potential,” “may,” “will,”
“should,” “project” and similar expressions as they relate to the Company are
intended to identify said forward-looking statements. Investors are cautioned
that all forward-looking statements involve risks and uncertainties, which may
cause actual results to differ from those anticipated at this time. Such risks
and uncertainties include, without limitation, changes in demand for products,
delays in product development, delays in market acceptance of new products,
retention of customers, attraction and retention of management and key
employees, adequate supply of raw materials, inability to obtain or delays in
obtaining third party approvals, or required government approvals, the ability
to meet increased market demand, competition, protection of intellectual
property, non-infringement of intellectual property, seasonality, the ability to
obtain financing and other factors more fully described in the Company’s public
filings with the U.S. Securities and Exchange Commission, including, without
limitation, its Annual Report on Form 10-K for the year ended December 31,
2007.
  Background
 
 The
Company is an antibody technology company with a core mission of developing,
commercializing and marketing innovative and proprietary biotechnology that
preserves and enhances the quality of human health. By applying its core
competencies of proprietary antibody and assay development, the Company produces
unique, sophisticated diagnostic testing and reagent systems that are responsive
to customer diagnostic and information needs. Customers benefit from a
quantifiable “return on investment” by reducing time, labor, and/or material
costs associated with applications for which the Company’s products are used.
This is accomplished while increasing accuracy, reliability and actionability of
essential test results. The Company is focused on sustaining this competitive
advantage by leveraging its expertise in immunology, proteomics,
bio-luminescence and other bio-reactive technologies to continue its successful
customer-focused research and development efforts. Recent innovations in high
throughput production of antibodies from genetic antigens will complement the
Company’s established leadership in commercial and custom antibody production
for the research, human and animal diagnostics, and pharmaceutical industries,
and position the Company for broader participation in proteomics research and
discovery.
  Our
antibody product group provides a wide array of antibodies and antibody
services, including hybridoma development, genomic antibody development,
calibrators, antigens and reagents and the production of monoclonal and
polyclonal antibodies. These antibodies are incorporated into test kits we
manufacture and diagnostic and therapeutic products, and used in clinical
research.
  Our food
safety product group markets tests for food pathogens, tests to detect specific
traits in genetically engineered plants, tests to detect Genetically Modified
(GM) traits in food ingredients and food fractions and tests to detect naturally
occurring fungi in grains (mycotoxins).
  Our water
quality product group includes tests to detect toxicity in drinking water,
industrial process water and wastewater, and tests to detect specific traits in
soil and other waste matter for use at environmental remediation projects,
hazardous waste operations and other applications.
  We sell
products and services in the food safety, water quality and antibody market
categories through our U.S. direct sales force, a network of over 50
distributors in Canada, Mexico, Latin America, Europe and Asia and our corporate
partners. These products and services are sold to a wide range of customers
including water utilities, food processors, pharmaceutical, biotechnology and
diagnostic companies and major biomedical research centers.
  12
  Results
of Operations
  Three
Months Ended September 30, 2008 versus Three Months Ended September 30,
2007
  Revenues
for the third quarter of 2008 increased 5.0% to $6.9 million, compared to $6.6
million for the same period in 2007. The increase in revenues in the third
quarter of 2008 was primarily the result of a 38.2% increase in sales of food
pathogen products, a 13.8% increase in sales of water and environmental products
and a 3.9% increase in sales of Ag-GMO products when comparing the third quarter
of 2008 to the third quarter of 2007.  These increases were partially
offset by decreased sales of antibody products which decreased by 8.1% when
comparing the third quarter of 2008 to the third quarter of 2007 (see discussion
of product groups below).
  Operating
expenses for the third quarter of 2008 increased 25.4% to $8.0 million, compared
to $6.4 million for the third quarter of 2007.   As described
below, this increase is primarily attributable to a 34.0% increase in research
and development costs, a 32.9% increase in manufacturing costs and a 21.1%
increase in selling, general and administrative costs.
  Gross
profits (defined as total revenues less manufacturing costs) for the third
quarter of 2008 were $3.3 million compared to $3.9 million for the same period
in 2007. Gross margins were 48.4% and 59.4% for the third quarters of 2008 and
2007, respectively. The decrease in margins and related increase in
manufacturing costs was primarily attributable to increased write-offs for
obsolete inventory and additional employee costs in the Company’s test kit
business, and increased costs of production in the antibody business due to the
expansion of the Company’s antibody production capabilities, creating an
unfavorable overhead absorption rate.
  Research
and development spending was $969,000, or 14.1% of revenues, in the third
quarter of 2008, compared to $723,000, or 11.0% of revenues, in the third
quarter of 2007.  This increase was primarily due to increased
spending and effort on the development of the Company’s proprietary phage
technology for use in the production of ethanol.
  Selling,
general and administrative expenses were $3.5 million for the third quarter of
2008, compared to $2.9 million for the same quarter in 2007. The increase is
primarily attributable to increased recruiting costs associated with the
Company’s continued expansion of its sales and marketing efforts.
  Gain on
disposal of assets of $11,000 was recorded in the third quarter of 2008,
relating to the sale and disposal of rental equipment.  Loss on
disposal of assets of $108,000 was recorded in the third quarter of 2007,
relating to the replacement of manufacturing equipment that was no longer fit
for use.
  The
Company recorded net interest income of $35,000 in the third quarter of 2008
compared to $109,000 in the third quarter of 2007. The decrease was primarily
due to increased debt and related interest expense during the third quarter of
2008 when compared to the third quarter of 2007, and decreased interest rates
received on invested cash during the third quarter of 2008.
  As a
result of the reduced margins and higher costs discussed above, pre-tax loss
totaled ($1.1 million) for the three months ended September 30, 2008 compared to
pre-tax income of $275,000 for the same period in 2007.
  Income
tax expense for the third quarter of 2008 includes approximately $1.6 million in
expense for a valuation allowance against deferred tax assets relating to
approximately $4.6 million in federal net operating loss carryforwards that will
expire in the year 2010. The tax rate without the effect of the additional $1.6
million expense for the three month period ending September 30, 2008 was
approximately 39.9%.
  Income
tax expense for the third quarter of 2007 included an additional expense of
$158,000 associated with the reconciliation of the December 2006 tax provision
to the actual 2006 tax return filed in the third quarter of 2007.  The
difference between the 2006 tax provision and the 2006 tax return is primarily
due to the amount of research and experimentation credits utilized, and changes
in applicable tax rates.  The tax rate without the effect of the
additional $158,000 expense as described above for the three month period ending
September 30, 2007 was approximately 42.5%.
  Net loss
in the third quarter of 2008 was ($2.2 million), or ($0.11) per diluted share,
compared to no net income or loss for the same period in 2007. Diluted shares
utilized in these computations were 20.4 million and 20.5 million for the third
quarters of 2008 and 2007, respectively.
  13
  Product
Groups
  Antibody
Products
  Antibody
product revenues decreased 8.1% to $3.3 million for the third quarter of 2008,
compared to $3.6 million for the same quarter in 2007.  The Company
recorded an increase of $339,000, or 190.8%, in sales of its custom antibody
services utilizing its new Genomic Antibody Technology TM
platform.  This increase was offset by a $378,000 decrease in sales of
custom monoclonal services, a $188,000 decrease in sales of custom polyclonal
services and a decrease of $116,000 in sales of bulk products.  The
decreases in the monoclonal services and bulk products were primarily the result
of decreased orders by customers that had previously accumulated excess
inventories.  For the third quarter of 2008, antibody revenues were
47.9% of total Company revenues compared to 54.7% in the third quarter of
2007.
  Food Safety
Products
 
 Food
safety revenues increased 26.1% to $2.1 million for the third quarter of 2008,
compared to $1.7 million in the third quarter of 2007.
 
 Food
pathogen sales (which are a subset of food safety revenues) increased 38.2% to
$1.5 million in the third quarter of 2008 as compared to $1.1 million for the
third quarter of 2007, due to increased sales of products that detect the three
major food pathogens, E. coli, salmonella and listeria.
 
 Ag-GMO
product sales (which are a subset of food safety revenues) increased 3.9% to
$626,000 for the third quarter of 2008 as compared to $602,000 for the third
quarter of 2007.  This increase is primarily attributable to increased
demand for the Company’s testing products in Brazil where the Company has had
strong sales efforts since 2000.
  Water and Environmental
Products
 
 Water and
environmental products revenue increased 13.8% to $1.4 million for the third
quarter of 2008 as compared to $1.3 million for the third quarter of
2007.  This increase is primarily due to increased sales of water
testing equipment in China.
  Nine
Months Ended September 30, 2008 versus Nine Months Ended September 30,
2007
  Revenues
for the first nine months of 2008 increased 3.5% to $20.6 million, compared to
$19.9 million for the same period in 2007. The increase in revenues in the first
nine months of 2008 was primarily the result of a 29.6% increase in sales of
food safety products when comparing the first nine months of 2008 to the first
nine months of 2007 and a 10.6% increase in sales of water and environmental
products when comparing the first nine months of 2008 to the first nine months
of 2007.  These increases were partially offset by a 4.3% decrease in
the sale of antibody products when comparing the first nine months of 2008 and
2007 (see discussion of product groups below).
  Operating
expenses for the first nine months of 2008 increased 24.7% to $23.5 million,
compared to $18.8 million for the first nine months of 2007.  This
increase is primarily attributable to a 29.6% increase in research and
development costs, a 24.9% increase in selling, general and administrative costs
and a 24.8% increase in manufacturing costs.
  Gross
profits (defined as total revenues less manufacturing costs) for the first nine
months of 2008 were $10.8 million compared to $12.0 million for the same period
in 2007. Gross margins were 52.2% and 60.4% for the nine month periods ending
September 30, 2008 and 2007, respectively.  The decrease in margins
and related increase in manufacturing costs was primarily attributable to
increased write-offs for obsolete inventory in the Company’s test kit business
and increased costs of production in the antibody business due to the expansion
of the Company’s antibody production capabilities, all creating an unfavorable
overhead absorption rate.
  Research
and development spending was $2.8 million, or 13.7% of revenues, in the first
nine months of 2008, compared to $2.2 million, or 11.0% of revenues, in the
first nine months of 2007.  This increase was primarily due to
increased spending and effort on development of the Company’s proprietary SEQerTM
antibodies, which are produced by the Company’s Genomic Antibody Technology TM
platform and are being sold through the Company’s antibody catalog, and
increased spending and effort on development of the Company’s proprietary phage
technology for use in the production of ethanol.
  14
  Selling,
general and administrative expenses were $10.8 million for the first nine months
of 2008, compared to $8.7 million for the same period in 2007. The increase is
primarily due to severance costs for the former Chief Executive Officer of
$630,000, and increased costs associated with the Company’s continued expansion
of its sales and marketing efforts.
  Gain on
disposal of assets of $11,000 was recorded in the first nine months of 2008,
relating to the sale and disposal of rental equipment.  Loss on
disposal of assets of $108,000 was recorded in the first nine months of 2007,
relating to the replacement of manufacturing equipment that was no longer fit
for use.
  The
Company recorded net interest income of $134,000 in the first nine months of
2008 compared to $335,000 in the first nine months of 2007. The decrease was
primarily due to increased debt and related interest expense and decreased
interest rates received on invested cash during the first nine months of
2008.
  As a
result of the reduced margins and higher costs discussed above, pre-tax loss
totaled ($2.7 million) for the nine months ended September 30, 2008 compared to
pre-tax income of $1.4 million for the same period in 2007.
  Income
tax expense in the first nine months of 2008 includes approximately
$1.6 million in expense for a valuation allowance against deferred tax assets
relating to approximately $4.6 million in federal net operating loss
carryforwards that will expire in the year 2010. The tax rate without the effect
of the additional $1.6 million expense for the nine month period ending
September 30, 2008 was approximately 35.8%.
 Income
tax expense in the first nine months of 2007 includes additional expense of
approximately $158,000 associated with the reconciliation of the December 2006
tax provision to the actual 2006 tax return filed in the third quarter of
2007.  The difference between the 2006 tax provision and the 2006 tax
return is primarily due to the amount of federal research and experimentation
credits utilized and changes in applicable effective state tax
rates.  The tax rate without the effect of the additional $158,000
expense as described above for the nine month period ending September 30, 2007
was approximately 40.3%.
  Net loss
in the first nine months of 2008 was ($3.3 million), or ($0.16) per diluted
share, compared to net income of $694,000, or $0.03 per diluted share, for the
same period in 2007. Diluted shares utilized in these computations were 20.4
million for the first nine months of 2008 and 20.5 million for the first nine
months of 2007.
  Product
Groups
  Antibody
Products
  Antibody
revenues decreased 4.3% to $10.0 million for the first nine months of 2008,
compared to $10.5 million for the same period in 2007.  The Company
recorded increases of $595,000 in sales of its custom antibody services
utilizing its new Genomic Antibody Technology TM platform, but had decreases of
$523,000 in sales of custom polyclonal services, $434,000 in sales of bulk
products and $198,000 in custom monoclonal services.  The decreases in
the monoclonal services and bulk products were primarily the result of decreased
orders by customers that had previously accumulated excess
inventories.
  Food Safety
Products
 
 Food
safety revenues increased 12.4% to $6.4 million for the first nine months of
2008, compared to $5.7 million in the first nine months of 2007.
 
 Food
pathogen sales (which are a subset of food safety revenues) increased 29.6% to
$4.2 million in the first nine months of 2008 as compared to $3.3 million in the
first nine months of 2007, due to increased sales of products that detect the
three major food pathogens, E. coli, salmonella and listeria.
 
 Ag-GMO
product sales (which are a subset of food safety revenues) decreased 10.1% to
$2.2 million, for the first nine months of 2008 as compared to $2.5 million for
the first nine months of 2007.  This decrease is primarily
attributable to the reduction in sales of tests to detect StarlinkTM in
grain.
  15
  Water and Environmental
Products
 
 Water and
environmental products revenue increased 10.6% to $4.2 million for the first
nine months of 2008 as compared to $3.8 million for the first nine months of
2007.  This increase is primarily due to increased sales of water
testing equipment in China.
  Liquidity
and Capital Resources
  The net
cash used in operating activities of $618,000 for the first nine months of 2008
was primarily the result of the ($3.3 million) net loss recorded for the period
and a $260,000 increase in other current assets offset by non-cash charges
for depreciation, amortization, deferred income tax provision and share-based
compensation expense of $2.1 million. The increase in other current assets was
primarily the result of the purchase of insurance for 2008.
  Net cash
used in investing activities of $687,000 for the first nine months of 2008 was
primarily related to the capital expenditures for the period. This compares to
net cash used in investing activities of $2.3 million for the first nine months
of 2007. The capital expenditures for the first nine months of 2008 were
primarily related to purchases of laboratory and manufacturing equipment, and
the capital expenditures for 2007 were primarily attributable to the expansion
of the Company’s antibody production facility in Maine.
  Net cash
used in financing activities of $403,000 for the first nine months of 2008 was
primarily the result of scheduled debt repayments.  Net cash provided
by financing activities for the first nine months of 2007 of $2.3 million was
primarily driven by proceeds from the issuance of a $2.0 million term loan for
construction of a new facility at the Company’s Maine location and the exercise
of stock options which was partially offset by net repayments of outstanding
debt.
  The
Company’s working capital, current assets less current liabilities, decreased
$3.8 million to $16.2 million at September 30, 2008 from $20.0 million at
December 31, 2007, primarily due to changes in classification of $1.2 million of
debt from long-term debt to current debt,, reduction in current deferred tax
assets of $199,000 and an increase in other current assets as described above.
Outstanding debt decreased $458,000 from $2.3 million at December 31, 2007 to
$1.8 million at September 30, 2008, due to scheduled repayments.
  On May 5,
2000, the Company entered into a financing agreement with a commercial bank
which was amended on August 10, 2007 (the “Credit Agreement”).  The
Credit Agreement provides for up to a $5.0 million revolving line of credit,
none of which was outstanding and all of which was available at September 30,
2008.  The revolving line of credit bears a variable interest rate of
100 basis points to 225 basis points over the one month London Interbank Offered
Rate (LIBOR) depending upon the ratio of the Company’s funded debt to
EBITDA.  The Company’s annual effective rate of interest on this line
of credit, taking into account the variable interest rate and LIBOR, was
approximately 3.47% at September 30, 2008.
  On
December 13, 2001, the Company received a term loan under the Credit Agreement
to finance the construction of new facilities at its Windham, Maine location.
This term loan provided for up to $1.5 million in financing, $193,000 of which
was outstanding at September 30, 2008, and is repayable over seven years, with
principal payments that began on October 1, 2002. The loan bears a variable
interest rate of 100 basis points to 275 basis points over the one month LIBOR
rate depending upon the ratio of the Company’s funded debt to EBITDA. Payments
are due monthly, with equal amortization of principal payments plus interest.
The Company’s annual effective rate of interest on this loan at September 30,
2008 was approximately 3.47%.
  On August
21, 2007, the Company received a term loan under the Credit Agreement to finance
the construction of new facilities at its Windham, Maine location. This term
loan provided for up to $2.0 million in financing, $1.6 million of which was
outstanding at September 30, 2008, and is repayable over five years, with
principal payments that began on October 1, 2007. The loan bears a fixed
interest rate of 5.96% with equal amortization of principal payments plus
interest.
  Under the
Credit Agreement, the Company is required to meet certain quarterly financial
covenants that include a ratio of EBITDA to current maturities of debt plus
interest and cash paid for taxes greater than 1.50 and a ratio of funded debt to
EBITDA not to exceed 3.25.  The Company did not meet its financial
covenants with respect to its indebtedness at September 30, 2008 and does not
expect that it will be able to meet all of its financial covenants under the
Credit Agreement for the next twelve months.  The Company received a
waiver of the financial covenants relating to the above financing from its
commercial bank as of September 30, 2008.
  16
  As of
September 30, 2008, the Company has classified the balance of its long-term
obligations under the Credit Agreement of $1.2 million as current debt in the
consolidated balance sheet as the Company believes it is probable that there
will be a violation of the same covenants within the next twelve months if the
covenant terms are not amended.  If the Company is unable to obtain a
waiver of future debt covenant violations, the Company will be unable to draw
upon its line of credit until such violations are cured.  As of
September 30, 2008, the Company is not required to repay these long-term debt
obligations within twelve months and expects to amend its bank Credit Agreement
before December 31, 2008 to allow the Company to meet its financial covenants
and reclassify these long-term obligations from current to non-current in the
consolidated balance sheet.
  For the
nine months ended September 30, 2008, the Company satisfied all of its cash
requirements from cash on-hand.  At September 30, 2008, the Company
had $1.8 million in debt and stockholders’ equity of $34.3 million.
  Based
upon its cash on-hand and the anticipated sales of current and new products, the
Company believes it has, or has access to, sufficient resources to meet its
operating requirements through the next twelve months. The Company’s ability to
meet its long-term capital needs will depend on a number of factors, including
compliance with existing and new loan covenants, the success of its current and
future products, the focus and direction of its research and development
programs, competitive and technological advances, future relationships with
corporate partners, government regulation, the Company’s marketing and
distribution strategy, its successful sale of additional common stock and/or the
Company successfully locating and obtaining other financing, and the success of
the Company’s plan to make future acquisitions. Accordingly, no assurance can be
given that the Company will be able to meet the future liquidity requirements
that may arise from these inherent and similar uncertainties.
  17
  Non-GAAP Financial
Measures
  The
Company presents an EBITDA measure as the Company believes this provides
investors and the Company’s management with additional information to measure
the Company’s liquidity. EBITDA measures are not a measure of performance under
GAAP, and therefore should not be considered in isolation or as a substitute for
net income or cash flows from operations. Additionally, the Company’s EBITDA
calculations may differ from the EBITDA calculations for other
companies.  The Company excludes stock compensation expense from its
measure of EBITDA.
  The
calculation of the Company’s EBITDA measure (as discussed above), and the
reconciliation of the Company’s EBITDA measure to net cash provided by or (used
in) operating activities for the nine month periods ended September 30, 2008 and
2007 is as follows:
  Nine
      Months Ended
                  September
      30,2008
                
                
                2007(in
      thousands)Net
      cash provided by (used in) operating activities
                
                $
                (618
                )
                
                $
                871Changes
      in assets and liabilities:Receivables
                
                
                (241
                )
                
                
                177Inventories
                
                
                (215
                )
                
                
                1,218Other
      current assets
                
                
                260
                
                
                
                239Other
      assets
                
                
                (3
                )
                
                
                4Accounts
      payable
                
                
                (54
                )
                
                
                147Accrued
      expenses
                
                
                (197
                )
                
                
                63Deferred
      revenue
                
                
                (120
                )
                
                
                12Other
      non-current liabilities
                
                
                -
                
                
                
                (117
                )Gain
      (loss) on disposal of fixed assets
                
                
                11
                
                
                
                (93
                )Net
      change in deferred income tax
                
                
                (597
                )
                
                
                (570
                )Income
      tax provision (benefit)
                
                
                582
                
                
                
                733Share-based
      compensation expense
                
                
                (533
                )
                
                
                (352
                )Interest
      income, net
                
                
                (134
                )
                
                
                (335
                )EBITDA
                
                $
                (1,859
                )
                
                $
                1,997
  Critical
Accounting Policies
  The
preparation of financial statements in accordance with generally accepted
accounting principles (“GAAP”) requires management to make a number of
judgments, estimates and assumptions that affect the reported amounts of assets,
liabilities, income and expenses in the consolidated financial
statements.  Understanding the Company’s accounting policies and the
extent to which the Company uses management’s judgment and estimates in applying
these policies is integral to understanding the Company’s financial
statements.  The Company has identified the following as the most
critical accounting policies and estimates:
 
 o
              Valuation
      of Accounts Receivableo
              Valuation
      of Inventoryo
              Deferred
      Taxeso
              Revenue
      Recognitiono
              Valuation
      of Long-Lived Assetso
              Stock-Based
      Compensation
  Described
below are the significant changes in judgments and assumptions that the Company
made during the first nine months of 2008 in applying the critical accounting
policies and estimates.  Also see “Part II – Item 7 – MD&A –
Critical Accounting Policies” of the Company’s Annual Report on Form 10-K for
the fiscal year ended December 31, 2007 for additional information about the
Company’s critical accounting policies and estimates.
  18
  Deferred
Taxes
  The
Company recognizes deferred tax assets and liabilities for the future tax
consequences related to differences between the financial statement carrying
amounts of existing assets and liabilities and their tax bases, and for tax
credits.  The Company’s net deferred tax assets totaled approximately
$8.6 million at December 31, 2007.  The Company evaluates its deferred
tax assets for recoverability based on available evidence, including assumptions
about future profitability.  The Company is required to establish a
valuation allowance for deferred tax assets and record a charge to income if it
determines, based on available evidence at the time the determination is made,
that it is more likely than not that some portion or all of the deferred tax
assets will not be realized.  Such a charge likely would have a
material adverse effect on the Company’s results of operations and financial
condition.  In evaluating the need for a valuation allowance, the
Company estimated future taxable income based upon management approved business
plans and ongoing tax planning strategies.  This process involves
significant management judgment about assumptions that are subject to change
from period to period based on variances between the Company’s future projected
operating performance and its actual results.  Accordingly, the
Company has included the assessment of a deferred tax asset valuation allowance
as a critical accounting policy.
 
 While the
Company is not in a cumulative book pre-tax loss position for the three-year
period ended September 30, 2008, the Company projects that it will be in a
cumulative book pre-tax loss position as of December 31, 2008. The realization
of the Company’s deferred tax assets is dependent upon the generation of
sufficient future taxable income to support such realization. For purposes of
establishing a deferred tax asset valuation allowance, this projection of a
cumulative book pre-tax loss position is considered significant, objective
evidence that the Company may not be able to realize some portion of its
deferred tax assets in the future, because its future taxable income may not be
sufficient. In assessing the nature of the Company’s cumulative book pre-tax
loss position, management evaluated the factors contributing to these losses and
analyzed whether these factors were temporary or indicative of a permanent
decline in the Company’s earnings. Management determined that the current
cumulative book pre-tax loss position was caused primarily by severance costs
incurred relating to the Company’s former CEO and an increase in manufacturing
costs related to the increase in the Company’s antibody production
capabilities.
 
 Prior to
2008, the Company had generated pre-tax book income for eight of the prior
eleven fiscal years, including in each of the most recent consecutive four
fiscal years. Due to the significant losses the Company has incurred through the
third quarter of 2008 and the timing of when certain tax net operating loss
carryforwards are scheduled to expire, the Company has determined that a
valuation allowance should be established with regard to a portion of the
deferred tax assets related to federal tax loss carryforwards that expire in
2010.  Based on management’s forecasts of future taxable income, the
Company anticipates that it is more likely than not that its results of future
operations will generate sufficient taxable income to realize the remaining
portion of its deferred tax assets which primarily relate to federal tax loss
carryforwards that do not begin to expire until the year 2017. Therefore, the
Company did not record a valuation allowance against the remaining portion of
its deferred tax assets.   If future events differ from current
forecasts, then an additional valuation allowance may need to be established,
which likely would have a material adverse effect on the results of operations
and financial condition of the Company.  Conversely, should the
Company’s operating results for 2009 or 2010 reflect sufficient taxable income,
it will be able to realize all or a portion of the deferred tax assets against
which it is establishing a valuation allowance, despite the fact that it has
established such allowance.
 The
Company provides additional detail on the components of its deferred tax assets
and deferred tax liabilities as of December 31, 2007 in the Company’s
Annual Report on Form 10-K for the fiscal year ended December 31, 2007 in
“Notes to Consolidated Financial Statements—Note 10, Income Taxes” and
provides information on the changes in its deferred tax assets since
December 31, 2007 in “Notes to Consolidated Interim Financial
Statements—Note 7, Income Taxes” of this report.
 Item
3. Quantitative and Qualitative Disclosures About Market Risk
  The
Company has exposure to changing interest rates, and is currently not engaged in
hedging activities. Interest on approximately $193,000 of outstanding
indebtedness is at a variable rate of 1.00% to 2.75% over the published LIBOR,
based upon the Company’s ratio of funded debt to EBITDA, and was 1.00% over
LIBOR on average for the year. At the Company’s current level of indebtedness,
each 1% change in the variable interest rate will have an effect of $2,000 on
the Company’s annual interest expense charges.
  19
  The
Company conducts operations in the United Kingdom. The consolidated financial
statements of the Company are denominated in U.S. dollars and changes in
exchange rates between foreign countries and the U.S. dollar will affect the
translation of financial results of foreign subsidiaries into U.S. dollars for
purposes of recording the Company’s consolidated financial results.
Historically, the effects of translation have not been material to the
consolidated financial results.
  Item
4. Controls and Procedures
  (a)
              Evaluation
      of Disclosure Controls and
Procedures
  Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934, as amended, as of the end of the period covered by this report. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, as of September 30, 2008, our disclosure controls and procedures
were effective to provide reasonable assurance that the information required to
be disclosed by us in reports filed under the Securities Exchange Act of 1934,
as amended, is recorded, processed, summarized and reported within the time
periods specified in the SEC’s rules and forms, and that information required to
be disclosed by us in the reports we file or submit under the Securities
Exchange Act of 1934, as amended, is accumulated and communicated to our
management, including our principal executive and financial officers, or persons
performing similar functions, as appropriate to allow timely decisions regarding
required disclosure.
  (b)
              Change
      in Internal Control over Financial
Reporting
  No change
in the Company’s internal control over financial reporting occurred during the
most recent fiscal quarter that has materially affected, or is reasonably likely
to materially affect, the internal control over financial
reporting.
 
 20
  PART
II – OTHER INFORMATION
  Item
1A.  Risk Factors
 
 There
have been no material changes to the risk factors disclosed in the Company’s
Annual Report on Form 10-K for the fiscal year ended December 31, 2007. However,
readers should carefully consider the following additional risk
factor:
 
 The
Company may have future capital needs and may not be able to obtain additional
financing on acceptable terms.
 
 As a
result of market conditions, the cost and availability of credit has been and
may continue to be adversely affected by illiquid credit markets. Concern about
the general stability of the markets has led many lenders and institutional
investors to reduce, and in some cases, cease to provide, funding to
borrowers.  The Company’s ability to utilize its current credit
facility and to secure additional financing, as necessary, and to satisfy its
financial obligations under indebtedness outstanding from time to time, will
depend upon the Company’s future operating performance, which is subject to
prevailing general economic and credit market conditions, including the
availability of credit generally, and financial, business and other factors,
many of which are beyond the control of the Company. The prolonged continuation
or worsening of current credit market conditions would have a material adverse
effect on the Company’s ability to secure financing on favorable terms, if at
all.
 
 The
Company may be unable to secure additional financing or financing on favorable
terms or the Company’s operating cash flow may be insufficient to satisfy its
financial obligations under indebtedness outstanding from time to time (if any).
Furthermore, if financing is not available when needed, or is not available on
favorable terms, the Company may be unable to develop new or enhance its
existing products or otherwise take advantage of business opportunities or
respond to competitive pressures, any of which could have a material adverse
effect on the business, financial condition and results of operations of the
Company.
  Item
6. Exhibits
  10.1
              Employment
      Agreement, dated as of October 13, 2008, between the Company and Francis
      M. DiNuzzo (Filed as Exhibit 99.1 to the Company’s Current Report on Form
      8-K filed with the Securities and Exchange Commission on October 16, 2008,
      and incorporated by reference herein).31.1
              Certifications
      of the Chief Executive Officer of Strategic Diagnostics Inc. required by
      Rule 13a-14(a) under the Securities Exchange Act of
193431.2
              Certifications
      of the Chief Financial Officer of Strategic Diagnostics Inc. required by
      Rule 13a-14(a) under the Securities Exchange Act of
193432.1
              Certification
      of the Chief Executive Officer of Strategic Diagnostics Inc. pursuant to
      18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      Sarbanes-Oxley Act of 200232.2
              Certification
      of the Chief Financial Officer of Strategic Diagnostics Inc. pursuant to
      18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      Sarbanes-Oxley Act of 2002
 
 21
  SIGNATURES
  Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
  STRATEGIC
      DIAGNOSTICS INC.Date:
      November 14, 2008
              
              /s/
      Francis M. DiNuzzoFrancis
      M. DiNuzzo
                President
      and Chief Executive Officer
                (Principal
      Executive Officer)
   Date:
      November 14, 2008
              
              /s/
      Stanley A. FronczkowskiStanley
      A. Fronczkowski
                Vice
      President – Finance and Chief Financial Officer
                (Principal
      Financial and Accounting
Officer)






22