**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended December 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from                to                       **

**CommissionFile Number: 000-50786**

**STRATAGENE CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                    | ** ** | **33-0683641**       |
|-------------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of                |       | (I.R.S. Employer     |
| incorporation or  organization)                 |       | Identification  No.) |
| **11011 North Torrey Pines Road, La Jolla, CA** | ** ** | **92037**            |
| (Address of  principal executive offices)       |       | (Zip Code)           |

 

**(858) 373-6300**

(Registrant’s telephonenumber, including area code)

Securities registeredpursuant to Section 12(b) of the Act:

| **Common Stock, $.0001 par value** |   | **Nasdaq  Global Market**               |
|------------------------------------|--------|-----------------------------------------|
| (Title of class)                   |   | (Name of Exchange  on which Registered) |

 

Securities registeredpursuant to Section 12(g) of the Act: **None**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes £ No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Act. Yes £ No x

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes x No £

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. £

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act(Check one):

| Large accelerated filer £ |   | Accelerated filer £ |   | Non-accelerated  filer x |
|--------------------------------|--------|--------------------------|--------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes £ No x

As of June 30, 2006,the last day of the registrant’s second fiscal quarter of fiscal 2006, theaggregate market value of the common stock held by non-affiliates of theregistrant was approximately $55.0 million, based on the last reported saleprice on the preceding business day. Shares of common stock held by eachexecutive officer and director and by each person or group who owns 10% or moreof the outstanding common stock have been excluded in that such persons may bedeemed to be affiliates. This determination of affiliate status is notnecessarily a conclusive determination for other purposes.

The number of outstandingshares of the registrant’s common stock as of March 8, 2007 was22,454,488.

DOCUMENTSINCORPORATED BY REFERENCE: Certain information called for by Part III ofthis Form 10-K will either be filed with the Commission underRegulation 14A under the Securities Exchange Act of 1934 or by amendment tothis Form 10-K, in either case not later than 120 days after December 31,2006.

 

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**STRATAGENE CORPORATIONAnnual Report on Form 10-KTable of Contents**

|               | ** **                                                                                                         | **Page** |
|---------------|--------------------------------------------------------------------------------------------------------------------|----------|
| Part I.  |                                                                                                               |     |
| Item 1.       | Business                                                                                                           |     | 1 |
| Item 1A.      | Risk Factors                                                                                                       |     | 9 |
| Item 1B.      | Unresolved Staff Comments                                                                                          |     | 22 |
| Item 2.       | Properties                                                                                                         |     | 23 |
| Item 3.       | Legal  Proceedings                                                                                                 |     | 23 |
| Item 4.       | Submission of Matters to a Vote of Security Holders                                                                |     | 28 |
| Part II  |                                                                                                               |     |
| Item 5.       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |     | 29 |
| Item  6.      | Selected  Financial Data                                                                                           |     | 30 |
| Item 7.       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |     | 31 |
| Item 7A.      | Quantitative and Qualitative Disclosures about Market  Risk                                                        |     | 47 |
| Item 8.       | Financial Statements and Supplementary Data                                                                        |     | 49 |
| Item 9.       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |     | 89 |
| Item 9A.      | Controls and Procedures                                                                                            |     | 89 |
| Item  9B.     | Other  Information                                                                                                 |     | 89 |
| Part III |                                                                                                               |     |
| Item 10.      | Directors, Executive Officers and Corporate Governance                                                             |     | 90 |
| Item 11.      | Executive Compensation                                                                                             |     | 90 |
| Item 12.      | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |     | 90 |
| Item 13.      | Certain Relationships and Related Transactions, and  Director Independence                                         |     | 90 |
| Item 14.      | Principal Accountant Fees and Services                                                                             |     | 90 |
| Part IV  |                                                                                                               |     |
| Item 15.      | Exhibits and Financial Statement Schedules                                                                         |     | 91 |
| Signatures    |                                                                                                               | 94       |
| Schedule II   |                                                                                                               | 95       |
|               |                                                                                                                    |          |  |  |

 

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**PART I.**

**Item 1.   Business**

**Cautionary NoteRegarding Forward-Looking Statements**

ThisAnnual Report on Form 10-K includes “forward-looking statements”intended to qualify for the safe harbor from liability established by thePrivate Securities Litigation Reform Act of 1995. Some of the statements inthis Annual Report on Form 10-K, including, but not limited to,statements contained in the “Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” are forward-looking statements within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. These statements aretherefore entitled to the protection of the safe harbor provisions of theselaws. We generally identify forward-looking statements in this Annual Report byusing words such as “believe,” “intend,” “target,” “expect,” “estimate,” “may,”“should,” “plan,” “project,” “contemplate,” “anticipate,” “predict” or similarexpressions. You can also identify forward-looking statements by discussions ofstrategies, plans or intentions, among other things. These statements involveknown and unknown risks, uncertainties and other factors that may cause ouractual results, levels of activity, performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by these forward-looking statements. Thesefactors include the absence of a public market for our common stock prior tothe Hycor merger, the challenges of integrating our business with that of Hycor’s,our ability to introduce new products and the acceptance of these products bythe marketplace, competition, the inability to sell products as a result of thepossible termination of license agreements, fluctuations in operating results,dependence on key employees, our indebtedness, future capital requirements, thepossibility of unproductive research and development projects, ability tomanage growth, price volatility of our common stock, the impact of future salesof common stock on our stock price, potential declines in research anddevelopment budgets or funding, our ongoing ability to protect our ownintellectual property rights and avoid violating the intellectual property rightsof third parties, extended manufacturing difficulties and currencyfluctuations.

Althoughwe believe that the expectations reflected in our forward-looking statementsare reasonable, we cannot guarantee future results, events, levels of activity,performance or achievement. Any forward-looking statements are made pursuant tothe Private Securities Litigation Reform Act of 1995 and, as such, speak onlyas of the date made. We undertake no obligation to publicly update or reviseany forward-looking statements, whether as a result of new information, futureevents or otherwise, unless required by law.

**Overview**

Stratagene Corporation andsubsidiaries, which we refer to collectively as we, our or us, develop andmanufacture biological products, instruments and software designed to improvethe speed and accuracy of life sciences research and clinical diagnosis. Wemarket our products to researchers and clinicians in clinical laboratories andacademic, hospital and government institutions, as well as to scientists inpharmaceutical and biotechnology companies, in the U.S. and internationally.Scientists and clinicians use our products to identify genes and proteins,study how genes and proteins regulate cells, determine the molecular mechanismsof health and disease, search for new drug therapies, and develop diagnostictests.

We were incorporated inDelaware in November 1995 under the name Stratagene Holding Corporationand in 2003, we changed our name to Stratagene Corporation and amended ourArticles of Incorporation to reflect such name change. We engage in businessactivity in two operating segments: Research Supplies and Clinical Diagnostics.We have marketed and sold our Research Supplies products since 1984, while theClinical Diagnostics products are an addition to our product portfolio as aresult of a merger with Hycor Biomedical Inc., or Hycor, in June 2004.Hycor’s experience in manufacturing and marketing Food and Drug Administration,or FDA, regulated clinical diagnostic products also spans 20 years. (See Note 12to the Financial Statements for additional information on segments andgeographic areas in which we operate.)

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Our Research Supplies products incorporate a diverserange of molecular biology technologies used for gene transfer, gene andprotein expression, gene cloning, protein and gene functional analysis, nucleicacid and protein purification and analysis, microarrays, DNA replication andnucleic acid quantification. Our Clinical Diagnostics products focus on allergyand autoimmune testing and urinalysis. We manufacture our Research Suppliesproducts in our facility near Austin, Texas, and we manufacture our Diagnosticsproducts in our Garden Grove, California and Edinburgh, Scotland facilities.

Our ResearchSupplies segment offers a broad portfolio of products in each of the followingthree market categories:

·       *Gene Analysis:*Our gene analysis products,which accounted for 28.2%, 22.9%, and 38.1% of total revenue in 2006, 2005 and2004, respectively, help researchers study gene activity, variations within DNAand RNA compositions, and gene dosage. Other products within the category areuseful for the purification and amplification of nucleic acid sequences.

·       *QPCR Systems:*Our Quantitative PolymeraseChain Reaction products, or QPCR products, provide users with all necessaryreagents and equipment to perform QPCR. These products accounted forapproximately 22.9%, 16.0% and 20.4% of total revenue in 2006, 2005 and 2004,respectively.

·       *Protein Analysis and Cell Biology:*Ourprotein analysis and cell biology products help researchers study signalingpathways within and between cells and tissues; create, purify and measureproteins; and change the chemical composition of proteins. These productsaccounted for approximately 16.7%, 12.9% and 20.1% of total revenue in 2006,2005 and 2004, respectively.

Our ClinicalDiagnostics segment, which reflects sales from the date of the Hycor merger in June 2004and, accordingly, does not reflect a full year of results for fiscal 2004,offers products in the following areas:

·       *Allergy:*Our allergy diagnostic productline, which accounted for approximately 11.9%, 7.9% and 6.8% of total revenuein 2006, 2005 and 2004, respectively, is a complete line of radioimmunoassay,or RIA, and enzymatic immunoassay, or EIA, procedures to test for specificallergies to more than 1,000 different allergens such as grasses, weeds, trees,epidermals (i.e., animal hair), dust, dust mites, molds, and foods. We alsooffer general screening tests. Unlike the traditional prick puncture andintradermal testing methods of diagnosing allergies, our products permit aphysician to diagnose allergies by testing a sample of the patient’s blood forthe presence of the specific IgE antibody, which reacts with the correspondingallergen. This method has many advantages over the traditional methods ofallergy diagnosis, not the least of which is patient comfort.

·       *Urinalysis:*The KOVATM Urinalysis Systemaccounted for approximately 11.4%, 8.4% and 7.4% of total revenue in 2006, 2005and 2004, respectively. The KOVA System provides laboratories with thecapability to perform uniform and reliable microscopic analyses of urine specimensand quality control for bio-chemical urinalysis. It is comprised of plasticcollection containers, tubes and pipettes, patented microscopic slides, andhuman urine-based control materials.

·       *Autoimmune:*Our autoimmune diagnosticproduct line, which accounted for approximately 2.1%, 1.3% and 1.2% of totalrevenue in 2006, 2005 and 2004, includes tests used to diagnose and monitorautoimmune disorders such as rheumatoid arthritis and systemic lupuserythematosus, among others. Autoimmune diseases may be systemic ororgan-specific and we expect the need for this type of diagnostic testing toincrease as the population ages and primary care physicians learn more aboutautoimmune diseases. We base our tests on enzyme immunoassay technology in amicroplate format. Unlike traditional methods like immunofluorescence, whichrequires a dedicated and highly trained technologist to read slides manuallythrough a microscope one at a time, our products can automate this processeither on our HY-TEC instruments or on general microplate processors.

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Our allergy and autoimmune product lines also includethe HY-TEC 480 and HY-TEC 288 automated diagnostic systems that provideclinical laboratories with significant productivity improvement capabilities.The HY-TEC systems include the instruments, software, and test reagentsnecessary to perform allergy and autoimmune testing. We place a largepercentage of the HY-TEC systems on a “reagent rental” basis. A “reagent rental”transaction, common to the diagnostic market, involves placing an instrument inthe laboratories of customers that pay for the system over an agreed contractperiod by purchasing test reagents. Our HY-TEC reagent rental program issimilar in that we typically place instruments in use with direct customers thatpay for the instrument over an agreed contract period by purchasing testreagents, but also includes selling some instruments to distributors and directcustomers. The typical contract period for the HY-TEC reagent rental is between3 and 5 years. The instruments that we sell to distributors recognize a minimalgross profit to assist them with their instrument placements, with theexpectation that we will earn a profit on the subsequent sales of reagentsnecessary to operate the instrument.

We believe that ourcompetitive strengths position us to compete effectively within the lifesciences research and clinical diagnostics markets. These strengths includeinnovative product research and development, a diverse intellectual propertyportfolio, a dedication to quality and customer service, effective sales andmarketing, and an experienced management team.

**Research andDevelopment**

We believe that we have a strong scientific team. Asof December 31, 2006, our research and development department had 60employees, 19 of whom have Ph.Ds or M.Ds. Our employees actively stay abreastof scientific and industry developments in an effort to identify and acquireinnovative technologies from researchers and research institutions throughoutthe world. As of December 31, 2006, we owned approximately 210 patents andhad approximately 220 patent applications pending. We spent $12.5 million,$12.4 million and $10.8 million on proprietary research and developmentactivities during fiscal 2006, 2005 and 2004, respectively.

Our core strengths are inthe areas of molecular biology, including gene cloning, gene expression andgene detection, and the development of complex antigen-based clinicalimmunoassays. We have focused research groups in DNA replication factors,nucleic acid and protein purification, E. coli and mammalian genetics,polymerase chain reaction (PCR) and quantitative PCR (QPCR), proteomics, andmicroarrays.

**Sales and Marketing**

We currently market our products in over 60 countriesworldwide. We sell our products directly to customers in the U.S., Canada,Germany, France, Switzerland, Austria, Belgium, Luxembourg, the Netherlands,Japan, and the United Kingdom. In addition, we use specialized distributors tomarket our products in more than 50 other countries. As of December 31,2006, we employed 139 highly trained and skilled people in our sales andmarketing department to market our products and provide customer technicalsupport and service. Over 67% of our sales and marketing staff have degreeswith approximately 35% of those degrees in the biological sciences field, andover 20% of the sales and marketing staff have advanced degrees.

Our customers include most major pharmaceutical andbiotechnology companies, including Merck, Pfizer, Sanofi Aventis, Amgen andGenentech. We also serve academic research laboratories, including the UnitedStates National Institutes of Health, Harvard University, Stanford Universityand the University of California system, Max Planck Institut, CambridgeUniversity, Cancer Research UK, Institut Pasteur, and theRiken Institute in Japan. Additionally, we serve the two largest referencelaboratories in the United States, Quest Diagnostics and Laboratory Corporationof America (LabCorp). Quest Diagnostics 

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standardizes their memberand managed laboratories on our KOVA-Trol urinalysis controls, and we are theprime allergy testing vendor to LabCorp. As a result of our long history ofproviding products to the molecular biology research and diagnostics markets,we believe we enjoy a high degree of brand awareness.

Due to the highly technical nature of our products, weemploy and train scientists to work as technical sales representatives. Eachtechnical sales representative has an extensive background in molecularbiology, which includes spending time in the laboratory doing research beforewe hire them for the sales department. To guide the professional training ofour technical sales representatives, we developed a comprehensive producttraining and consultative selling skills curriculum called *Stratagene**University*. Technical sales representatives matriculatethrough a series of courses to increase their product knowledge and develop theskills necessary to assist customers in making informed buying decisions.Strong consultative skills, in-depth product knowledge and a thoroughunderstanding of molecular biology techniques and the research process allowour sales representatives to become advisors, acting in a consultative rolewith their customers. Our technical sales representatives also seek to identifyunmet market needs and opportunities for licensing and product development.

Our marketing departments in San Diego, California andGarden Grove, California combine various types of advertising media and methodsto inform customers of new product developments and enhancements to existingproducts. We advertise in many prominent scientific journals, periodicallypublish a product catalog, distribute quarterly *Strategies* newsletters and conduct direct and onlineelectronic mail campaigns to researchers in the U.S. and Europe. We also reacha broad range of scientists by presenting at scientific seminars and exhibitingat scientific meetings.

Our web site allowsresearchers to learn about new products, view an on-line catalog, place orders,download technical manuals and vector sequences, read our newsletter andsubscribe to monthly announcements about new products and other pertinentscientific information. We currently accept orders on-line and are working tomake our entire order fulfillment and billing processes available to ourcustomers electronically. As a result, we are able to support our customers asthey seek to shift their purchasing from current conventional procurementprocesses to e-commerce over the Internet.

**Manufacturing**

We maintain manufacturing facilities in Garden Grove,California, the Austin, Texas area and Edinburgh, Scotland. In June 2004,we decided to move our remaining manufacturing operations at the San Diegofacility to our Texas facility, which we completed in the second quarter of2005. Our Garden Grove and Edinburgh facilities support our ClinicalDiagnostics products, while our Texas facility supports our Research Suppliesproducts. We have distribution and warehouse facilities in Scotland, Germany,the Netherlands and Japan. We also provide instrument service capabilities inour sites in Texas and Germany. An integrated planning, purchasing andwarehousing system, which includes incoming materials inspection and qualityassurance testing, support our manufacturing at both the California and Texasfacilities. Our biological process improvement department within themanufacturing sector supports our new product introductions, and existingproduct and process improvements. All products must meet or exceed rigidquality control testing specifications.

Our Garden Grove and Edinburgh facilities areregistered as a manufacturer of medical devices with the FDA. To comply withFDA requirements, we must manufacture our Clinical Diagnostics products inconformance with the FDA’s medical device Quality System Regulation, also knownas Good Manufacturing Practices, or GMP. Our existing Clinical Diagnosticsproducts are also subject to certain FDA pre-market notification requirements.

Our Garden Grove,Edinburgh, and the Austin area facilities are also certified underInternational Organization for Standardization (ISO) 13485. ISO 13485 is thestandard specific to medical devices and requires high levels of quality in allareas of development, production and servicing. The requirements 

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includestringent detail and record retention of technical data, complaints andfollow-up, environmental monitoring, risk identification and analysis, andaccountability. ISO 13485 is globally recognized as a stringent standard ofquality management systems for medical devices.

**Patents andProprietary Technologies**

We consider the protection of our proprietarytechnologies and products to be important to the success of our business. Werely on a combination of patents, licenses, trade secrets and trademarks to establishand protect our proprietary rights in our technologies and products. Ourproduct portfolio includes many products in which we have a proprietaryinterest. As of December 31, 2006, we owned approximately 210 patents andhad approximately 220 patent applications pending. Additionally, we haveentered into over 65 licenses with academic, government or commercial entities,which provide us with access to additional technologies. To stimulate growth,we continued to invest in excess of 13% of product sales in research anddevelopment during each of fiscal 2006 and 2005 and in excess of 12% duringfiscal 2004. This investment in research and development is necessary tocontinue an accelerated rate of creating new intellectual property.

Generally, patents issued in the U.S. have a term of20 years from the date of filing the application in the case of patents issuedfrom applications submitted on or after June 8, 1995 and 17 years from thedate of issue for patents issued from applications submitted prior to June 8,1995. Patents in most other countries have a term of 20 years from the date offiling the patent application. Our material patents expire at various timesbetween 2010 and 2017. As the publication of discoveries in the scientificand/or patent literature tends to lag behind actual discoveries by at leastseveral months, there may be patent applications or scientific discoveries ofwhich we are not currently aware. Accordingly, we cannot assure you thatpatents will issue from any of our patent applications or from applicationslicensed to us.

Our success depends to asignificant degree upon our ability to develop proprietary products andtechnologies. It is important to our success that we adequately protect ourintellectual property associated with these products and technologies. Weintend to continue filing patent applications as we develop new products andtechnologies. Patents provide some degree of protection for our intellectualproperty. However, the assertion of patent protection involves complex legaland factual determinations and is therefore uncertain and expensive. See “RiskFactors—Inability to secure and maintain intellectual property protection forour products and technologies could adversely affect our ability to compete”and “—Intellectual property litigation could seriously harm our business.”

**CorporateCollaborations**

In December 2005, we entered into a strategicpartnership with Strand Life Sciences, or Strand, to develop a suite of nextgeneration bioinformatics software tools. Under the terms of the agreement,Strand and we collaborated on designing and developing innovative softwaretools to address the increasingly complex demands of biological data analysisfor life scientists. We exclusively market and sell the jointly developedproducts, which will use Strand’s award-winning avadisTM technology. Theagreements required us to make aggregate milestone payments of $0.9 million toStrand upon our acceptance of certain deliverables. Research and developmentexpense of $0.2 million and $0.6 million was recorded in the years ended December 31,2006 and  2005 respectively. Theadditional $0.1 million will be expensed in 2007. Also, the agreements requireus to make $1.5 million in minimum annual payments to Strand in the firsttwelve months after our first commercial sale or 60 days after our finalacceptance of the product. The first minimum annual payment period began on April 1,2006. We offset the $1.5 million minimum annual payments by $0.5 million of the$0.9 million milestone payments in the first twelve months of the payment term.The agreements also require us to make $1.7 million in minimum annual paymentsto Strand in the second twelve months.

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We also entered into a License, Manufacturing andSupply Agreement with privately-held Focus Diagnostics, Inc., or Focus, inOctober 2005, to address the growing molecular diagnostics market forinfectious diseases. Focus is a specialty diagnostics company that developsinnovative infectious disease products and is a leading reference laboratoryfor infectious and immunological diseases. Under the agreement, we have grantedFocus a non-exclusive license to our proprietary FullVelocity technology, andwill provide expertise and knowledge that Focus will use to develop selectedmolecular diagnostics testing kits and products. In exchange, Focus will pay usa royalty based on Focus’ sales of finished products. We will also manufacturethe diagnostic products which Focus intends to commercialize globally.Additionally, we will manufacture and sell reagents to Focus forlaboratory-developed tests to be used in Focus’ national reference laboratory.Focus was acquired by Quest Diagnostics Incorporated, or Quest, in July 2006.Quest is the leading provider of diagnostic testing, information and sciencesthat patients and doctors need to make better healthcare decisions.

We also entered into an agreement with the DiagnosticsDivision of Bayer HealthCare LLC, or Bayer, in December 2005, wherebyBayer will purchase a customized version of our Mx3005P instrument system foruse in a new platform Bayer is developing for performing molecular diagnosticstests worldwide. Bayer is currently developing a system to market to clinicallaboratories for performing kinetic PCR molecular diagnostics tests and will useour instruments as the QPCR instrument component of the system. Under the termsof the agreement, we will develop customized software and system features forBayer’s use. The agreement also calls for us to implement Quality SystemRegulations (QSR) and procedures under which we will manufacture the customizedMx3005P instruments for Bayer. Our facility in the Austin, Texas area, where wemanufacture the Mx3005P, is currently certified under ISO 13485 as ahigh-quality medical devices developer and manufacturer with technical andadministrative controls to assure safety and reliability under all regulatoryand customer requirements. We are receiving milestone payments based upon uscompleting software-based customization and regulatory activities needed tomeet Bayer’s clinical requirements.

We also entered into a Joint Development and LicenseAgreement with Rosetta Inpharmatics LLC (“Rosetta”) in July 2006, whereby weand Rosetta will work together to develop an RNA extraction product. Theproduct consists of a machine, a consumable cartridge, and a reagent pack thatfits in the machine. The cartridge contains the sample to be processed and themachine moves fluids from the reagent pack through the card in order to purifyRNA. The product will be used to get RNA profiles from clinical trialpatients.  Rosetta will pay us formilestones achieved during the development period. In the case of a successfulproduct, Rosetta will also pay us a royalty on our sales of finished productsto Merck (Rosetta’s parent company) and other third parties.

**TechnologyLicensing**

Products sold pursuant to license agreements accountedfor approximately 40% of our product sales in 2006. Under these agreements, wepay royalties to the licensor based upon a percentage of the sales of theproducts containing or using the licensed technology and/or intellectualproperty rights. We believe that our ability to license new technologies fromthird parties is and will continue to be important to our ability to offer newproducts.

There can be no assurance that we will be able tocontinue to successfully identify new technologies developed by others. Even ifwe are able to successfully identify new technologies of interest, we may notbe able to negotiate a license on favorable terms, or at all. See “Risk Factors—Failureto license new technologies could impair our new product development.” Some ofour licenses may not run for the life of the applicable patent. We may not beable to renew our existing licenses on favorable terms, or at all. If we loseour rights to patented or proprietary technology, we may need to redesign ourproducts or we may lose a competitive advantage. Potential competitors couldlicense technologies that we fail to license and 

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potentially erode ourmarket share for certain products. See “Risk Factors—We may not be able torenew our existing licenses, which could prevent us from selling some of ourproducts.”

**Competition**

The markets for ourproducts are highly competitive. We expect the intensity of competition toincrease. Our principal competitors in the Research Supplies segment include:

·       InvitrogenCorporation;

·       Takara/Clontech;

·       Sigma;

·       PromegaCorporation;

·       NewEngland Biolabs;

·       Qiagen;

·       RocheApplied Sciences (formerly Roche Molecular Systems);

·       Applera(formerly Applied Biosystems);

·       CorbettResearch; and

·       Bio-Rad.

Our Clinical Diagnostics product lines have severaldifferent competitors. The KOVA Urinalysis System has significant competitionfrom at least two national diagnostic product manufacturing and distributioncompanies that market products performing similar functions. We believe that weare the leading supplier of standardized microscopic urinalysis systems.

Phadia Inc., Siemens, Bio-Rad, Inova, and otherdiagnostics companies have products that compete with our allergy diagnosticand autoimmune products.

Many of our competitors have greater financial,operational and sales and marketing resources and more experience in researchand development than we do. These competitors and other companies may havedeveloped or could in the future develop new technologies that compete with ourproducts or which could render our products obsolete. See “Risk Factors—Themarkets for our products are extremely competitive and subject to rapidtechnological change and if we fail to compete effectively, our business maysuffer.”

We believe that customersin our markets display a significant amount of loyalty to their initialsupplier of a particular product. Therefore, there is a significant competitiveadvantage in being the first to introduce a new product to market. Accordingly,we believe that to compete effectively, we will need to consistently be firstto market with innovative new research products and services. See “Risk Factors—Ourfuture success depends on the timely introduction of new products and theacceptance of these new products in the marketplace.”

**GovernmentRegulation**

Our Research Supplies products are not subject todirect governmental regulation other than the laws and regulations generallyapplicable to businesses in the jurisdictions in which we operate, includingthose governing the handling and disposal of hazardous wastes and otherenvironmental matters. Our research and development activities involve thecontrolled use of small amounts of hazardous materials, chemicals andradioactive compounds. Although we believe that our safety procedures forhandling and disposing of such materials comply with applicable regulations, wecannot completely eliminate the risk of accidental 

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contamination or injuryfrom these materials. In the event of such an accident, we could be held liablefor resulting damages. Any such liability could have a material adverse effecton us. However, we do not expect that complying with governmental regulationsthat we are subject to will have a material effect on our capital expenditures,earnings or competitive position.

Government regulations directed towards containing thecost of medical services and limiting the amount of reimbursement to serviceproviders indirectly affects our Clinical Diagnostics products. These types ofregulations, which are applicable to both domestic and international markets,will tend to limit growth rates in our target markets for these products. Wedesigned our products, including the HY-TEC automated diagnostic system, toprovide a cost effective solution to service providers, thereby aiding in thecost containment efforts. However, we cannot predict the long-term effect onrevenue growth resulting from these regulations.

Our Garden Grove and Edinburgh facilities are eachregistered as a manufacturer of medical devices with the FDA. To comply withFDA requirements, we must manufacture our Clinical Diagnostics products inconformance with the FDA’s medical device Quality System Regulation, also knownas Good Manufacturing Practices, or GMP. Our existing Clinical Diagnosticsproducts are also subject to certain FDA pre-market notification requirements.

Receiving, using, and disposing radioactive materialsare subject to licensing requirements of the Nuclear Regulatory Commission, orNRC. We hold a radioactive materials license from the NRC for our radioactivelabeling activities, and the NRC periodically inspects our facilities.

We would be adverselyaffected if we were unable to maintain our governmental licenses or continue tocomply with applicable federal and state regulations, but we do not expect thisto occur. We cannot predict whether future changes in government regulationsmight substantially increase compliance costs, adversely affect the timerequired to develop and introduce products, or limit or preclude the sale ofour new products.

**Employees**

As of December 31,2006, we employed 453 persons, of whom 58 held Ph.D. or M.D. degrees. As ofthat date, 60 employees were engaged in research and development, 139 in salesand marketing, 137 in manufacturing and 117 in supporting business development,information services, intellectual property, legal, finance, human resourcesand other functions. We do not enter into collective bargaining agreements withour employees, and we believe that we maintain good relations with ouremployees.

**AvailableInformation**

You may electronically obtain all materials we filewith the Securities and Exchange Commission, or SEC, by visiting the SECinternet site, http://www.sec.gov. Additionally, you may obtain these materialsthrough the SEC’s Public Reference Room at 100 F Street, N.E., Washington,D.C. 20549 or by calling the SEC at 1-800-SEC-0330.

Our Internet address iswww.stratagene.com. We make available free of charge through our Internet website our annual report on Form 10-K, quarterly reports onForm 10-Q, current reports on Form 8-K and amendments tothose reports filed or furnished pursuant to Section 13(a) of theSecurities Exchange Act of 1934, as amended, as soon as reasonably practicableafter we electronically file such material with, or furnish it to, the SEC. Ourinternet address is not intended to function as a hyperlink, and theinformation therein is not and should no be considered part of this report andis not incorporated by reference in this document.

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**Item 1A.**   RiskFactors

It is important tocarefully consider the following risks, together with other matters describedin this Form 10-K or in other documents referred to in this Form 10-Kin evaluating our business and prospects. If any of the following risks occur,our business, financial condition or operating results could be harmed. In suchcase, the trading price of our common stock could decline. The risks describedbelow are not the only risks we face. Additional risks not presently known tous or that we currently deem immaterial may also impair business operations.

**Ourfuture success depends on the timely introduction of new products and theacceptance of these new products in the marketplace.**

Rapid technological change and frequent new productintroductions are typical for the markets we serve. Our future success willdepend in large part on continuing to develop and introduce new products in atimely manner that address evolving market requirements.

We believe successful new product introductions providea significant competitive advantage because customers make an investment oftime in selecting and learning to use new products and are reluctant to switchthereafter. To the extent that we fail to introduce new and innovativeproducts, we may lose market share to our competitors, which may be difficultto regain. Any inability, for technological or other reasons, to successfullydevelop and introduce new products could materially damage our business.

In the past we haveexperienced, and are likely to experience in the future, delays in developingand introducing products. We cannot assure you that we will keep pace with therapid rate of change in life sciences or clinical diagnostic research, or thatour new products will adequately meet the requirements of the marketplace orachieve market acceptance. Some of the factors affecting market acceptance ofnew products include:

·       availability,quality and price relative to competitive products;

·       thetiming of introducing the product relative to competitive products;

·       customers’opinions of the product’s utility;

·       citationof the product in published research; and

·       general trends in lifesciences and clinical diagnostics research.

**Themarkets for our products are extremely competitive and subject to rapidtechnological change. If we fail to compete effectively, our business maysuffer.**

The markets for ourproducts are highly competitive. We compete with many other suppliers of lifesciences research products and clinical diagnostic products. Many of ourcompetitors have greater financial, operational and sales and marketingresources and more experience in research and development than we do. Thesecompetitors and other companies may have developed or could in the futuredevelop new technologies that compete with our products or even render ourproducts obsolete. Competition in our markets is primarily driven by:

·       productperformance, features and reliability;

·       price;

·       timingof product introductions;

·       abilityto develop, maintain and protect proprietary products and technologies;

·       salesand distribution capabilities;

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·       technicalsupport and service; and

·       breadthof product line.

If a competitor develops or acquires superiortechnology or cost-effective alternatives to our products, our business, financialcondition and results of operations could be materially adversely affected.

Our competitors have in the past and may in the futurecompete by lowering prices. We may respond by lowering our prices, which couldreduce revenues and profits. Conversely, failure to anticipate and respond toprice competition may damage our market share. In addition, we must continuallyadapt to new marketing and distribution trends in order to compete effectively.

We believe that customersin our markets display a significant amount of loyalty to their initialsupplier of a particular product. Therefore, it may be difficult to make salesto customers who have previously purchased products from our competitors. Tothe extent we are unable to be the first to develop and supply new products,our competitive position may suffer.

**Wemay be prevented from selling some of our products if our existing licenseagreements are terminated.**

Approximately 40% of our product sales in 2006 wereattributable to products sold pursuant to license agreements. If we lose therights to use a patented technology, we may be forced to stop selling some ofour products or redesign our products and may lose significant sources ofrevenues. In addition, potential competitors could license technologies that wefail to license. Losing a significant license could have a material adverseeffect on our business.

Our licensesinclude:

·       alicense from Applera Corporation (which license was assigned to Applera fromHoffman La Roche and Roche Molecular Systems, Inc. in 2005) granting us,among other rights, the right to manufacture, promote and sell certain productsfor use in the research field in a process referred to as the “PCR process;”and

·       alicense from Applied Biosystems, which grants us rights to manufacture, promoteand sell thermal cyclers (certain laboratory instruments capable of generatingand maintaining specific temperatures for a defined period of time) undercertain patents for use in the research field.

Applera may terminate its license agreement (1) forcause, (2) if certain parties acquire more than 50% of the voting stock ofour subsidiary that is a party to the agreement, and (3) in the event ofour bankruptcy or insolvency. Since mid-2003 and through late 2005, wewithheld royalty payments to Applera under this license agreement pendingfurther evaluation of a potential overpayment of royalties paid to Applera inprior periods. During that period, we continued to record estimated quarterlyroyalties payable under this license agreement and report these amounts toApplera. We believe that we determine the royalties we calculate and accruesuch royalties in accordance with the terms of this patent license agreement.However, our royalty calculations are subject to review by Applera. Our financialposition or results of operations could be materially affected if the partiesdetermine that the royalties differ significantly from the amounts we haverecorded. Additionally, there can be no assurances that we will recover anyoverpayment in royalties paid in prior periods. The U.S. patents that coveredthe PCR process underlying this royalty obligation expired in March 2005.Certain of the corresponding foreign patents expired in 2006, while othersexpire in 2007. Upon expiration of these patents outside of the United States,we will no longer be required to pay royalties under these patents on futureproduct sales.

The agreement with Applied Biosystems may beterminated (1) for cause, (2) upon the change in control of oursubsidiary that is a party to the license agreement, and (3) in the eventof our bankruptcy or insolvency.

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We do not anticipate that either of these licenseagreements will terminate in the near future.

Our licenses typicallysubject us to various commercialization, sublicensing and other materialobligations. If we fail to comply with these requirements, we could loseimportant rights under a license, such as the right to exclusivity in aspecified market. In some cases, we could also lose all rights under a license.In addition, the licensor could lose patent protection for a number of reasons,including the invalidity or unenforceability of the licensed patent. Wetypically do not receive significant indemnification under such arrangementsfrom a licensor against third party claims of intellectual propertyinfringement.

**Becauseour quarterly revenue and operating results may vary significantly in futureperiods, our stock price may decline.**

Our operating results havefluctuated in the past and may continue to fluctuate in the future. Inparticular, we have historically seen slower sales in the fourth quarter as aresult of reduced purchases by academic and research institutions as well asthe closing of such facilities during the holiday period. Our revenues areunpredictable and may also fluctuate due to changes in demand for our products,delays in developing and introducing new products and new product introductionsby our competitors. A high proportion of our costs are fixed, due in part tosignificant research and development costs. Thus, small declines in revenuecould disproportionately affect operating results in a quarter and the price ofour common stock may decline. Moreover, a variety of factors may affect ourability to make accurate forecasts regarding our operating results. Because ofthese factors, our operating results in one or more future quarters may fail tomeet the expectations of securities analysts or investors, which could alsocause our stock price to decline.

**Ourfounder, chairman of our board of directors, chief executive officer andpresident exerts considerable control over our business.**

As of December 31,2006, Joseph A. Sorge, M.D., our founder, chairman of the board of directors,chief executive officer and president, beneficially owned approximately 59% ofour outstanding common stock. As a result, Dr. Sorge controls all mattersrequiring approval of our stockholders, including electing directors andapproving mergers or other business combinations. Such a concentration ofownership may have the effect of delaying or preventing transactions resultingin our change of control, including transactions where stockholders mightotherwise receive a premium for their shares over then current market prices.

**Wedepend substantially on key employees, and losing the services of any of ourkey employees or failing to hire qualified employees could seriously damage ourbusiness.**

To a large degree, we depend on our founder, chairmanof our board of directors, chief executive officer and president, Joseph A.Sorge, M.D. Dr. Sorge has significant expertise in the life sciencesresearch market and has been instrumental in establishing and executing ourbusiness plan. Losing Dr. Sorge’s services could have a material adverseeffect on our business. Dr. Sorge has an existing employment agreementwith us, which expires in June 2007, subject to automatic one yearrenewals unless either party provides timely notice of non-renewal. We maintaindirectors and officers insurance for the benefit of our officers and directors.In the second quarter of 2006, we purchased a key man life insurance policyinsuring Dr. Sorge with a face value of $10.0 million.

Because our products andservices are highly technical in nature, only highly qualified and trainedscientists have the necessary skills to develop and market our products andprovide our services. As such, our future success also will depend in largepart on the continued service of our key scientific and management personnel,including research and development, customer service, marketing and salesstaffs. We face intense competition for these professionals from ourcompetitors, our customers and other 

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companiesthroughout our industry. We do not generally enter into employment agreementsrequiring these employees to continue their employment for any period of time.Any failure on our part to hire, train and retain a sufficient number ofqualified professionals could seriously damage our business.

**Ourindebtedness could limit our ability to operate our business, obtain additionalfinancing and pursue other business opportunities.**

As of December 31,2006, we had approximately $3.8 million of outstanding indebtedness related toindustrial revenue bonds. In addition, we have a credit agreement with a lenderbut due to a default under the credit agreement at September 30, 2006 thelender has terminated the revolving credit facility portion of the creditagreement. There was no outstanding balance under this revolving creditfacility since December 2005. Our existing or future indebtedness couldhave negative consequences for us, including the following:

·       wewill need a portion of our cash flow to pay the principal and interest on ourindebtedness, including indebtedness we may incur in the future;

·       paymentsof our indebtedness will reduce the funds that would otherwise be available forour operations and future business opportunities;

·       wemay have greater relative debt burdens than our competitors, which may place usat a competitive disadvantage;

·       ourdebt level may make us more vulnerable than our competitors to a downturn inour business or the economy in general; and

·       there would be a materialadverse effect on our business and financial condition if we are unable toservice our indebtedness or obtain additional financing.

**Wemay not have financing for future capital requirements, which may have amaterial adverse effect on our business.**

Although historically our cash flow from operationshas been sufficient to satisfy working capital, capital expenditure andresearch and development requirements, in the future we may need to incuradditional debt or issue equity in order to fund these requirements as well asto fully pay outstanding judgments or litigation settlements or makeacquisitions and other investments. Our senior credit facility restricts ourability to incur new debt and our revolving credit facility has recently beenterminated. While we are seeking to obtain a new senior lender there is noassurance we will be able to obtain new senior financing on acceptable terms orat all. If we cannot obtain additional debt or equity financing on acceptableterms or if we are limited with respect to incurring additional debt or issuingequity, we may be unable to address gaps in our product offerings or improveour technology, particularly through strategic acquisitions or investments.

We may need toraise substantial amounts of money to fund a variety of future activitiesintegral to the development of our business, including, but not limited to, thefollowing:

·       forresearch and development to successfully develop additional products;

·       tofile and prosecute patent applications and defend and assert patents to protectour technology;

·       toretain qualified employees, particularly in light of intense competition forqualified scientists;

·       tomanufacture additional products ourselves or through third parties;

·       toacquire new technologies, products or companies; and

·       topay outstanding judgments or to fund litigation settlements.

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If we raise funds throughthe issuance of debt or equity, any debt securities or preferred stock issuedwill have rights, preferences and privileges senior to those of holders of ourcommon stock in the event of a liquidation. The terms of the debt securitiesmay impose restrictions on our operations. If we raise funds through theissuance of equity, this issuance would dilute the ownership interest of ourexisting stockholders. We expect to fund future acquisitions in part by issuingadditional equity. If the price of our equity is low or volatile, we may not beable to acquire other companies.

**Ourinability to secure and maintain intellectual property protection for ourproducts and technologies could adversely affect our ability to compete.**

Our success depends to a significant degree upon ourability to develop, maintain and protect proprietary products and technologies.We file patent applications in the United States and selectively in foreigncountries as part of our strategy to protect our proprietary products andtechnologies. However, patents provide only limited protection of ourintellectual property. The assertion of patent protection involves complexlegal and factual determinations and is therefore uncertain and expensive. Wecannot provide assurances that patents will be granted with respect to any ofour pending patent applications, that the scope of any of our patents will besufficiently broad to offer meaningful protection, or that we will developadditional proprietary technologies that are patentable. Our issued patents, orthird party patents that we license, could be successfully challenged,invalidated or circumvented. This could result in our patent rights failing tocreate an effective competitive barrier. Losing a significant patent or failingto get a patent to issue from a pending patent application that we considersignificant could have a material adverse effect on our business.

The laws governing the scope of patent coverage in theUnited States and abroad continue to evolve, particularly in the life sciencesarea. The laws of some foreign countries may not protect our intellectualproperty rights to the same extent as United States laws. We hold patents onlyin selected countries. Therefore, third parties can make, use and sell productscovered by our patents in countries in which we do not have patent protection.

We give our customers the right to use some of ourproducts for research purposes only under certain licenses. These licensescould be contested. Therefore, no assurances can be given that we would eitherbe aware of an unauthorized use or be able to enforce these license limitationsin a cost-effective manner.

We attempt to protect ourtrade secrets by entering into confidentiality agreements with employees,consultants and third parties. However, these agreements might be breached and,if they are, there may not be an adequate remedy available to us. Also, ourtrade secrets might become known to a third party through means other than bybreach of its confidentiality agreements, or they could be independentlydeveloped by our competitors. If our trade secrets become known, our businessand competitive position could be adversely affected.

**Weare currently, and could in the future be, subject to lawsuits, arbitrations,and other legal actions, particularly involving claims for infringement ofpatents and other intellectual property rights.**

We believe that we have meritorious defenses againstthe claims currently asserted against us and intend to defend them vigorously.However, the outcome of legal actions is inherently uncertain, and we cannot besure that we will prevail in any of these actions. An adverse determination insome of our current legal actions, particularly the cases described below,could have a material adverse effect on our business. Our products are based oncomplex, rapidly developing technologies. These products could be developedwithout knowledge of previously filed patent applications that mature intopatents that cover some aspect of these technologies. In addition, our beliefthat our products do not infringe the technology covered by valid andenforceable patents could be successfully challenged by third parties. We havefrom time to time been notified that we may be infringing patents and otherintellectual property rights of 

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others. Also, in thecourse of our business, we may from time to time have access to confidential orproprietary information of third parties, and these parties could bring a claimagainst us asserting that we had misappropriated their technologies and hadimproperly incorporated such technologies into our products. Due to thesefactors, there remains a constant risk of intellectual property litigationaffecting our business. We have been made a party to litigation involvingintellectual property matters. Such actions currently include the litigationsdescribed in the following paragraphs, some of which, if determined adversely,could have a material adverse effect on us. To avoid or settle legal claims, itmay be necessary or desirable in the future to obtain licenses relating to oneor more products or relating to current or future technologies, and we cannotbe certain that we will be able to obtain these licenses or other rights oncommercially reasonable terms.

We have been involved in significant patent disputeswith third parties, a number of which remain unresolved. For example, we areinvolved in litigation with Invitrogen Corporation regarding patents relatingto certain enzymes and competent cell products. The case went to trial on July 17,2006, and on July 25, 2006, the jury returned a verdict that one suchpatent was valid and that Stratagene’s infringement of the patent was willful. Thejury denied Invitrogen’s request for lost profits damages in the amount of $32million dollars but returned a verdict for a reasonable royalty of approximately$7.9 million, based on a 15% royalty rate. On October 31, 2006, the district courttrebled a portion of the $7.9 million that was related to sales made prior to November 2,2001 for a total award of $16.2 million plus attorneys’ fees and costs in anamount to be determined by the district court and pre-judgment interest. On November 15,2006, we filed a supersedeas bond in the amount of $11.5 million inorder to permit us to appeal the judgment of the district court without beingsubject to collection activities by Invitrogen. The appeal bond is secured by$11.5 million of cash in an interest-bearing restricted account.  In January 2007, the judge in the FederalDistrict Court ruled on the allowable attorneys’ fees and court costs in thecase, which totaled $2.1 million. The court also ruled that a $12.2 millionsupersedeas bond was appropriate in this case. We increased the bond amount to$12.2 million and funded the additional bond collateral from our existing cashbalances in January 2007. As of December 31, 2006, we have accrued$19.6 million related to this verdict, which is comprised of damages of $16.2million plus attorneys’ fees and costs of approximately $2.1 million andpre-judgment interest of approximately $1.3 million. Post-judgment interest atthe rate of approximately 5.05% compounded annually will accrue unless thejudgment is reversed. If we are ultimately required to pay out all or a portionof the $19.6 million of damages accrued for this matter upon an adversejudgment rendered by the court and affirmed on appeal, it would negativelyimpact our cash position. We currently have the ability to pay such damageaward with our existing cash resources.

We are also involved in litigation with AppleraCorporation regarding a patent that Applera alleges is infringed by ourreal-time PCR instrumentation and certain related reagents. In November 2004,we received notice of a patent infringement suit filed by Applera against usand other parties for alleged infringement of United States patent no.6,814,934. Since that time, the other parties have settled out-of-court withApplera. The details of those settlements are not known by Stratagene. Applerais seeking an outcome that would require Stratagene to license the Appleratechnology.

Applera had also filed an infringementaction against us in the Dusseldorf District Court in Germany relatingto EP patent 0 872 562, the European counterpart of the ‘934 patent. OnNovember 10, 2006, we filed our response to the complaint. The DusseldorfDistrict Court is currently scheduled to conduct a trial of this action in May 2007.The outcome of the trial is uncertain but if the Court were to find that weinfringe the patent, the Court could enjoin us from further sales of ourinstruments in Germany. An estimate of the possible loss or range of losscannot be made at this time and we are unable to determine whether the outcomeof the litigation could have a material impact on our results of operations,financial condition, or cash flows in any future period.

In addition, we are involved in litigation in theWisconsin Federal District Court with Third Wave Technologies regarding patentsrelating to certain assays for the detection of nucleic acids. In a trial in 

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August 2005, the juryreturned a verdict that the Third Wave patents-in-suit were valid and infringedby us, for monetary damages in the amount of $5.3 million, and that ourinfringement was willful. Based on the jury’s verdict, the district courtpermanently enjoined us from further infringement. The district court awardedThird Wave treble damages of $15.9 million, attorneys’ fees and costs in anamount of $4.2 million, pre-judgment interest of $0.5 million and $0.1 millionof additional court costs. We posted a $21.0 million civil supersedeas bond to staypayment of the judgment of the district court, and filed an appeal to theFederal Circuit Court of Appeals. In May 2005, we filed a lawsuit inDelaware against Third Wave for infringement of certain Stratagene patents.

In January 2007, we reached an out-of-courtsettlement with Third Wave for $10.75 million. Stratagene paid Third Wave$10.75 million in cash as full satisfaction for the judgment. The companiesalso have agreed to stay any further litigation for nine months. Stratagenealso dismissed without prejudice Stratagene’s lawsuit against Third Wave in theU.S. Court in Delaware. Stratagene and Third Wave have also agreed to a processto resolve that case or any other disputes through an agreement that enableseither company to elect to arbitrate a patent dispute or to resolve it througha royalty-bearing license. As result of the settlement, we adjusted our accrualfrom $20.7 million to $10.75 million at December 31, 2006. The settlementpayment was made with funds from the $21.0 million appeal bond in February 2007.

We are the plaintiff in litigation with InvitrogenCorporation regarding one of our patents relating to polymerase blend productsand a defendant in litigation with Invitrogen related to patents relating toRNase H minus reverse transcriptase products. As part of the patentinfringement claims in these matters, each party seeks monetary damages,injunctive relief and attorneys’ fees. As stated above, the outcome of any such litigation or appeal isinherently uncertain.

These cases are described in further detail in Note 11to our consolidated financial statements contained in Part I of thisreport. The cost of litigation and the amount of management time associatedwith these cases is significant. There can be no assurance that these matterswill be resolved favorably, that we will continue to be able to sell theproducts in question or other products as a result, or that any monetary orother damages assessed against us will not have a material adverse effect onour business. Even a successfuloutcome may take years to achieve and the costs associated with suchlitigation, in terms of dollars spent and diversion of management time andresources, could seriously harm our business.

Moreover, if a third partyclaims an intellectual property right to technology that we use, we may beforced to discontinue an important product or product line, alter our productsand processes, pay license fees, pay damages for past infringement or ceasecertain activities. Under these circumstances, we may attempt to obtain alicense to such intellectual property, but we may not be able to do so oncommercially reasonable terms, or at all.

**Wemay spend resources on research and development projects without being able toachieve an adequate return, if any, on our investment.**

It is important for us tocontinue to invest heavily in research and development. However, because wecompete in a relatively new and constantly evolving market, we may pursueresearch and development projects that do not result in viable commercialproducts. In addition, we have in the past, and may in the future, terminateresearch efforts in a particular area after we have made substantial initialfunding commitments in that area. Any failure to translate research anddevelopment expenditures into successful new product introductions could havean adverse effect on our business.

**Ourbusiness could suffer if we fail to manage our growth effectively.**

A significant portion ofour historical revenue growth is attributable to internal product development.We are one of the smaller companies in our industry, and therefore particularlydependent on internal invention and product development to replace olderproducts in our product line. Our ability to achieve 

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ourexpansion objectives and to manage our growth effectively depends upon avariety of factors, including our ability to internally develop products, toattract and retain skilled employees, to successfully position and market ourproducts and to identify and acquire technologies and intellectual propertyrights from third parties. In addition, we face significant challenges andrisks in building and managing our sales team, including managinggeographically dispersed sales efforts and adequately training our sales peoplein the use and benefits of our products. To accommodate our growth and competeeffectively, we will be required to improve our information systems, createadditional procedures and controls and expand, train, motivate and manage ourwork force. Our future success will depend in part on the ability of currentand future management personnel to operate effectively, both independently andas a group. We cannot be certain that our personnel, systems, procedures andcontrols will be adequate to support our future operations.

**Ourstock price could be adversely affected if we are unable to implement andmaintain effective internal control over financial reporting.**

Item 308 of Regulation S-K promulgated under Section 404of the Sarbanes-Oxley Act of 2002 requires that public companies annuallyevaluate the effectiveness of their internal control over financial reportingas of the end of each fiscal year, and include a management report assessingthe effectiveness of such internal control over financial reporting in allannual reports. Item 308 of Regulation S-K also requires that the independentaccountants of public companies attest to, and report on, management’sassessment of its internal control over financial reporting. The initialcompliance date with respect to these requirements depends on whether a companyis an “accelerated filer” as determined by Rule 12b-2 of theExchange Act. An “accelerated filer” must begin to comply with the rules regardingmanagement’s report on internal control over financial reporting for its firstfiscal year ending on or after November 15, 2004. The first managementreport for a “non-accelerated filer” must be provided for fiscal years endingon or after Dec. 15, 2007, with the first auditor’s report on internalcontrol due one year later. “Accelerated filer” status is measured as of theend of each fiscal year and is determined in part on whether the aggregatemarket value of the common equity of a company held by non-affiliates of suchcompany is $75.0 million or more measured as of the last business day of thecompany’s most recently completed second fiscal quarter.

We are not an “accelerated filer” as of December 31,2006 because the aggregate market value of our common stock held bynon-affiliates as of June 30, 2006 was not equal to or greater than $75.0million. However, we will not be able to determine if we will be subject to therules regarding the auditor’s report on internal control over financialreporting for the fiscal year ending December 31, 2007 until June 30,2007. If the aggregate market value of our common stock held by ournon-affiliates as of June 30, 2007 is equal to or greater than $75.0million, then we will become an “accelerated filer” effective as of December 31,2007 and will be required to comply with the rules regarding management’sreport and the auditor’s report on internal control over financial reportingfor fiscal 2007. Conversely, if the aggregate market value of our common stockheld by non-affiliates as of June 30, 2007 is less than $75.0 million,then we will continue to be a “non-accelerated filer” for fiscal 2007 and willbe required to comply with the rules regarding management’s report oninternal control over financial reporting for the fiscal year ending December 31,2007 and the first auditor’s report will be required for the fiscal year endingDecember 31, 2008. Notwithstanding the extension of this compliance date,we are currently making efforts to prepare ourselves to be able to comply withsuch requirements. These efforts include documenting, evaluating the design,and testing the effectiveness of our internal control over financial reporting.During this process, we expect to make improvements in the design and operationof our internal control over financial reporting, including furtherformalization of policies and procedures, improved segregation of duties andadditional monitoring of controls.

Our management, including our Chief Executive Officerand our Chief Financial Officer, cannot guarantee that our internal controlover financial reporting will prevent all errors and all fraud. A control 

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system, no matter how welldesigned and operated, can provide only reasonable, not absolute, assurancethat the control system’s objectives will be met. Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs. Because ofthe inherent limitations in all control systems, no evaluation of controls canprovide absolute assurance that all control issues and instances of fraud, ifany, within our company have been, or will, be detected. These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and we cannot assure you that any design willsucceed in achieving its stated goals under all potential future conditions.Over time, controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures. Becauseof the inherent limitations in a cost-effective control system, misstatementsdue to error or fraud may occur and not be detected.

We cannot assure you thatwe or our independent registered public accounting firm will not identify amaterial weakness in our internal control over financial reporting. A materialweakness in our internal control over financial reporting would requiremanagement and our independent registered public accounting firm to evaluateour internal control over financial reporting as ineffective. If our internalcontrol over financial reporting is not considered adequate, we may experiencea loss of public confidence, which, among other things, could have an adverseeffect on our business and our stock price.

**The price of ourcommon stock is expected to be volatile.**

The market price ofour common stock may be subject to significant fluctuations. These fluctuationsmay occur, among other reasons, in response to:

·       quarterlyfluctuations in our operating and earnings per share results;

·       technologicalinnovations or new product introductions by us or our competitors;

·       delaysin developing and introducing new products;

·       disputesconcerning patents, licenses or other proprietary rights;

·       changesin earnings estimates by equity and market research analysts;

·       salesof common stock by existing stockholders;

·       lossof key personnel; and

·       securitiesclass actions or other litigation affecting us or other companies in ourindustry.

Any failure to meetanalysts’ expectations could have an adverse effect on the market price for ourcommon stock. In addition, the stock market is subject to extreme price andvolume fluctuations. This volatility has had a significant effect on the marketprices of securities issued by many companies for reasons unrelated to theoperating performance of these companies. In the past, following periods ofvolatility in the market price of a company’s securities, securities classaction litigation has often been instituted against that company. If similarlitigation were instituted against us, it could result in substantial costs anda diversion of our management’s attention and resources, which could have anadverse effect on our business, financial condition and results of operations.In addition, we cannot predict the extent to which investors’ interest in uswill lead to a liquid trading market in our common stock.

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**Futuresales of currently outstanding shares of our common stock could adverselyaffect our stock price.**

As of December 31, 2006, we had approximately22.5 million shares of common stock outstanding. We have entered into aregistration rights agreement with Dr. Sorge and certain of his affiliatespursuant to which, at the request of Dr. Sorge and subject to specifiedconditions, we will file a registration statement under the Securities Actcovering 2,000,000 shares of our common stock held by Dr. Sorge andspecified trusts and partnerships controlled by Dr. Sorge. Dr. Sorgeand such trusts and partnerships are also entitled to register the remainingapproximately 11.2 million shares of our common stock held by them in specifiedsituations. The shares held by Dr. Sorge and such trusts and partnershipsmay also be sold from time to time in the public market subject to therequirements of Rule 144 under the Securities Act.

In addition, on June 8, 2006, Dr. Sorgeestablished a stock trading plan in accordance with the guidelines of Rule 10b5-1of the Securities and Exchange Act of 1934. SEC Rule 10b5-1 allowsexecutive officers, directors and other insiders to individually adoptpre-arranged, structured stock trading plans when they are not in possession ofmaterial non-public information. Once these plans are adopted, the officers anddirectors have no discretion over the timing, price or terms of any sales madepursuant to such plans. The transactions under the plan will be disclosedpublicly through Form 4 filings and will be subject to the restrictionsand filing requirements mandated by Rule 144 of the U.S. Securities Act of1933. Under Dr. Sorge’s 10b5-1 plan, Dr. Sorge may sell sharesof our common stock at prevailing market prices (but not below a predeterminedminimum price of $9.00 per share and subject to other restrictions). The totalnumber of shares subject to Dr. Sorge’s plan is 876,000. These sales areexpected to take place periodically on a monthly basis through June 2007. Thesale by our current stockholders of a substantial number of shares, or theexpectation that such sales may occur, could significantly reduce the marketprice of our common stock.

We have also registeredthe shares of common stock that we may issue from time to time under our employeebenefits plans. As a result, these shares can be freely sold in the publicmarket upon issuance, subject to restrictions under the securities laws. If anyof our stockholders cause a large number of securities to be sold in the publicmarket, the sales could reduce the trading price of our common stock. Thesesales also could impede our ability to raise future capital.

**Reductionsin research and development budgets or government funding may impact our sales.**

Fluctuations in the research and development budgetsof our customers could have a significant effect on the demand for ourproducts. Research and development budgets fluctuate due to changes inavailable resources, spending priorities and institutional budgetary policies.Our business could be seriously damaged by any significant decrease in researchand development expenditures by pharmaceutical and biotechnology companies,academic institutions or government and private laboratories.

A substantial portion of our sales have been toresearchers at universities, government laboratories and private foundationswhose funding is dependent upon grants from government agencies, such as theUnited States National Institutes of Health. Although we are not aware of anyimpending reductions in governmental grants, government funding of research anddevelopment is subject to the political process and as a result the amount ofavailable funding may decrease. Our sales may be adversely affected if ourcustomers delay purchases as a result of uncertainties surrounding the approvalof government budget proposals. A reduction in government funding for theNational Institutes of Health or other government research agencies couldseriously damage our business.

In recent years, the pharmaceutical and biotechnologyindustries have undergone substantial consolidation. Further mergers orcorporate consolidations in these industries could cause us to lose existingcustomers and potential future customers. Pharmaceutical and biotechnologycompanies have generally raised little money in the past few years, and someare low on funds. Some of these companies 

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have begun to reduce theirresearch and development budgets in recent years. It is possible that thesebiotechnology and pharmaceutical companies will continue to reduce spending onresearch and development in the future and some companies may go out ofbusiness entirely. In addition, health care reform and other changes in theregulatory environment affecting these industries could have an adverse impacton research and development expenditures by pharmaceutical and biotechnologycompanies, which would negatively impact our business.

Our academic customersgenerally receive funds from approved grants at particular times of the year,as determined by the government. Grants have in the past been frozen forextended periods or have otherwise become unavailable to various institutionswithout advance notice. The timing of the receipt of grant funds affects thetiming of purchase decisions by our customers and, as a result, can causefluctuations in our sales and operating results.

**Failureto license new technologies could impair our new product development.**

In order to meet the needs of our customers, we mustdevelop a broad spectrum of products. To develop a product line, it is sometimesadvantageous or necessary to license technologies from third parties.Approximately 40% of our product sales for 2006 were attributable to productsmanufactured or sold under licenses from third parties. As a result, we believeour ability to license new technologies from third parties is and will continueto be important to our ability to offer new products.

From time to time, we are notified or become aware ofpatents held by third parties that are related to technologies we are sellingor may sell in the future. After consideration of these patents, we may attemptto obtain a license for these technologies. We can give no assurances that wewill be able to negotiate such licenses on commercially reasonable terms, or atall.

Our ability to gain accessto technologies necessary to develop new products depends, in part, on ourability to convince third parties that we can successfully commercialize theirtechnologies. We can give no assurances that we will be able to continue toidentify new technologies developed by others or that we will be able tonegotiate appropriate licenses on commercially reasonable terms, or at all.

**Wemay acquire other businesses or form joint ventures that could decrease ourprofitability, dilute your ownership, increase our debt or cause us to incursignificant expense.**

As part of our business strategy, we intend to pursueacquisitions of other complementary businesses and technology licensingarrangements. We also intend to pursue strategic alliances that leverage ourcore technology and industry experience to expand our product offerings andgeographic presence. We have limited experience with respect to acquiring othercompanies and limited experience with respect to forming collaborations,strategic alliances and joint ventures. If we were to make any acquisitions, wemay not be able to integrate these acquisitions successfully into our existingbusiness and we could assume unknown or contingent liabilities. Any futureacquisitions we make could also result in large and immediate write-offs or theincurrence of debt and contingent liabilities, any of which could harm ouroperating results. Integrating an acquired company also may require managementresources that otherwise would be available for ongoing development of our existingbusiness. We may not identify or complete these transactions in a timelymanner, on a cost-effective basis, or at all, and we may not realize theanticipated benefits of any acquisition, technology license or strategicalliance. In addition, existing and future collaborations, strategic alliancesand joint ventures may be impacted by acquisitions or other factors beyond ourcontrol relating to our collaboration, strategic alliance or joint venturepartners.

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**Changesin distribution and purchasing methods by our customers may force us to usemore expensive marketing and distribution channels.**

A number of our customers have developed purchasinginitiatives to reduce the number of vendors they purchase from in order tolower their supply costs. In some cases, these customers have establishedagreements with large distributors, which include discounts and thedistributors’ direct involvement with the purchasing process. These activitiesmay force us to supply these large distributors with our products at a discountto continue to reach our customers. For similar reasons, many of our largercustomers, including the government, have requested and may in the futurerequest special pricing arrangements, including blanket purchase agreements. Todate, we do not believe that these special pricing arrangements have had amaterial effect on either revenues or margins. However, in the future theseagreements may limit our pricing flexibility, which could adversely impact ourbusiness, financial condition and results of operations. In addition, if welose one or more of our distributors and cannot arrange suitable alternatives,our business could be adversely affected.

Several of our customershave requested that we sell our products through third party, e-commerce websites. While this trend does not seem to be growing, offering our productsthrough these web sites generally requires us to agree to offer volume-relateddiscounts and pay commissions on the sales made through these web sites tothese third party e-commerce providers. Consequently, margins on sales madethrough these third party web sites would generally be lower than those onsales made through traditional channels. Our business may be harmed as a resultof these web sites or other sales methods that may be developed in the future.

**Werely on third party manufacturers for raw materials and product components.**

We rely on thirdparty manufacturers to supply many of our raw materials and product components.Some of these components are only available from a single supplier or a limitedgroup of suppliers, either because the market for these components is too smallto support multiple suppliers or because the components are protected bypatents, in which case there may only be a single supplier for the coveredcomponents. Our reliance on outside vendors generally, and a sole supplier or alimited group of suppliers in particular, involves several risks, including:

·       aninability to obtain an adequate supply of required components due tomanufacturing capacity constraints, the discontinuance of a product by athird-party manufacturer, or an acquisition of the manufacturer by one of ourcompetitors or other supply constraints;

·       delaysand long lead times in receiving materials from vendors; and

·       reducedcontrol over quality and pricing of components.

If a sole source thirdparty supplier were to go out of business, we might be unable to find areplacement for such source or it might take us several months to be able tomake the substance or component internally. If a sole source third partysupplier were to be acquired by a competitor, that competitor may elect not tosell to us in the future.

**Adversedevelopments affecting our international operations or foreign currencyfluctuations could harm our results from operations.**

Including salesmade by our subsidiaries and distributors, our products are currently marketedin over 60 countries throughout the world. Measured in U.S. dollars, ourrevenue outside the United States for the twelve months ended December 31,2006 was approximately 32%. In addition, approximately 19% of our total salesfor the twelve months ended December 31, 2006 were for products exportedfrom the United States. We expect that international sales will continue toaccount for a significant percentage of our 

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revenuesfor the foreseeable future, in part because we intend to expand ourinternational operations. There are a number of risks arising from ourinternational business, including:

·       difficultiesand costs associated with staffing and managing foreign operations;

·       unexpectedchanges in regulatory requirements;

·       thedifficulties of compliance with a wide variety of foreign laws and regulations;

·       morelimited protection for intellectual property rights in some countries;

·       changesin our international distribution network and direct sales force;

·       potentialtrade restrictions and exchange controls;

·       importand export licensing requirements;

·       longeraccounts receivable collection cycles in certain foreign countries; and

·       potentialincreased costs associated with overlapping tax structures.

A significant portion ofour business is conducted in currencies other than the U.S. dollar, which isour reporting currency. We recognize foreign currency gains or losses arisingfrom our operations in the period incurred. As a result, currency fluctuationsamong the U.S. dollar and the currencies in which we do business couldadversely affect our results of operations. We cannot predict the effects ofexchange rate fluctuations upon our future operating results because of thenumber of currencies involved, the variability of currency exposures and thepotential volatility of currency exchange rates. In the past, we have engagedin foreign currency exchange hedging transactions to manage our foreign currencyexposure, but we cannot assure you that our future strategies will adequatelyprotect our operating results from the effects of exchange rate fluctuations.

**Ouractivities involve hazardous materials and may subject our business to costlyenvironmental liability.**

We use hazardousmaterials, including phenol, chloroform and ethanol, and radioactive isotopesin connection with our research and development activities, as well as in ourmanufacturing processes and in evaluating the performance of various products.We are subject to federal, state and local laws and regulations governing theuse, manufacture, storage, handling and disposal of these materials andspecified waste products. We cannot completely eliminate the risk of accidentalcontamination of property or injury to individuals from these materials. In theevent of such an accident, we could be liable for any damages that result,which could have a material adverse effect on our business, financial conditionand results of operations. We carry insurance for contamination resulting fromusing hazardous materials with $25,000 limitations per incident with respect topollution clean-up and removal and radioactive contamination. Additionally, anyaccident could partially or completely shut down our research and manufacturingfacilities and operations. We may also have to incur substantial costs tocomply with current or future environmental laws and regulations.

**Interruptionsin our manufacturing operations could adversely impact our ability toeffectively operate our business.**

We maintain manufacturingfacilities in Garden Grove, California, in the Austin, Texas area, and inEdinburgh, Scotland. Damage to these facilities due to fire, earthquake orother natural disaster, power loss, unauthorized entry or other events couldcause an interruption in producing our products. We do not have or plan toobtain earthquake insurance. In late 1999 and early 2000 we opened amanufacturing facility outside of Austin, Texas and moved 100 jobs to thatlocation. During the transition process, we lost some key personnel who wereimportant to certain manufacturing processes. As a result, we were unable 

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tomanufacture certain products for a period of three to six months. Many of thecustomers who wanted to purchase the affected products during this periodswitched to other suppliers and we found it difficult to reacquire thesecustomers once we were able to manufacture the products again. Accordingly, webelieve that a prolonged interruption in our manufacturing operations couldhave a material adverse impact on our ability to effectively operate ourbusiness.

**Wecould incur substantial unexpected expenses, experience product returns andsuffer damage to our brand and reputation if our biological products andinstruments are not properly produced or manufactured.**

Our biological productsand instruments are complex and may be improperly produced or manufactured. Inthe past, we have voluntarily recalled several of our products. In each case,we identified and corrected the problem. If we need to recall our products, wecould experience decreased sales and loss of customers and market share. Inaddition, a recall would divert managerial and financial resources and couldharm our reputation with customers.

**Ourbusiness could suffer if our access to necessary tissue samples is restrictedor ethical concerns surrounding the use of genetic information becomewidespread.**

We require access to humanand other tissue samples and other biological materials to continue to developour products. We compete with many other companies for these materials and maynot be able to obtain or maintain access to these materials on acceptableterms, or at all. In addition, genetic testing has raised ethical issuesregarding confidentiality and the appropriate use of the resulting information.Governmental regulation in the United States and foreign countries could limitaccess to, or use of, human and other tissue samples or restrict the use of, orregulate, genetic testing. If we lose access to sufficient numbers or sourcesof tissue samples, or if tighter restrictions are imposed on our customers’ useof the information generated from tissue samples, our business could suffer.

**Anti-takeoverprovisions of our certificate of incorporation and bylaws and provisions ofDelaware law could delay or prevent a change of control that you may favor.**

Provisions of our amended and restated certificate ofincorporation and amended and restated bylaws may discourage, delay or preventa merger or other change of control transactions that stockholders may considerfavorable or may impede the ability of the holders of our common stock tochange our management. The provisions of our amended and restated certificateof incorporation and amended and restated bylaws, among other things, authorizeour board of directors to issue preferred stock in one or more series, withoutstockholder approval.

Because we have not chosen to be exempt from Section 203of the Delaware General Corporation Law, this provision could also delay or preventa change of control that you favor. Section 203 provides that, subject tolimited exceptions, persons that acquire, or are affiliated with a person thatacquires, more than 15 percent of the outstanding voting stock of a Delawarecorporation shall not engage in any business combination with that corporation,including by merger, consolidation or acquisition of additional shares, for athree-year period following the date on which that person or its affiliatecrosses the 15 percent ownership threshold.

Additionally, because Dr. Sorgeowns approximately 59% of the Company’s outstanding common stock, he controlsall matters requiring approval of our stockholders. As a result, among otherthings, Dr. Sorge must approve any merger or other business combinationrelated to our company.

**Item 1B.   Unresolved Staff Comments**

None.

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**Item 2.   Properties**

At December 31, 2006,we had the following facilities:

*Owned Facilities*

·       Weown approximately 42 contiguous acres in the Austin, Texas area, where during1998 and 1999 we constructed an 85,000 square foot facility to support productmanufacturing activities, warehousing and distribution of our Research Suppliesproducts.

·       We also own anapproximately 6,000 square foot facility in Jackson, Wyoming, operatedexclusively for research and development activities.

*Leased Facilities*

·       SanDiego, California—This facility is approximately 47,000 square feet and servesas our company’s headquarters, as well as our base for marketing and productsupport operations and research and development activities. The lease for thisfacility expires in September 2008 and we have the right to renew thislease for an additional five-year period.

·       GardenGrove, California—This approximately 76,000 square foot facility is where wemanufacture our Clinical Diagnostics products. The lease for this facility hasa ten-year term and expires in December 2007, and we have a right to renewthis lease for an additional five-year period.

·       Amsterdam,the Netherlands—This facility is approximately 7,300 square feet and supportsEuropean sales and distribution of our Research Supplies products. The leasefor this facility expires in August 2007. We are currently negotiating anew lease.

·       Tokyo,Japan—There are two small facilities to support sales and distribution channelsin Asia. The leases for these facilities cover approximately 3,300 square feetof space and expire in July 2007 and February 2008.

·       Kassel,Germany—This facility is approximately 12,900 square feet and is used forpackaging, warehousing, and distributing our Clinical Diagnostics products. Thelease for this facility expires in March 2009.

·       Edinburgh,Scotland—This facility is approximately 7,000 square feet and supports researchand development, manufacturing, warehousing, and distributing of our ClinicalDiagnostics products. The lease for this facility expires in September 2011.We have the right to extend this lease for an additional five-year period.

In our opinion, ourfacilities and equipment are adequately maintained, in good operating conditionand adequate for our present needs. We upgrade and modernize our facilities andequipment and expand our facilities as necessary to meet customer andregulatory requirements.

**Item 3.   Legal Proceedings**

We are a party tolitigation in the ordinary course of business. Due to the uncertaintiesinherent in litigation, no assurances can be given as to the outcome of theseproceedings. If any of these matters were resolved in a manner unfavorable toour company, our business, financial condition, results of operations, and cashflows could be materially harmed. Additionally, favorable outcomes or gaincontingencies that may result from these matters, if any, are not recognizeduntil they are realized. Information on the most significant of these mattersfollows.

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***Invitrogen Corporation***

In June 2000, we were sued by InvitrogenCorporation (formerly Life Technologies, Inc.) in the United StatesDistrict Court for the District of Maryland. The complaint alleges that wewillfully infringed United States patent no. 6,063,608 (and United Statespatent nos. 5,244,797 and 5,405,776) for making, using and selling productsderived from, using or containing RNase H minus reverse transcriptase enzymes.Invitrogen’s motion for a preliminary injunction was denied and the case wasstayed pending a trial in a related action involving Invitrogen and a thirdparty regarding the same patents. Invitrogen appealed the denial of aninjunction and the stay to the Federal Circuit Court of Appeals. In February 2002,the Federal Circuit Court of Appeals affirmed the district court’s decision.The case against us remains administratively stayed.

In March 2001, we were sued by InvitrogenCorporation in the United States District Court for the Western District ofTexas (Austin). The complaint alleged (1) that we willfully infringedUnited States patent no. 4,981,797 for making, using and selling competent *E. coli*cell products and (2) forlost profits and/or reasonable royalty damages of up to approximately $22.0million. In November 2001, the district court granted our motion forsummary judgment, finding that we did not infringe the ‘797 patent. Invitrogenappealed the judgment to the Federal Circuit Court of Appeals which, in May 2003,reversed the district court’s decision in part and remanded the case forfurther proceedings. In January 2004, on remand from the Federal CircuitCourt, the district court determined on Invitrogen’s motion for partial summaryjudgment that we infringed the ‘797 patent based on our then existingmanufacturing process and further held on partial summary judgment, that whilethe ‘797 patent was not invalid for indefiniteness, the ‘797 patent was invalidbecause of public use under 35 U.S.C. § 102(b). Invitrogen appealed thedistrict court’s ruling of invalidity, and oral arguments were heard before theFederal Circuit Court of Appeals in May 2005. In October 2005, theFederal Circuit Court reversed the district court’s summary judgment ofinvalidity due to public use, affirmed the district court’s partial summaryjudgment of infringement, affirmed the district court’s denial of summaryjudgment of invalidity due to indefiniteness, and remanded the case for furtherproceedings. Invitrogen admitted that our current manufacturing processes donot infringe the ‘797 patent and that there is no claim for an injunction. Thecase went to trial on July 17, 2006, and on July 25, 2006, the juryreturned a verdict that the ‘797 patent was valid and that our infringement ofthe patent was willful. The jury denied Invitrogen’s request for lost profitsdamages in the amount of $32 million dollars but returned a verdict for areasonable royalty of approximately $7.9 million, based on a 15% royalty rate.

On October 31, 2006, the district court awardedInvitrogen $16.2 million plus attorneys’ fees and costs in an amount to bedetermined by the district court and pre-judgment interest. The district courtfirst adjusted a portion of the $7.9 million jury award and then trebled aportion of the award that was related to our sales of the allegedly infringingproducts made prior to November 2, 2001. We believe that the jury’sverdict and the damages awarded by the district court were not supported by thefacts of the case or the law and as a result, we have appealed the decision. Inappealing the jury’s verdict and the court’s subsequent post trial rulings, wewill be challenging the finding of validity of the patent, the appropriatenessof the damages determined by the jury, the trebling of a portion of the amountby the court and the award of attorney’s fees. We had previously modified ourprocess for manufacturing competent E. coli cell products and, as a result,Invitrogen has agreed that our products sold in recent years and currentlyoffered for sale will not be affected by the jury verdict. The jury found thatInvitrogen was not entitled to lost profits because we have had anon-infringing manufacturing process for competent cells.

In November of 2006, we filed a supersedeas bondin the amount of $11.5 million in order to permit us to appeal the judgment ofthe district court without being subject to collection activities byInvitrogen. On January 10, 2007, the district court issued an orderestablishing the attorney’s fees and costs at $2.1 million and fixed thesupersedeas bond amount at $12.2 million. In January 2007, we funded thebond to 

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the approved amount of$12.2 million for the term of the appeal. The bond is secured by $12.2 millionof cash in an interest-bearing restricted account.  The $12.2 million amount for the supersedeasbond is comprised of the $7.5 million compensatory portion of the amended juryverdict, plus estimated attorneys fees and costs of $2.1 million, pluspre-judgment interest of $1.5 million and post-judgment interest of $1.1million.

In considering whether to record a loss contingency and,if so, an amount, we considered the guidance provided by FASB Statement ofFinancial Accounting Standards (“SFAS”) No. 5, *Accounting for Contingencies,*and FASB Interpretation No. 14(As Amended), *Reasonable Estimation of theAmount of a Loss, an Interpretation of FASB Statement No. 5*.SFAS No. 5 requires an accrual to be made when a loss is probable andestimable. We have now accrued an aggregate of $19.6 million in expense for thejudgment awarded in this matter. We accrued $7.9 million for this matter in thesecond quarter of 2006 based on the jury verdict. We accrued an additional$12.5 million in the third quarter of 2006 based upon the court judgment. Theaccrual was then reduced by $0.8 million in the fourth quarter of 2006 basedupon the adjustment to estimated legal fees and court costs by the court. The$19.6 million accrual includes total damages of $16.2 million, attorneys’ feesand costs of $2.1 million, and pre-judgment interest of $1.3 million. Although we have appealed the district courtjudgment to the Federal Circuit Court of Appeals, we have accrued $19.6million, as we believe that we have met the conditions for accrual as stated inSFAS No. 5. Post-judgment interest at the rate of approximately 5.05%compounded annually will be applied to the compensatory portion of the damagesand will be accrued against our earnings until the matter is resolved.

In November 2001, wefiled a complaint in the United States District Court for the District ofMaryland charging Invitrogen Corporation with willful infringement and inducingothers to infringe United States patent no. 5,556,772 for making, using,selling and offering for sale certain polymerase blend products. We seek apermanent injunction against continued infringement as well as monetary damages(compensatory and enhanced) and recovery of our attorneys’ fees and costs.Given the nature of patent litigation, at the present time we are unable toquantify the amount of remuneration we will ultimately seek in this proceedingor the likelihood of recovering any portion of such remuneration oncequantified. Pursuant to a stipulation of the parties, the case is presentlyadministratively stayed and no trial date is currently set for this case. Wehave been advised by the United States Patent Office of its Notice of Intent toIssue Reexamination Certificate. The parties have agreed to a schedule tocomplete discovery and for trial to begin once the reexamination certificateissues.

***Takara Bio***

In November 2002, wefiled a complaint in the United States District Court for the District ofMaryland charging Takara Bio with willful infringement of and inducing othersto infringe United States patent no. 5,556,772 for making, using, selling andoffering for sale certain polymerase blend products. We and Takara Bio have nowreached a mutually beneficial settlement resolving the district courtlitigation and a patent interference proceeding in the U.S. Patent &Trademark Office. We believe the principal financial effect of the settlementwill be the avoidance of the costs and risks of continued litigation. Further,potential disputes in the future will be avoided through cross-licenses of theparties’ respective patent rights relating to enzyme blends.

***Third Wave Technologies***

In September 2004, we were sued by Third WaveTechnologies, Inc., or Third Wave, in the United States District Court forthe Western District of Wisconsin. The complaint alleged that we infringedUnited States patent nos. 6,348,314 and 6,090,543, and have induced orcontributed to infringement of the patents-in-suit, by making, using,importing, offering for sale and/or selling assays employing cleavage ofnucleic acids, including at least our FullVelocity products. Third Wave soughta preliminary and 

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permanent injunction,monetary damages (compensatory and enhanced), and recovery of its attorneys’fees and costs. In October 2004, we filed our answer to the complaintresponding that we did not infringe a valid or enforceable claim of eitherpatent. We also asserted affirmative defenses, including invalidity andunenforceability, and counterclaims of invalidity and non-infringement. Wesought an award of our fees and costs incurred in defending ourselves in thisaction. A jury trial commenced on August 22, 2005. The jury returned averdict that the patents-in-suit were valid and infringed by us. Additionally,the jury returned a verdict for monetary damages in the amount of $5.3 millionand that our infringement was willful. Based on the jury’s verdict, thedistrict court permanently enjoined us from making, advertising, promoting theuse of, selling, offering to sell, using, permitting to be used, contributingto the use, sale or offering for sale of, or inducing the use, sale or offeringfor sale the FullVelocity QPCR and FullVelocity QRT-PCR products, or any otherproduct used in a method that meets all of the limitations of any of theasserted claims. On December 19, 2005, the district court awarded ThirdWave treble damages of $15.9 million, attorneys’ fees and costs in an amount tobe determined by the district court and pre-judgment interest. In January 2006,we posted a $21.0 million civil supersedeas bond to stay payment of thejudgment of the district court, and filed an appeal to the Federal CircuitCourt of Appeals. In December 2005, we accrued $20.6 million in expensefor the judgment awarded in this matter. This amount included total damages of$15.9 million, attorneys’ fees and costs of $4.2 million, and pre-judgmentinterest of $0.5 million. In March 2006, Third Wave was awarded an additional$0.1 million for other court costs, bringing the total award to $20.7 million. Thedistrict court’s award was appealed to the Federal Circuit Court of Appeals andthe arguments were heard on December 7, 2006.

In January 2007, we reached an out-of-courtsettlement with Third Wave for the Wisconsin case for $10.75 million. We agreedto pay Third Wave $10.75 million in cash as full satisfaction for the judgment.The companies also have agreed to stay any further litigation for nine months.We have also agreed to a process to resolve that case or any other disputesthrough an agreement that enables either company to elect to arbitrate a patentdispute or to resolve it through a royalty-bearing license. As a result of thesettlement agreement, we adjusted our accrual from $20.7 million to $10.75million at December 31, 2006. The settlement payment was made with fundsfrom the $21.0 million appeal bond in February 2007.

In May 2005, we fileda complaint in the United States District Court for the District of Delawarecharging Third Wave Technologies with willful infringement of and inducingothers to infringe United States patent nos. 6,528,254 and 6,548,250 formaking, using, selling and offering for sale certain of its Invader® Plus products. We were seeking a permanentinjunction against continued infringement as well as monetary damages(compensatory and enhanced) and recovery of our attorneys’ fees and costs. Inconnection with the settlement of the Third Wave vs. Stratagene matters in January 2007,we also dismissed without prejudice Stratagene’s lawsuit against Third Wave in the U.S. Court in Delaware.

***Applera Corporation***

In November 2004, we received notice of a patentinfringement suit filed by Applera Corporation against us and other parties inthe United States District Court for the District of Connecticut for allegedinfringement of U.S. patent no. 6,814,934. The Stratagene products alleged toinfringe are the Mx4000 and Mx3000P instruments and certain related reagents.In December 2004, we filed our answer to the complaint responding that wedo not infringe, directly or indirectly, any valid and enforceable claim of the‘934 patent and asserting related counterclaims of invalidity andnon-infringement. In April 2006, the court held a Markman hearing andissued its claim construction. Thereafter, the parties entered into anagreement to stay further discovery and motions pending the outcome ofsettlement negotiations between the parties. This agreement has now expired anddiscovery is again proceeding while the parties continue their negotiations. Anestimate of the possible loss or range of loss cannot be made at this time andwe are unable to determine whether the outcome of the litigation could have amaterial impact on our results of operations, financial condition, or cashflows in any future period.

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In June 2005, wereceived notice that Applera had filed an infringement action against usin the Dusseldorf District Court in Germany relating to EP patent 0 872562, the European counterpart of the ‘934 patent. By decision of theOpposition Division of the European Patent Office dated January 7, 2005,the ‘562 patent was revoked. Based upon that revocation, we moved to staythe district court proceedings in July 2005. That motion was granted. On July 7,2006, an appellate panel of the European Patent Office reversed the revocationdecision of the Opposition Division and remanded the case back to theOpposition Division for further consideration of additional invalidity grounds.Applera moved to lift the stay in the Dusseldorf District Court. The courtgranted the motion and the proceedings have resumed. On November 10, 2006,we filed our response to the complaint. The Dusseldorf District Court iscurrently scheduled to conduct a trial of this action in May 2007. Theoutcome of the trial is uncertain but if the Court were to find that weinfringe the patent, the Court could enjoin us from further sales of ourinstruments in Germany. An estimate of the possible loss or range of losscannot be made at this time and we are unable to determine whether the outcomeof the litigation could have a material impact on our results of operations,financial condition, or cash flows in any future period.

***Ariadne Genomics***

In March 2005, wefiled a demand for arbitration with the American Arbitration Association, orAAA, against Ariadne Genomics, Inc., or Ariadne, for declaratory reliefand damages relating to the Exclusive Marketing and Distribution Agreement, orthe Agreement, executed in December 2002 between the parties. Ariadnefiled counterclaims in the AAA, which we denied. The parties have now reachedan amicable settlement of this matter. In October 2005, we and Ariadneexecuted a Binding Settlement Agreement Term Sheet, or the Term Sheet, toresolve all of the disputes, and the parties are in the process of completing acomprehensive Settlement Agreement. In brief, the settlement memorialized inthe Term Sheet provides that our exclusive right to market, sell and distributethe software products covered by the Agreement between the parties has beenconfirmed, and that the term of that Agreement has been extended through December 31,2005. In addition, Ariadne agreed to pay us a sum of $300,000 by December 31,2005, which has now been paid. All proceedings between the parties will bedismissed with prejudice, and all disputes in the United States Patent &Trademark Office will be dismissed by agreement. After executing the TermSheet, we and Ariadne entered into negotiations for a comprehensive settlementagreement, but have been unable to resolve certain remaining issues. Pursuantto the Term Sheet, any remaining disputes regarding the settlement or theparties’ claims against each other are to be submitted to binding arbitrationbefore a single neutral arbitrator in San Diego County. That arbitrationoccurred on February 27, 2006. The arbitration decision was rendered on March 20,2006, which affirmed and interpreted the parties’ Term Sheet and requiredcertain actions on the part of both parties, none of which involved the paymentof any amounts to the other party. Ariadne then filed a request that thearbitration award be revised or amended. The arbitrator declined to do so in aruling on April 19, 2006, declaring that the previous arbitration awardwas final and would not be changed.

***Bio-Rad Laboratories, Inc.***

On November 20, 2006,we filed a complaint in the United States District Court for the SouthernDistrict of California for patent infringement against Bio-Rad Laboratories, Inc.,MJ GeneWorks, and MJ Research, Inc. (both subsidiaries of Bio-Rad) forwillful infringement of United States Patent Nos. 6,054,263, 5,779,981,5,288,647, and 5,395,591, which are owned by Stratagene. We seek monetarydamages (compensatory and enhanced), attorneys’ fees and costs and aninjunction. Stratagene is presently exploring settlement with Bio-Rad and hasagreed not to formally serve the complaint pending these discussions.

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***Other Legal Matters***

Pursuant to the terms of a 2002 litigation settlement,we were entitled to receive 35,290 shares of a European company. We received11,763 shares in August 2004, 11,764 shares in September 2004 and thefinal 11,763 shares in March 2005. These shares were sold and convertedinto cash upon receipt, resulting in a gain in other income of approximately$530,000 during the quarter ended March 31, 2005 and $664,000 during thequarter ended September 30, 2004.

During 2005, we paid $2.9 million in legal fees to anoutside law firm that represented us in a litigation matter that was triedbefore a jury. In 2006, we ended our attorney/client relationship with thisfirm and indicated that we may pursue claims for damages against the outsidelaw firm. The outside law firm indicated that it may adjust billing creditspreviously applied to payments made through the third quarter of 2005 in theamount of $1.1 million. We believe that we have fairly stated our legalexpenses in 2005 and 2006 after considering these unresolved issues. As of December 31,2006, accrued but unpaid legal fees amounted to $1.0 million.

In October, 2005 werealized pre-tax income of approximately $34.1 million from a settlement withCambridge Antibody Technology related to certain patent rights. This $34.1million was offset by a $10.7 million royalty obligation related to thissettlement due to a third party. The amount due related to the third party hasnot been settled and remains accrued as of December 31, 2006.

**Item 4.   Submission of Matters to a Vote ofSecurity Holders**

During the fourth quarter of the fiscal year ended December 31,2006, there were no matters submitted to a vote of security holders.

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**PART II.**

**Item 5.   Marketfor Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases of EquitySecurities**

***Market Price of Common Stock***

Ourcommon stock trades on The Nasdaq Stock Market’s National Market under thesymbol “STGN”. The following table sets forth the range of high and low tradingprices for the common stock for the periods indicated as reported on the NasdaqNational Market. The prices do not include retail markups, markdowns, orcommissions and may not represent actual transactions.

| ** **                          | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------|------------|----------|------------|---------|------------|
| Year ended  December 31, 2006: |       |     |       |    |       |
| Fourth quarter                      |       | $        | 7.74       |    | $          | 6.07 |   |
| Third quarter                       |       | $        | 7.70       |    | $          | 3.98 |   |
| Second quarter                      |       | $        | 11.41      |    | $          | 5.51 |   |
| First quarter                       |       | $        | 11.00      |    | $          | 9.50 |   |
| Year ended  December 31, 2005: |       |     |       |    |       |
| Fourth quarter                      |       | $        | 10.93      |    | $          | 8.67 |   |
| Third quarter                       |       | $        | 10.33      |    | $          | 6.42 |   |
| Second quarter                      |       | $        | 10.44      |    | $          | 7.25 |   |
| First quarter                       |       | $        | 8.83       |    | $          | 6.51 |   |

 

On March 8, 2007, the last reported sale of ourcommon stock on the Nasdaq National Market was $8.52. There were 759stockholders of record as of March 8, 2007 with 22,454,488 sharesoutstanding. The aforementioned number of stockholders of record as of March 8,2007 does not reflect persons or entities that hold their stock in nominee or “street”name through various brokerage firms. No dividends have been paid to ourstockholders during the past five years except for a special cash dividend of$0.25 per share to holders of record of our common stock paid on January 6,2006. The special cash dividend was paid in connection with the recognition ofapproximately $23.4 million in pre-tax income in the fourth quarter of 2005 dueto a settlement related to our licensing certain technology to CambridgeAntibody Technology. We have no intentions of paying any subsequent cashdividends in the foreseeable future. Our credit facilities also restrict thepayment of dividends, and we received a consent from the credit facility holderto pay the January 6, 2006 dividend.

Prior to June 2, 2004, our financials werepresented on a combined basis with BioCrest Holdings, LLC, or BCH, since BCHwas in common control with Stratagene and substantially all of the BCHmembership units were held by certain Stratagene shareholders. The members ofBCH did receive distributions. However, since we acquired the BCH assets on June 2,2004, no further distributions have been made. On February 9, 2006, wedissolved BCH.

Our 2007 Annual Meeting ofShareholders is scheduled to be held on May 31, 2007 at 9:00 a.m. atthe Stratagene offices on 11011 North Torrey Pines Road, La Jolla, CA 92037.

***Performance Graph***

The following graphcompares the cumulative total stockholder return on our Common Stock since June 17,2004 (the date on which we began “regular way trading” two weeks following ourmerger with Hycor on June 2, 2004) to the Nasdaq Market Index (U.S.) andthe Nasdaq Pharmaceutical Index. The graph assumes that the value of theinvestment in our Common Stock and each index was $100 at June 17, 

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2004,and that all dividends were reinvested. The stock price performance shown on thefollowing graph is not necessarily indicative of future performance.

**Comparison ofCumulative Total Return**

| ** **                   | ** ** | **6/17/04** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |
|------------------------------|------------|-------------|------------|--------------|------------|--------------|------------|--------------|------------|
| Conversion  Dollars:         |       |        |       |         |       |         |       |         |       |
| Stratagene Corporation       |       | $           | 100.00     |         | $          | 94.63        |       | $            | 122.59     |   | $ | 90.84 |   |
| Nasdaq Market Index (U.S.)   |       | 100.00      |       | 109.77       |       | 112.10       |       | 123.18       |       |
| Nasdaq  Pharmaceutical Index |       | 100.00      |       | 105.88       |       | 116.58       |       | 114.15       |       |
|                              |            |             |            |              |            |              |            |              |            |  |  |  |  |

 

**Item 6.   SelectedFinancial Data**

Thefollowing selected historical consolidated financial data as of and for thefiscal years ended December 31, 2006, 2005, 2004, 2003 and 2002, presentedbelow under the captions “Operating Results” and “Financial Position,” havebeen derived from our audited consolidated financial statements as of thosedates and for those periods. The selected historical consolidated financialdata and notes should be read in conjunction with “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and our consolidatedfinancial statements.

| ** **                                        | ** ** | **Year Ended December 31,**                         | ** ** |
|---------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                        | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                        | ** ** | **(In thousands, except per share data)** | ** ** |
| **Operating Results**                             |       |                                                               |       |   |   |   |   |   |   |   |   |
| Total revenue(a)                                  |       | $                                                                  | 95,557     |   | $ | 130,285 |   | $ | 84,813 |   | $ | 69,703 |   | $ | 64,512 |   |
| Operating income  (loss)(b)                       |       | (1,432                                                             | )          | 11,173 |   | 10,135 |   | 9,830 |   | 3,933 |   |
| Net income                                        |       | 59                                                                 |       | 7,788 |   | 7,438 |   | 3,252 |   | 505 |   |
| Basic earnings  per share(c)                      |       | 0.00                                                               |       | 0.35 |   | 0.39 |   | 0.21 |   | 0.03 |   |
| Diluted earnings  per share                       |       | 0.00                                                               |       | 0.35 |   | 0.39 |   | 0.21 |   | 0.03 |   |
| Weighted average  shares outstanding—basic   |       | 22,389                                                             |       | 22,113 |   | 19,308 |   | 15,633 |   | 15,634 |   |
| Weighted average shares  outstanding—diluted |       | 22,444                                                             |       | 22,259 |   | 19,313 |   | 15,633 |   | 15,634 |   |
|                                                   |            |                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                                    | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Financial Position**                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Working capital                               |       | $                                          | 21,632     |   | $ | 18,942 |   | $ | 17,899 |   | $ | 9,485 |   | $ | 6,172 |   |
| Net property and  equipment                   |       | 10,927                                     |       | 11,267 |   | 12,112 |   | 10,321 |   | 11,186 |   |
| Total assets(d)                               |       | 129,576                                    |       | 124,682 |   | 80,332 |   | 38,588 |   | 34,198 |   |
| Total debt                                    |       | 3,775                                      |       | 9,515 |   | 9,707 |   | 30,381 |   | 30,469 |   |
| Total stockholders’  equity (deficit)(e) |       | 61,117                                     |       | 58,490 |   | 55,160 |   | (5,947 | ) | (8,248 | ) |
|                                               |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(a)           2005 total revenueincludes a royalty revenue settlement of $34.1 million from a third party.

(b)          2006 and 2005 includes$9.8 million and $20.6 million of litigation charges related to the Third Waveand Invitrogen cases, respectively. See Item 3. *LegalProceedings* for more information.

(c)           Earnings per shareinformation for the years ended December 31, 2002 and 2003 has beencalculated assuming our acquisition of substantially all of the assets of BCHhad occurred at the beginning of the first period presented, by dividing therespective net income by the weighted average shares of our common stock forthe respective period.

(d)          2006 through 2004 totalassets include goodwill of approximately $27.2 million resulting from themerger with Hycor in June 2004.

(e)           Afterdistributions to BCH members of $476,280, $544,707, and $809,909 for the yearsended December 31, 2004 through 2002, respectively. 2005 includes therecognition of the special cash dividend of $5,571,321 that we paid on January 6,2006, which was declared on November 7, 2005.

**Item 7.   Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

*The followinginformation should be read in conjunction with the financial statements and therelated notes included in Item 8 of Part II of this Annual Report on Form 10-Kand with the financial statements. Our financial information includes theaccounts and balances of Stratagene Corporation and subsidiaries on aconsolidated basis, and includes the results of operations of Hycor BiomedicalInc. and subsidiaries since our acquisition of Hycor on June 2, 2004.*

*This “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and other sections of thisAnnual Report on Form 10-K contain forward-looking statements andinclude assumptions concerning our operations, future results and prospects.These forward-looking statements are based on current expectations and aresubject to a number of risks, uncertainties and other factors. Our actualresults could differ materially from those expressed in or implied by theseforward-looking statements as a result of various factors, including those setforth under “Risk Factors” in Item 1A of Part 1 of this Annual Report on Form 10K.*

**Overview**

We develop and manufacture biological products,instruments and software designed to improve the speed and accuracy of lifesciences research and clinical diagnosis. We market our products to researchersand clinicians in clinical laboratories and academic, hospital and governmentinstitutions, as well as to scientists in pharmaceutical and biotechnologycompanies, in the U.S. and internationally. Scientists and clinicians use ourproducts to identify genes and proteins, study how genes and proteins regulatecells, determine the molecular mechanisms of health and disease, search for newdrug therapies, and develop diagnostic tests.

We engage in businessactivity in two operating segments: Research Supplies and Clinical Diagnostics.We have marketed and sold our Research Supplies products for over 20 years,while the Clinical 

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Diagnosticsproducts are a new addition to our product portfolio as a result of the mergerwith Hycor Biomedical Inc. in June 2004. Hycor’s experience inmanufacturing and marketing Food and Drug Administration, or FDA, regulatedclinical diagnostic products also spans 20 years.

**Merger with Hycor**

On June 2, 2004, weacquired all of the outstanding shares of Hycor Biomedical Inc. through amerger of a wholly owned subsidiary of our company with Hycor, with Hycorcontinuing as a wholly owned subsidiary of ours. Pursuant to the merger, Hycor’sstockholders received 0.6158 of a share of our common stock in exchange foreach share of Hycor common stock, plus cash for any fractional shares. Themerger has been recognized as a tax-free reorganization. We filed aregistration statement on Form S-4 (No. 333-109420) andrelated amendments in connection with the transaction, which registrationstatement was declared effective by the Securities and Exchange Commission on April 29,2004. We incurred merger-related costs of approximately $1.7 million, whichwere capitalized as a component of the purchase price.

**BCH AssetAcquisition**

Concurrently with the closing of the Hycor merger, weacquired substantially all of the assets of BCH, including BCH’s interests inits subsidiaries. In exchange, we forgave all of the outstanding intercompanyindebtedness owed by BCH and its subsidiaries to us of approximately $5.4million and assumed all of the other outstanding liabilities of BCH and itssubsidiaries of approximately $0.8 million. Because we and BCH were undercommon control, with substantially all of the BCH membership units held bycertain of our shareholders, the acquisition of BCH was recorded on ahistorical cost basis. As such, there was no adjustment of BCH’s assets andliabilities to fair value and no goodwill resulting from the purchase. As ofand for the year ended December 31, 2004, our financial statements arepresented on a consolidated basis. There was no change to income for previousperiods presented on a combined basis. For income tax purposes, thistransaction was taxable. The financial statements in 2004 reflected netdeferred tax assets of $875,000 for differences between the tax and book basesof assets and liabilities that we acquired. With the completion of the initialconsolidated tax returns in 2005, we adjusted the deferred tax asset associatedwith the acquired assets and liabilities and reflected a reduction ofapproximately $514,000 to the net deferred tax asset and additional paid-incapital in accordance with SFAS No. 109, *Accountingfor Income Taxes.*

Prior to the acquisition date, we presented ourfinancial statements on a combined basis with BCH. BCH was a limited liabilitycompany treated as a partnership for income tax purposes; therefore, anyrelated income tax obligations were the responsibility of the members of BCH.As a result, the operations of BCH did not reflect a provision for income taxesin the combined financial statements. Beginning on June 2, 2004, ourconsolidated results, which includes the results of BCH, includes a provisionfor income taxes.

As part of the acquisition of BCH, we acquired BCH’sinterests in its subsidiaries, which include Phenogenex, LLC, or Phenogenex, IobionInformatics, LLC and subsidiaries, which we refer to collectively as Iobion,and an investment in a joint venture consisting of a 49% interest in a limitedpartnership, which we refer to as the LP, that operates a research lab. Theinvestment in a joint venture was accounted for under the equity method. In December 2004,the LP redeemed our rights and interests in the LP.

At the time of the BCH acquisition, we owned 100% ofPhenogenex and approximately 78% of Iobion. The remaining 22% interest inIobion was held by two individuals, neither of which is now associated with theCompany.. In October 2004, we purchased the remaining 22% outstandingmembership interests in Iobion owned by these individuals. As a result of thepurchase of these minority interests, we now own 100% of Iobion. Total cashconsideration of $330,000 was paid and was recorded to intangible assets based onthe fair value of the assets and liabilities acquired.

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During 2005, we mergedIobion and Phenogenex into us, leaving only the Iobion Informatics (Canada),Ltd. subsidiary remaining, and on February 9, 2006, we dissolved BCH.There was no financial statement impact to this merger or dissolution.

**Basis of Presentation**

Our financial information has been presented on aconsolidated basis, and includes the results of operations of Hycor BiomedicalInc. and subsidiaries since we acquired Hycor on June 2, 2004. Thefinancial information also includes the results of operations of BCH, whoseassets we acquired on June 2, 2004 and accordingly is presented on aconsolidated basis for all periods (See Note 3 to financial statements).

**Critical AccountingPolicies and Estimates**

Our consolidated financialstatements are prepared in accordance with accounting principles generallyaccepted in the United States of America and management is required to makecertain estimates, judgments and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the periods presented. Thesignificant accounting policies that we believe are the most critical to aid infully understanding and evaluating its reported financial results include thefollowing:

***Use of Estimates***

Preparing the financialstatements in conformity with accounting principles generally accepted in theUnited States requires management to make estimates and assumptions that affectthe amounts reported in the consolidated financial statements and disclosuresmade in the accompanying notes. Actual results could differ from thoseestimates.

***Revenue Recognition***

We recognize revenue from research supplies,diagnostic and basic instrumentation product sales under the provisions ofStaff Accounting Bulletin, or SAB, No. 104, *Revenue Recognition,*which is generally when we ship ourproducts, transfer title and eliminate our risk of loss. In accordance withStatement of Position, or SOP, No. 97-2, *Software Revenue Recognition*, as amended by SOP No. 98-9,for instrumentation products where software is considered more than incidentalto the product, we recognize revenue when persuasive evidence of an arrangementexists, delivery has occurred, the sales price is fixed or determinable andcollectibility is probable. Generally, these criteria are met at the time weship the product and transfer the title. When substantive contractualacceptance clauses exist, we recognize revenue upon satisfaction of suchclauses. We record amounts received in advance of performance or acceptance asdeferred revenue.

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Thefollowing table summarizes the types of deferred revenue and the timing of whenwe recognize that revenue:

| **Type of deferred revenue**                      | ** ** | ** **                                                                                                                                                                                                                               | ** ** | **When recognized** |
|---------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|
| Extended warranty or maintenance agreements       |       | Recognized over the term  of the contract, generally 12 months. In most cases, these contracts were  sold at the time of product purchase and the recognition of revenue begins  after the warranty period, which is generally one year. |
| License agreements                                |       | Recognized over  the term of the agreement, generally 12 months.                                                                                                                                                                         |
| Collaboration  agreements—milestone payments |       | Recognized over the  period that the specified services or products are delivered and accepted by  the customer.                                                                                                                         |

 

Thefollowing table provides the percentage of the ending balance in deferredrevenue that each type of deferred revenue represents as of December 31,2006 and 2005:

| **Type of deferred revenue**               | ** ** | ** ** | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|------------|
| Extended  warranty, installation or maintenance agreement |       |       | 41         | %                           |       |                        | 59         | % |   |
| License  agreements                                       |       |       | 23         | %                           |       |                        | 41         | % |   |
| Collaboration  agreements—milestone payments         |       |       | 36         | %                           |       |                        | 0          | % |   |
| Total deferred revenue                                    |       |       | 100        | %                           |       |                        | 100        | % |   |

 

Some of our agreements contain multiple elements.Emerging Issues Task Force (“EITF”) No. 00-21, *Revenue Arrangements with Multiple Deliverables,*provides guidance on accounting for arrangements that involve the delivery orperformance of multiple products, services, or rights to use assets withincontractually binding arrangements. We recognize revenue for delivered elementsin accordance with SAB No. 104 and our revenue recognition policy onlywhen we determine that the earnings process is complete and all events forrecognition of contract revenue have been achieved.

Some of our agreementsalso contain milestone payments. Revenue from a milestone achievement isrecognized when earned, as evidenced by acknowledgement from our collaborator,provided that (i) the milestone event is substantive, (ii) themilestone represents the culmination of an earnings process, (iii) themilestone payment is non-refundable and (iv) there are no furtherperformance obligations on the part of Stratagene. If all of these criteria arenot met, the milestone achievement is recognized over the remaining minimumperiod of our performance obligations under the agreement.

***Accounts Receivable***

We perform ongoing creditevaluations of our customers and adjust credit limits based upon paymenthistory and the customer’s current creditworthiness. We regularly monitorcollections and payments from customers and maintain a provision for estimatedcredit losses based upon historical experience and any specific customercollection issues that have been identified. Our credit losses havehistorically been within expectations and the provisions established.

***Inventories***

We value inventories at the lower of the actual costto purchase and/or manufacture the inventory or the current estimated marketvalue of the inventory. Cost is determined on a first-in, first-out basis. We 

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regularly review inventoryquantities on hand and record a provision for excess and obsolete inventory onspecifically identified items based primarily on an estimated forecast ofproduct demand and production requirements. Our losses from disposal of excessor obsolete inventory have historically been within expectations and theprovisions established. However, our estimates of future product demand mayprove to be inaccurate, in which case we may have understated or overstated theprovision required for excess and obsolete inventory. In addition, rapidtechnological change or new product development could result in an increase inthe quantity of obsolete inventory on hand. In the future, if our inventory isdetermined to be overvalued, we would be required to recognize such costs inour cost of products sold at the time of such determination. Likewise, if ourinventory is determined to be undervalued, we may have over-reported our costof products sold in previous periods and would be required to recognize suchadditional operating income at the time of sale or disposition.

Additionally, ourmanufacturing costs and inventory carrying costs are dependent on our accurateestimates of customer demand for our products. A significant increase in thedemand for our products could result in a short-term increase in the cost ofinventory purchases, while a significant decrease in demand could result in anincrease in the amount of excess inventory quantities on hand and increase theexpense of storing and maintaining the inventory until it is sold. As a result,although we attempt to maximize the accuracy of our forecasts of future productdemand, any significant unanticipated changes in demand or technologicaldevelopments could have a significant impact on the value of our inventory andour reported operating results.

***Deferred Taxes***

Our deferred tax assetsrelate to prior operating losses that are available to offset future taxableincome and tax credits that are available to offset future income taxes. Wealso recognize deferred taxes for differences between the financial statementcarrying amounts and the tax bases of assets and liabilities. We evaluate avariety of factors in determining the amount of deferred income tax assets tobe recognized pursuant to SFAS No. 109. We believe that realization of ourdeferred tax assets is more likely than not because of our ability to generatesufficient future taxable income in the carryback and carryforward periodsbased on the criteria set forth in SFAS No. 109.

***Long-lived Assets***

We account for long-livedassets in accordance with the provisions of SFAS No. 142, *Goodwill and Intangibles,*and SFAS No. 144,*Accounting for the Impairment or Disposal ofLong-Lived Assets.*These Statements require that long-lived assetsand certain identifiable intangible assets be reviewed annually for impairmentor whenever events or changes in circumstances indicate that the carryingamount of an asset may not be recoverable. Recoverability of assets to be heldand used is measured by a comparison of the carrying amount of the asset to thefuture net undiscounted cash flows expected to be generated by the asset. Withthe acquisition of Hycor in the second quarter of 2004, we have substantialamortizable and non-amortizable long-lived assets (including goodwill) that arereviewed for impairment annually and when there is an indication that thecarrying value of an asset may not be recoverable. If such assets areconsidered to be impaired, the impairment we would recognize is measured by theamount by which the carrying amount of the assets exceeds the fair value of theassets. Assets to be disposed of are reported at the lower of the carryingamount or fair value less sale costs.

***Royalties***

We enter into licenseagreements in the ordinary course of our business, which require royaltypayments to be made based on specified product sales. These agreements coverthe majority of our products. We believe that we determine the royalties wecalculate and accrue in accordance with the patent license agreement. However,our royalty calculations are subject to review by the license holder.Therefore, 

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ourfinancial position, results of operations, or cash flows could be materiallyaffected if the parties determine that the royalties differ significantly fromthe amounts we have recorded. From mid-2003 through late 2005, wewithheld payments to a license holder while we evaluated a possible overpaymentin the royalties we paid in prior periods. During this time, we continued toaccrue and record the estimated quarterly royalty payable under the patentlicense agreement and reported this amount to the license holder. As of December 31,2006, the amount of accrued and unpaid royalties related to this patent licenseagreement was approximately $5.2 million. The patent underlying this royaltyobligation expired in the United States in March of 2005 and resulted inan approximately $250,000 per quarter reduction in royalty expense beginning inthe second quarter of 2005. In addition, upon the expiration of thecorresponding foreign patents, we achieved an additional $125,000 reduction inroyalty expense since March 2006. We believe that this decrease in royaltyexpense has been partially offset by decreases in the average unit sellingprice of products using the patented technology following the expiration of thepatents.

***Warranties***

We generally warrantcertain equipment against defects in workmanship or materials for a period ofone year from the date of purchase. Upon shipment of equipment sold thatincludes a warranty, we establish, as part of cost of products sold, aprovision for the expected costs of such warranty. While our warranty costshave historically not been significant, we cannot guarantee that we willcontinue to experience the same warranty return and repair rates that we havein the past. A significant increase in product return and repair rates couldhave a material adverse impact on operating results for the period or periodsin which such items materialize.

***Research and Development***

We focus our research and development efforts ondeveloping products that use innovative technologies in both our ResearchSupplies and Clinical Diagnostics product lines. Research and development costsare expensed as incurred. For the years ended December 31, 2006, 2005 and2004, our research and development expenses totaled approximately $12.5million, $12.4 million and $10.8 million, respectively, and we intend to spendbetween 13% and 15% of our revenues on research and development activities forat least the next few years.

We have numerous ongoing research and developmentinitiatives. Some of the efforts are for new product technologies, while othersare designed to support an existing product or products relating to one of ourmore than 4,000 stock keeping units, which cover approximately 85 existingproduct categories. In addition, the funds we used in our research anddevelopment activities are allocated among the various technologies andproducts in which we are currently involved and are not concentrated to onespecific product or product line.

We do not provideforward-looking estimates of costs and time to complete any of our individualongoing research and development projects because none of such projects arematerial to our company on an individual basis. In addition, any such estimateswould be subject to a number of risks and uncertainties, including our abilityto predict the outcome of complex research, competition from other entities ofwhich we may become aware in future periods, predictions of market potentialfrom products that may be derived from our research and development efforts andour ability to recruit and retain personnel with the necessary knowledge andskills to perform the required research activities.

***Share Based Compensation***

In December 2004, the Financial AccountingStandards Board (“FASB”) revised SFAS No. 123(R), *Share-BasedPayment*, which establishes accounting for share-based awardsexchanged for employee services and requires companies to expense the estimatedfair value of these awards over the requisite 

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employee service period.On April 14, 2005, the SEC adopted a new rule amending the effectivedates for SFAS No. 123(R). In accordance with the new rule, we adopted theaccounting provisions of SFAS No. 123(R) beginning in the firstquarter of 2006.

Under SFAS No. 123(R), share-based compensationcost is measured at the grant date, based on the estimated fair value of theaward, and is recognized as expense over the employee’s requisite serviceperiod. We have no awards with market or performance conditions. We adopted theprovisions of SFAS No. 123(R) on January 1, 2006, using themodified prospective application. Under the modified prospective application,prior periods are not revised for comparative purposes. Prior to January 1,2006, we followed Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees,* (“ABP No. 25”),**as amended, for its stockcompensation. No share-based employee compensation expense was recorded priorto January 1, 2006. The valuation provisions of SFAS No. 123(R) applyto new awards and to awards that are outstanding on the effective date andsubsequently modified or cancelled. We will recognize estimated compensationexpense for awards outstanding at the effective date over the remaining serviceperiod using the compensation cost calculated for pro forma disclosure purposesunder FASB Statement No. 123, *Accounting for Stock-BasedCompensation* (“SFAS No. 123”).

The value of Stratagene employee stock options wasestimated at the dates of grant using the minimum value method of SFAS No. 123from the inception date of the applicable stock option plan through June 2,2004, and the fair value method for all option grants made subsequent to thatdate using the Black-Scholes option pricing model. The fair value of the Hycoremployee stock options assumed by Stratagene in the Hycor merger were estimatedat the merger date using the Black-Scholes pricing model for all option grants.For options granted that have multiple cliff vesting periods, we amortize compensationcost using the graded vesting method prescribed by FASB Interpretation No. 28,*Accounting for Stock Appreciation Rights and OtherVariable Stock Option and Award Plans*. We have elected to follow thegraded vesting method and will continue to use the Black-Scholes valuationmethod under SFAS No. 123(R).

The estimates used in calculating compensation expenseare highly subjective and may result in materially different amounts shouldcircumstances change and we employ different assumptions in our application ofSFAS No. 123(R) in future periods.

Share-based compensationexpense totaled $0.9 million for the year ended December 31, 2006. As of December 31,2006, there were $1.3 million of total unrecognized compensation costs relatedto non-vested share-based compensation arrangements under the various optionplans. This cost is expected to be recognized over a weighted average period of2.1 years.

**Results ofOperations**

***Twelve months ended December 31, 2006 compared totwelve months ended December 31, 2005***

**Total Revenue**

Revenue decreased $34.7 million or 26.7% in 2006compared to 2005. We attribute this decrease primarily to recording $34.1million in 2005 as a lump-sum payment from a third party to fully satisfymonies due for certain patent interests. Additionally, sales decreased in 2006compared to 2005 due to decreased sales in older technology products of $3.8million offset by increased sales in QPCR, mutagenesis, autoimmune and allergyproducts of $2.6 million. Excluding the effect from the non-recurringsettlement, sales decreased 0.7% over the comparable 2005 period. The change inforeign exchange value of the dollar had an immaterial effect on sales in 2006when compared to 2005. We expect that future revenue will depend on a number offactors, including the market acceptance of new products, competitiveconditions, currency fluctuations and the continued funding of customerresearch budgets.

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The lump sum payment we received during 2005 was madepursuant to a settlement agreement by which the parties settled certain patentrelated matters. The technology owned by certain patent owners, including us,relates to a collaboration between Abbott Laboratories and Cambridge AntibodyTechnology for the development of Humira® forthe treatment of rheumatoid arthritis. The first commercial sales of thisproduct occurred in 2003. We agreed to a lump sum payment to satisfy in fulltheir interest with respect to the Humira® collaboration. Wealso have the right to realize approximately $0.8 million during the years 2006to 2010 if commercial sales of Humira® are continuing. During the twelve months endedDecember 31, 2006, we realized approximately $0.3 million in royaltiesrelated to sales of Humira®.

In addition to thesettlement of the obligations related to Humira®, the parties agreed to a decreasedroyalty rate on Abbott’s other fully human antibody that neutralizes human IL-12,which was also developed in collaboration with Cambridge Antibody Technology.This antibody is referenced as ABT-874 by Abbott and is in Phase II drugtrials. We cannot predict the likelihood or amount of income that we mayrealize as a result of commercialization of this product in the future.

**Cost of ProductSales**

Cost of product sales decreased $10.3 million, or22.9%, primarily due to 2005 including a $10.7 million royalty obligation dueto an unrelated third party. This decrease was offset by increases in royaltyexpense associated with newly developed software products and increases inmaterial and labor costs in our diagnostics segment during the twelve monthsended December 31, 2006 as compared to the twelve months ended December 31,2005. As a percentage of sales, cost of product sales increased 1.7% from 34.7%for the twelve months ended December 31, 2005 to 36.4% for the twelve monthsended December 31, 2006.

We were required to payminimum royalties in the amount of approximately $0.8 million in 2006associated with a software development and marketing agreement with athird-party. We are also required to pay approximately $1.5 million in 2007under this agreement.

**Research andDevelopment**

Research and developmentexpenses increased by $34,000 or 0.3% for the twelve months ended 2006 ascompared to the twelve months ended December 31, 2005. As a percentage oftotal revenue, research and development expenses increased from 9.6% in 2005 to13.1% in 2006 as a result of recognizing lower revenue during the twelve monthsended December 31, 2006 as compared to the twelve months ended December 31,2005. We intend to spend between 13% and 15% of total revenues on research anddevelopment for at least the next few years in support of new productintroductions.

**Selling andMarketing**

Selling and marketingexpenses remained constant for the twelve months ended December 31, 2006as compared to the twelve months ended December 31, 2005. As a percentageof total revenue, selling and marketing expenses increased from 16.3% in 2005to 22.3% in 2006 due to recording lower revenue for the twelve months ended December 31,2006 as compared to the twelve months ended December 31, 2005.

**General andAdministrative**

General and administrativeexpenses decreased by $1.1 million or 5.5% for the twelve months ended December 31,2006 as compared to the twelve months ended December 31, 2005. Thisdecrease was primarily due to incurring less legal expenses of $1.0 million forthe twelve months ended December 31, 2006 compared to the twelve monthsended December 31, 2005. As a percentage of total revenue, general 

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andadministrative expenses increased from 15.0% in 2005 to 19.4% in 2006 due tothe decreased revenue recognized during 2006 as compared to 2005.

**Litigation charge**

Litigation charges decreased $10.8 million from $20.6million for the twelve months ended December 31, 2005 to $9.8 million forthe twelve months ended December 31, 2006. Fiscal 2006 includes a $19.6million litigation charge related to the judgment awarded in the Invitrogen vs.Stratagene patent infringement matter. This $19.6 million includes totaldamages of $16.2 million, attorneys’ fees and costs of $2.1 million, andpre-judgment interest of $1.3 million. In considering whether to record a loss contingency, we considered theguidance provided by SFAS No. 5, *Accounting forContingencies.*Although we have now appealed the district courtjudgment to the Federal Circuit Court of Appeals, we have accrued $19.6million, as we believe that we have met the conditions for accrual as stated inSFAS No. 5. Post-judgment interest at the rate of approximately5.05% compounded annually will be applied to the compensatory portion of thedamages and will be accrued against Stratagene’s earnings until the matter isresolved.

The Invitrogen litigationcharge was offset by an approximately $9.8 million reduction in the litigationaccrual for the Third Wave litigation. In January 2007, Stratagene reachedan out-of-court settlement with Third Wave for the Wisconsin case for $10.75million. Stratagene agreed to pay Third Wave $10.75 million in cash as fullsatisfaction for the judgment. As a result of the settlement agreement,Stratagene adjusted its accrual from $20.7 million to $10.75 million at December 31,2006. The settlement payment was made with the funds from the $21.0 millionappeal bond in February 2007.

**Impairment ofLong-Lived Assets**

Impairment of long-lived assetsincreased by approximately $45,000, or 72.3%, from $62,033 for the twelvemonths ended December 31, 2005 to $106,901 for the twelve months ended December 31,2006. This expense relates to writing-off the remaining unamortized balances ofpatents that we believe are not recoverable.

**Other Income andExpenses**

Total other income, net ofexpense, increased $0.2 million, or 45.3%, from $0.5 million for the twelvemonths ended December 31, 2005 to $0.7 million for the twelve months endedDecember 31, 2006. This increase in income is primarily due to increasedinterest income of $1.1 million resulting from higher cash balances and a $0.2million decreased in loss on foreign currency transactions, offset by decreasesin other income of $0.9 million due to a litigation settlement recorded in 2005that did not reoccur in 2006, as well as $0.2 million higher interest expenseduring 2006 as a result of litigation charges incurring interest.

**Income Taxes**

We recorded a tax benefit of $746,000 for the twelvemonths ended December 31, 2006 as compared to $3.9 million of tax expenserecorded for the twelve months ended December 31, 2005. The effective tax(benefit) rate for the twelve months ended December 31, 2006 was (108.6%)compared to 33.4% for the twelve months ended December 31, 2005. TheCompany recorded a tax benefit for the twelve months ended December 31,2006 due to the loss before income taxes for the period. Tax expense or taxbenefits are generally comprised of the combined Federal and state tax rates ofapproximately 36% less the benefit of research and development and othercredits.

For the twelve months ended December 31, 2006, wereversed approximately $138,000 of tax reserves based upon the expected resultsof tax examinations currently in progress.

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We recognize federal andstate research and development and other credits when we generate them. Werecognize excess credits for mature operating entities and we will use theseexcess credits to offset future taxable income, as we believe it is more likelythan not that we will utilize the credits.

**Significant FourthQuarter Events**

On January 27, 2007, we reached an out-of-courtsettlement with Third Wave for $10.75 million related to the Stratagene vs.Third Wave patent litigation. We agreed to pay Third Wave $10.75 million incash as full satisfaction for the judgment. The companies also dismissedwithout prejudice Stratagene’s lawsuit against Third Wave in the U.S. DistrictCourt in Delaware.

Based on this settlement,we adjusted our previous litigation accrual of $20.7 million to $10.75 millionas of December 31, 2006. The difference of $10.0 million was reversed intoincome in December 2006. We also reversed $0.9 million of 2006post-judgment interest we had expensed related to this judgment in December 2006.These adjustments were made in December 2006, as they relate to activities in2006 and prior years.

***Twelve months ended December 31, 2005 compared totwelve months ended December 31, 2004***

**Total Revenue**

Revenue increased $45.5 million or 53.6% in 2005compared to 2004. We attribute this increase primarily to recording $34.1million in 2005 as a lump-sum payment from a third party to fully satisfymonies due for certain patent interests as well as recording a full year ofHycor’s diagnostics revenue of $23.3 million during 2005 as compared to onlyrecording seven months of diagnostics sales of $13.4 million during 2004.Excluding the effect from the non-recurring settlement and the increase due toa full twelve months of revenue from Hycor, sales increased 2.6% over thecomparable 2004 period. Also contributing to the growth were increased sales inQPCR and Mutagenesis product sales of $4.1 million offset by declines in oldertechnology products of $3.1 million. The strengthening foreign exchange valueof the dollar also affected sales in 2005 resulting in a negative foreignexchange impact to foreign sales of $0.2 million for a 0.2% decrease to totalworldwide revenue when compared to 2004.

The lump sum payment we received was made pursuant toa settlement agreement by which the parties settled certain patent relatedmatters. The technology owned by certain patent owners, including us, relatesto a collaboration between Abbott and Cambridge Antibody Technology for thedevelopment of Humira® for the treatment of rheumatoid arthritis. Thefirst commercial sales of this product occurred in 2003. We agreed to a lumpsum payment to satisfy in full their interest with respect to the Humira® collaboration. We also have the right torealize approximately $0.8 million during the years 2006 to 2010 if commercialsales of Humira® are continuing.

In addition to thesettlement of the obligations related to Humira®, the parties agreed to a decreasedroyalty rate on Abbott’s other fully human antibody that neutralizes human IL-12,which was also developed in collaboration with Cambridge Antibody Technology.This antibody is referenced as ABT-874 by Abbott and is in Phase II drugtrials. We cannot predict the likelihood or amount of income that we mayrealize as a result of commercialization of this product in the future.

**Cost of ProductsSold**

Cost of products soldincreased $15.8 million, or 54.0%, due to recording a CAT royalty obligation of$10.7 million due to an unrelated third party, as well as recording a full yearof Hycor’s results of operations for the twelve months ended December 31,2005 as compared to recording seven months of Hycor’s results of operations forthe twelve months ended December 31, 2004. During the twelve months ended December 31,2005, we also recorded less royalty expense on product sales due to theexpiration of 

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certainpatents held by a third party. As a percentage of sales, cost of products soldremained relatively constant at 34.7% for the twelve months ended December 31,2005 as compared to 34.6% for the twelve months ended December 31, 2004.

**Research andDevelopment**

Research and developmentexpenses increased $1.7 million or 15.7% for the twelve months ended 2005 ascompared to the twelve months ended December 31, 2004. This increase isdue to including a full year of Hycor’s diagnostic research and developmentexpenses for the twelve months ended December 31, 2005 as compared toincluding seven months of Hycor’s expense for the twelve months ended December 31,2004. The increased spending was also a result of increased research anddevelopment activities in molecular diagnostics and software solutions. As apercentage of total revenue, research and development expenses decreased from12.7% in 2004 to 9.6% in 2005 as a result of recognizing higher revenue duringthe twelve months ended December 31, 2005 as compared to the twelve monthsended December 31, 2004.

**Selling andMarketing**

Selling and marketingexpenses increased $3.1 million or 17.0% for the twelve months ended December 31,2005 as compared to the twelve months ended December 31, 2004. Theincrease in spending was partially due to including twelve months of Hycor’sselling and marketing expenses in 2005 as compared to including seven months ofHycor’s selling and marketing expense in 2004 resulting in $1.3 million of theincrease. During the twelve months ended December 31, 2005, we alsoincurred increased selling and marketing expense of $1.8 million related to ourJapanese operations, increased personnel costs and increased marketing communicationsexpenses. As a percentage of total revenue, selling and marketing expensesdecreased from 21.4% in 2004 to 16.3% in 2005 due to recording higher revenuefor the twelve months ended December 31, 2005 as compared to the twelvemonths ended December 31, 2004.

**General andAdministrative**

General and administrativeexpenses increased by $3.2 million or 19.9% for the twelve months ended December 31,2005 as compared to the twelve months ended December 31, 2004. Legalexpenses increased by approximately $5.1 million for the twelve months ended December 31,2005 compared to the twelve months ended December 31, 2004 as a result oftwo patent litigation matters in which we were a defendant. We also incurredincreased general and administrative expense due to including Hycor’s resultsfor the full twelve months ended December 31, 2005 as compared toincluding only seven months of Hycor’s results for the twelve months ended December 31,2004 resulting in $0.8 million of the increase. This increased spending waspartially offset by $2.4 million in expense related to bonuses paid to our CEOin connection with the Hycor merger for the twelve months ended December 31,2004. As a percentage of total revenue, general and administrative expensesdecreased from 19.3% in 2004 to 15.0% in 2005 due to the increased revenuerecognized during 2005 as compared to 2005.

**Litigation charge**

During the fourth quarterof 2005, we accrued $20.6 million in expense for the judgment awarded in theThird Wave Technologies vs. Stratagene patent infringement matter. This amountincludes total damages of $15.9 million, attorneys’ fees and costs of $4.2million, and pre-judgment interest of $0.5 million. In considering whether to record a losscontingency, we considered the guidance provided by SFAS No. 5, *Accounting for Contingencies.*Although we have now appealedthe district court judgment to the Federal Circuit Court of Appeals, we haveaccrued $20.6 million, as we believe that we have met the conditions foraccrual as stated in SFAS No. 5. Post-judgment interest at the rateof approximately 4.4% 

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compoundedannually remains in effect and unpaid unless the judgment is reversed. (SeeItem 3: Legal Proceedings).

**Impairment ofLong-Lived Assets**

Impairment of long-livedassets decreased by approximately $20,000, or 24.8%, from $82,446 for thetwelve months ended December 31, 2004 to $62,033 for the twelve monthsended December 31, 2005. This expense relates to writing-off the remainingunamortized balances of patents that we believe are not recoverable.

**Other Income andExpenses**

Total other expense, netof income, remained relatively constant for the twelve months ended December 31,2005 as compared to the twelve months ended December 31, 2004. Fluctuationswithin other income and expense included a decrease in income for the twelvemonths ended December 31, 2005 due to a 2004 $1.8 million gain recorded inequity in earnings of a joint venture, which was not repeated in 2005. Additionally,the twelve months ended December 31, 2005 recorded $1.4 million less ininterest expense due to less outstanding debt as compared to the twelve monthsended December 31, 2004.  The twelvemonths ended December 31, 2005 also recognized $0.4 million more in incomefor litigation settlements as compared to the twelve months ended December 31,2004.

**Income Taxes**

We recorded $3.9 million of tax expense in 2005. Theeffective tax rate increased from 30.5% in 2004 to 33.4% in 2005. The effectivetax rate for 2005 was higher than 2004 primarily due to BCH recording a gain inequity in earnings of a joint venture of $1.8 million in fiscal 2004 related tothe sale of certain assets of the joint venture, in which BCH had a minorityinterest. Prior to the BCH asset acquisition date, Stratagene and BCH presentedtheir financial statements on a combined basis as a result of being undercommon control and because certain Stratagene shareholders held substantiallyall the BCH membership units. BCH consisted substantially of limited liabilitycompanies that were treated as partnerships for income tax purposes; therefore,any related income tax liabilities were the responsibility of the members ofBCH. As a result, the operations of BCH did not reflect a provision for incometaxes prior to the acquisition date. The income taxes attributable to the $1.8million gain are the responsibility of the members of BCH and accordingly, theconsolidated financial statements do not include a provision for income taxeson this gain. On February 9, 2006, we dissolved BCH.

For the twelve months ended December 31, 2005, wereversed approximately $320,000 of tax reserves due to the completion of an IRSreview of our 2001 and 2002 federal tax returns. As a result, all reservespertaining to these tax years were no longer necessary.

We recognize state researchand development and other credits when we generate them. We recognize excesscredits for mature operating entities and we will use these excess credits tooffset future taxable income, as we believe it is more likely than not that wewill utilize the credits.

**Liquidity andCapital Resources**

Our liquidity requirements have historically consistedof research and development expenses, selling and marketing expenses, debtservice, capital expenditures, working capital and general corporate purposes.We have funded these expenses through cash from operations, supplemented withborrowings under credit facilities and other debt instruments.

For the twelve months ended December 31, 2006 and2005, we generated net cash from operating activities of approximately $15.6million and $36.8 million, respectively. We used net cash for investing 

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activities ofapproximately $36.3 million and $2.4 million for the twelve months ended December 31,2006 and 2005, respectively. Capital expenditures and additions to patents forthe twelve months ended December 31, 2006 totaled approximately $1.9million and $1.5 million, respectively, as compared to $1.5 million and$1.5 million, respectively, for the twelve months ended December 31, 2005.Restricted cash increased for the twelve months ended December 31, 2006 by$32.9 million and increased for the twelve months ended December 31, 2005by $0.4 million. See Note 2 to the financial statements for more information onrestricted cash, which was primarily the result of $33.1 million in suretybonds posted in the Third Wave and Invitrogen litigations.

Based on our review of our accounts receivables, anallowance for doubtful accounts is accrued, however, we do not write offindividual accounts receivable until we have exhausted substantially allavenues of legal recourse to collect the outstanding amount. The actualwrite-off for the twelve months ended December 31, 2006 was minimal. Nosignificant change to future liquidity is anticipated.

Net cash from operating activities was impacted by theaddition of $9.7 million in accrued expenses and other liabilities for thetwelve months ended December 31, 2006 primarily due to the accrual of theInvitrogen litigation verdict offset by the Third Wave settlement. For thetwelve months ended December 31, 2005, accrued expenses and otherliabilities effected our reconciliation of net income to net cash provided byoperating activities by $33.1 million due primarily to the fourth quarteraccrual of $20.6 million related to the Third Wave Technology vs. Stratagenejudgment, the change of $12.4 million in accrued royalties and approximately$0.4 million of accrued compensation.

Capital expenditures for property and equipment were$1.9 million and $1.5 million for the twelve months ended December 31, 2006and 2005, respectively. Capital expenditures on intangible assets were $1.4million and $1.5 million for the twelve months ended December 31, 2006 and2005, respectively. We currently anticipate capital spending on property andequipment to be in the range of $1.5 million to $2.0 million and capitalspending on intangible assets to be in the range of $1.5 million and $2.0million in fiscal 2007.

We had cash, cash equivalents, and restricted cashtotaling approximately $42.9 million and $40.7 million at December 31,2006 and December 31, 2005, respectively, and working capital ofapproximately $21.6 million and $18.9 million at December 31, 2006 and December 31,2005, respectively. Restricted cash deposits include a $21.0 million civilsupersedeas bond that Stratagene posted in order to permit the Company toappeal a judgment of the district court related to litigation with Third WaveTechnologies without being subject to collection activities by Third Wave. Thisbond is secured by $21.0 million of cash in an interest-bearing restrictedaccount. The cash collateral required to support the bond was provided from theavailable cash resources of the Company. For further detail on this litigation,see Note 11, *Commitments and Contingencies—Legal.*

Restricted cash deposits also include a $12.2 millioncivil supersedeas bond that Stratagene posted in order to permit the company toappeal a judgment of the district court related to the litigation withInvitrogen Corporation without being subject to collection activities byInvitrogen. This bond is secured by $12.2 million of cash in aninterest-bearing restricted account. The cash collateral required to supportthe bond was provided from the available cash resources of the Company. Forfurther detail on this litigation, see Note 11, *Commitmentsand Contingencies—Legal*.

As of December 31, 2006, BioCrest Manufacturing,L.P., our consolidated subsidiary, had approximately $3.8 million in totaldebt, which was attributable to industrial revenue bonds.

The obligations of BioCrest Manufacturing, L.P. undera reducing revolving line of credit were guaranteed by us and each of ourwholly owned domestic subsidiaries. The obligation was also generally securedby substantially all of our personal property assets and each of our whollyowned domestic subsidiaries, as well as liens on the real property andimprovements related to our Texas manufacturing 

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facility. The reducingrevolving line of credit was also secured by a pledge of our interest in IobionInformatics, LLC.

In January 2006, we entered into an amendment tothe credit agreement, which provided for the extension of the reducingrevolving line of credit to July 2008. Prior borrowings under the reducingrevolving line of credit incurred interest at a variable rate equal to thenapplicable one-month LIBOR plus 2.55%. The reducing revolving line of creditincluded customary but significant restrictions on the incurrence of additionaldebt, the payment of dividends, acquisitions and capital expenditures abovestated limits. The reducing revolving line of credit also contained restrictivecovenants requiring us to maintain certain financial ratios, including minimumdebt service coverage ratios, fixed charge coverage ratios and tangible networth. At September 30, 2006, we were not in compliance with its minimumtangible net worth covenant as a result of a non-cash litigation charge takenin the third quarter of 2006 of approximately $12.5 million related to theInvitrogen case. (See Note 11 for details on this case.)  As a result, we were in default of the termsof the credit agreement and the credit agreement holder terminated the reducingrevolving line of credit facility portion of the credit agreement. We have notdrawn on the revolving line of credit since December 2005, there were noamounts outstanding and we were not seeking to borrow against this revolvingline of credit. We have commenced discussions with other lenders to establishan alternative lending facility.

The industrial revenue bonds are secured by land,building and equipment acquired in Bastrop County, Texas with the proceeds fromthe issuance of the bonds. The average interest rate on the industrial revenuebonds was 3.62% for the year ended December 31, 2006 and 2.57% for theyear ended December 31, 2005. Under the instrument governing theindustrial revenue bonds, we were required to make sinking fund payments of$870,000 per year through April 2004 and $735,000 in April 2005. Thereafter,we are required to make sinking fund payments of $240,000 per year through April 2021,and $175,000 in April 2022 when the bonds mature. There is a stand-byletter of credit that guarantees the industrial revenue bonds. There are nocovenants related to this letter of credit.

On January 24, 2006, we posted a $21.0 millionsurety bond related to the Third Wave jury verdict of $20.6 million in order topermit us to appeal the verdict without being subject to collection activitiesby Third Wave. The $20.6 million is comprised of damages of $15.9 million,reimbursement of attorney’s fees and costs of $4.2 million, and pre-judgmentinterest of $0.5 million in connection with the Third Wave litigation. Post-judgmentinterest will also accrue at an annual percentage rate of approximately 4.4%.In March 2006, Third Wave was awarded an additional $0.1 million for othercourt costs, bringing the total award to $20.7 million. The cost of such suretybond was $84,000, and the bond is secured by $21.0 million of cash, which isbeing held in an interest bearing restricted account. In January 2007, wereached an out-of-court settlement with Third Wave for $10.75 million. Weagreed to pay Third Wave $10.75 million in cash as full satisfaction for thejudgment. Based on this settlement, we have adjusted our litigation accrual from$20.7 million to $10.75 million at December 31, 2006. The settlementpayment was made with the funds from the $21.0 million appeal bond in February 2007.

Cash was also impacted by the court judgment in thematter *of Invitrogen vs. Stratagene* that was filedon October 31, 2006 in Federal District Court in Texas. On November 15,2006, we filed a supersedeas bond in the amount of $11.5 million in order topermit us to appeal the judgment of the district court without being subject tocollection activities by Invitrogen. The cost of such surety bond was $46,000,and the bond was secured by $11.5 million of cash, which is being held in aninterest bearing restricted account. In January 2007, the District Courtordered that the bond amount should be $12.2 million and an additional $0.7million in cash is now being held in this account. We funded the amountrequired to collateralize the $12.2 million supersedeas bond from existing cashbalances on hand. We have now accrued an aggregate of $19.6 million related tothis verdict, which was reduced during the fourth quarter of 2006 by $0.8million due to less attorney’s fees and costs allowed by the Court. This $19.6million is comprised of damages of $16.2 million plus attorneys’ fees and costsof approximately $2.1 million and 

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pre-judgmentinterest of approximately $1.3 million. Post-judgment interest at the rate ofapproximately 5.05% compounded annually remains in effect and unpaid unless thejudgment is reversed. If we are ultimately required to pay out all or a portionof the $19.6 million of damages accrued for this matter upon an adversejudgment rendered by the court and affirmed on appeal, it would negativelyimpact our cash position. In the event of payment or settlement of the judgmentamounts against us for cash, we would realize an offsetting tax benefit whichwould partly mitigate our cash requirements. We currently have the ability topay such damage award with our existing cash resources.

In November 2004, we received notice of a patentinfringement suit filed by Applera against us and other parties for allegedinfringement of United States patent no. 6,814,934. Applera is seeking anoutcome that would require us to license the Applera technology claimed underU.S. Patent No. 6,814,934. If we were required to pay up-front licensefees or significant royalties to Applera for this technology, our financialposition could be negatively impacted.

In January 2006 we paid a special one-time cashdividend of $0.25 per common share to stockholders of record as of December 16,2005, which amounted to approximately $5.6 million in the aggregate. Wereceived a consent from the lender under our reducing revolving credit facilitywith respect to the declaration and payment of this dividend.

We expect that our currentcash and cash equivalents, funds from operations and interest income earnedthereon will be sufficient to fund our current operations for at least 12months and the foreseeable future. Our future capital requirements and theadequacy of our available funds will depend on many factors, including ourprofitability, future business acquisitions, scientific progress in ourresearch and development programs and the magnitude of those programs, ourability to establish collaborative and licensing arrangements, the costinvolved in preparing, filing, prosecuting, maintaining and enforcing patentclaims, the final outcome of pending patent litigations and appeals andcompeting technological and market developments.  Despite these expectations, we cannotguarantee we will have sufficient funds on hand to meet all of our cash needsas they arise during the next 12 months.

**ContractualObligations**

We lease certain facilities under noncancelableoperating leases, with facility leases for our headquarters in La Jolla, Californiaand our offices in Garden Grove, California, the Netherlands, Germany, Scotlandand Japan expiring on various dates between July 4, 2007 and September 30,2011.

In connection with the closing of the Hycor merger in June 2004,we entered into a new employment agreement with our CEO, pursuant to which,among other things, we reduced the CEO’s base annual salary from $1.1 millionto $450,000, and granted our CEO an option to purchase 738,960 shares ofStratagene common stock at an exercise price of $9.34 per share. The agreementprovides for the compensation committee of the board of directors to review theCEO’s base salary on at least an annual basis, and the committee may alsoincrease the CEO’s base salary from time to time in its discretion. Pursuant tothe employment agreement, the CEO is entitled to participate in our bonusprogram on a basis at least comparable to other senior executives. The CEO mayalso receive bonuses at the discretion of the board of directors upon thecompensation committee’s recommendation. The new employment agreement has aninitial term of three years and is subject to successive one year renewalsunless either party provides a notice of non-renewal at least 30 days prior tothe termination of the then current term.

Employment agreements that we have entered into withcertain of our officers have salary ranges from $260,000 to $500,000. Suchagreements are typically short in duration but are subject to successiveautomatic one year renewals unless one party gives proper notice of itsintention not to renew the employment agreement. These agreements generallyprovide for severance benefits if we terminate the officer other than forcause, as defined in the employment agreements. Employment agreements with noexpiration date are not included in the table below.

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We also entered into an Employment SeparationAgreement and Mutual General Release of all Claims, or the SeparationAgreement, with Ms. Ronni L. Sherman, our Executive Vice President andGeneral Counsel, in connection with her retirement from Stratagene. Thisagreement provides for her to remain as a paid hourly consultant for anadditional period of one year at rates of $250-$350 per hour depending onthe services rendered. Pursuant to the Separation Agreement, Ms. Shermanreceived a lump sum payment of approximately $225,000 and will be entitled toreceive an additional $40,000 in quarterly $10,000 installments over the nexttwelve months. In addition, she will be entitled to receive a minimum retainerfor her consulting services of $10,000 per three-month period duringeach of the next four three-month periods. Half of Ms. Sherman’shourly consulting service billings will be credited against suchretainer amounts. Her medical insurance benefits will also be continued atStratagene’s expense for a period of 18 months. Copies of the SeparationAgreement and the agreement governing Ms. Sherman’s consultingrelationship with us are attached hereto as Exhibits 10.1 and 10.2,respectively.

As discussed in Note 11 to the financials statements,we have entered into several license and collaboration agreements. The StrandLife Sciences, or Strand, agreement required us to make aggregate milestonepayments of $0.9 million to Strand upon our acceptance of certain deliverables.Research and development expense of $0.2 million and $0.6 million was recordedin the years ended December 31, 2006 and 2005 respectively. The additional $0.1 million will be expensed in 2007.Also, these agreements require us to make $1.5 million in minimum annualpayments to Strand in the first twelve months after our first commercial saleor 60 days after our final acceptance of the product. The first minimum annualpayment period began on April 1, 2006.  The minimum annual payments may be offset by$0.5 million of the milestone payments in the first twelve months of thecontract term. These agreements also require us to make $1.7 million in minimumannual payments to Strand in the second twelve months of the contract term. Thecontractual obligations table below reflects these obligations.

We also entered into an agreement with the DiagnosticsDivision of Bayer HealthCare LLC, or Bayer, in December 2005, pursuant towhich Bayer will purchase a customized version of our Mx3005P instrument systemfor use in a new platform Bayer is developing for performing moleculardiagnostics tests worldwide. Under the terms of the agreement, we aredeveloping customized software and system features for Bayer’s use. Theagreement also calls for us to implement Quality System Regulations (QSR) andprocedures under which we will manufacture the customized Mx3005P instrumentsystem for Bayer.

We also entered into a Joint Development and LicenseAgreement with Rosetta Inpharmatics LLC, or Rosetta, in July 2006, wherebywe and Rosetta will work together to develop an RNA extraction product. Theproduct consists of a machine, a consumable cartridge, and a reagentpack that fits in the machine. The cartridge contains the sample to beprocessed and the machine moves fluids from the reagent pack throughthe card in order to purify RNA. The product will be used to get RNAprofiles from clinical trial patients.  Rosetta will pay us for milestones achievedduring the development period. In the case of a successful product, Rosettawill also pay us a royalty on our sales of finished products to Merck (Rosetta’sparent company) and other third parties.

In addition, in the normal course of operations, weenter into purchase commitments with vendors and suppliers of key raw materialsand other goods and services through purchase orders or other documentation.Such obligations are generally outstanding for periods of less than one yearand are settled by cash payments upon delivery of goods and services. At December 31,2006, aggregate purchase commitments related to various key raw materials andother goods and services was approximately $3.1 million.

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Thefollowing table summarizes the approximate future minimum payments under theabove contractual obligations at December 31, 2006:

| ** **                       | ** ** | **Payment Due by Period** | ** ** |
|----------------------------------|------------|------------------------------------------|------------|
| **Contractual Obligations** | ** ** | ** **                               | ** ** | **Total** | ** ** | **Less than  1 Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **After 5  Years** | ** ** |
| Operating leases                 |       | $                                        | 3,539,756  |   | $ | 2,076,585 |   | $ | 1,354,272 |   | 108,899 |   | — |   |
| Principal on  long-term debt     |       | 3,775,000                                |       | 240,000 |   | 720,000 |   | 480,000 |   | 2,335,000 |   |
| Collaborative  agreements        |       | 1,950,000                                |       | 1,525,000 |   | 425,000 |   | — |   | — |   |
| Employment  agreements           |       | 196,875                                  |       | 196,875 |   | — |   | — |   | — |   |
| Consulting  agreements           |       | 125,000                                  |       | 105,000 |   | 20,000 |   | — |   | — |   |
| Other purchase  commitments      |       | 3,130,000                                |       | 3,130,000 |   | — |   | — |   | — |   |
| Total contractual  obligations   |       | $                                        | 12,716,631 |   | $ | 7,273,460 |   | $ | 2,519,272 |   | $ | 588,899 |   | $ | 2,335,000 |   |
|                                  |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Assuming that long-termdebt principal payments are made according to their respective paymentschedules, the future aggregate interest expense on long-term debt would beapproximately $1.2 million.

**Off-Balance SheetArrangements**

At December 31, 2006and December 31, 2005, we did not have any relationships withunconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance, variable interest or special purposeentities, which would have been established for the purpose of facilitatingoff-balance sheet arrangements or other contractually narrow or limitedpurposes. In addition, we do not engage in trading activities involvingnon-exchange traded contracts. As such, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin such relationships.

**New AccountingPronouncements**

Information regardingrecent accounting pronouncements is contained in Note 2 to the ConsolidatedFinancial Statements for the year ended December 31, 2006, which note isincorporated herein by this reference and is included as part of “Item 8.Financial Statements and Supplementary Data,” to this Form 10-K.

**Item7A.**               Quantitative andQualitative Disclosures about Market Risk

Our financial instrumentsinclude cash and cash equivalents, investments and long-term debt. At December 31,2006, the carrying values of our financial instruments approximated their fairvalues based on current market prices and rates.

***Foreign Currency Translation/Transaction***

We measure the accounts of our foreign subsidiariesand affiliates using the local currency as the functional currency. For theseoperations, we translate assets and liabilities accounts into U.S. dollars atperiod-end exchange rates, and we translate income and expense accounts ataverage monthly exchange rates. We exclude net translation gains or losses fromnet income and reflect them in accumulated other comprehensive income (loss) inthe accompanying consolidated balance sheets.

Our international sales expose us to foreign currencyrisk in the ordinary course of our business. Our foreign subsidiaries generatedapproximately 32%, 22% and 27% of our revenue for 2006, 2005 and 2004,respectively. The foreign subsidiaries sell products in various localcurrencies that they collect at future dates and purchase raw materials andfinished goods in both U.S. dollars and local currencies. Accordingly, we areexposed to transaction gains and losses that could result from changes inforeign currency exchange rates. We include realized gains and losses fromforeign currency transactions in operations as incurred.

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For financial reportingpurposes, we translate the foreign subsidiaries’ income statements from thelocal currency into U.S. dollars at the exchange rates in effect during thereporting period. When the local currency strengthens compared to the U.S.dollar, there is a positive effect on the foreign subsidiaries’ sales asreported in our consolidated financial statements. Conversely, when the U.S.dollar strengthens, there is a negative effect. For the year ended December 31,2006, the net impact to our reported sales from the effect of exchange ratefluctuations was immaterial when compared to the exchange rates for the yearended December 31, 2005.

***Derivative Financial Instruments***

As part of distributing our products, we regularlyenter into intercompany transactions with our foreign subsidiaries. Ourcurrency exposures vary, but are primarily concentrated in the Euro, BritishPound, Swiss Franc and Japanese Yen. In the past, we periodically entered intoderivative instruments to mitigate foreign currency risk on our Europeanrevenues, however, such derivative instruments did not qualify for hedgeaccounting under the provisions of SFAS No. 133, *Accounting for Derivative Instruments and**Hedging Activities,*as amended.Accordingly, we recognized both unrealized and realized gains or lossesresulting from changes in fair value as incurred in gain (loss) on foreigncurrency transactions in the current period income statement.

We currently do not enterinto foreign currency hedging arrangements. We settled all futures contractsentered into for fiscal year 2004 by December 31, 2004.

***Fair Value of Financial Instruments***

We consider the carryingamounts of cash and cash equivalents, restricted cash, accounts receivable,prepaid expenses and other current assets, accounts payable, accrued expenses,other current liabilities, and lines of credit to be representative of theirrespective fair values because of the short-term nature of these financialinstruments. The carrying amount of the long-term debt is a reasonable estimateof fair value, as the loans have terms based on market rates.

***Interest Rates***

We generally invest our cash and cash equivalents inmoney market accounts and short-term debt instruments of highly rated creditissuers. We limit the amount of credit exposure to any one issuer and seek toimprove the safety and likelihood of preserving our invested funds by limitingdefault risk and market risk. Based on our short-term investment portfolio at December 31,2006, we believe that a 10% rise or fall in interest rates would have had nomaterial impact on our financial statements.

The followingtable shows the average interest rate for the year ended December 31, 2006for each of our long-term debt obligations:

| **Long-term Debt Obligations** | ** ** | ** ** | ** ** | **Average Interest Rate for  the Year Ended  December 31, 2006** | ** ** |
|------------------------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------|------------|
| Industrial  revenue bonds                |       |       | 3.62       | %                                                                                                   |       |
|                                          |            |            |            |                                                                                                     |            |  |  |

 

48

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**Item 8.**                        FinancialStatements and Supplementary Data

Thefollowing documents are filed as part of this report:

|                                                                                                                 | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm for the years ended December 31, 2006 and 2005    |       |     | 50         |   |   |
| Report of Independent Registered Public Accounting  Firm for the year ended December 31, 2004              |       |     | 51         |   |   |
| Consolidated  Balance Sheets as of December 31, 2006 and 2005                                              |       |     | 52         |   |   |
| Consolidated Statements of Income for the years ended  December 31, 2006, 2005 and 2004                    |       |     | 53         |   |   |
| Consolidated Statements of Stockholders’ Equity for  the years ended December 31, 2006, 2005 and 2004 |       |     | 54         |   |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2006, 2005 and 2004                |       |     | 56         |   |   |
| Notes to Consolidated Financial Statements for the  years ended December 31, 2006, 2005 and 2004           |       |     | 58         |   |   |

 

49

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**REPORT OFINDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofStratagene Corporation

We have audited the accompanying consolidated balancesheets of Stratagene Corporation and subsidiaries (the “Company”) as of December 31,2006 and 2005, and the related consolidated statements of income, stockholders’equity and comprehensive income, and cash flows for each of the years thenended. Our audits also included the financial statement schedule listed in theIndex at Item 15(c). These financial statements and the financial statementschedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on these financial statements and the financialstatement schedule based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements and schedule are free ofmaterial misstatement. The Company is not required to have, nor were we engagedto perform, an audit of its internal control over financial reporting. Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements and schedule. An auditalso includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In ouropinion, such consolidated financial statements present fairly, in all materialrespects, the financial position of the Company as of December 31, 2006and 2005, and the results of its operations and its cash flows for each of theyears then ended, in conformity with accounting principles generally acceptedin the United States of America. Also, in our opinion, the financial statementschedule presents fairly, in all material respects, the information set forththerein.
| /s/ MAYER HOFFMAN MCCANN P.C. |   |   |
|-------------------------------|--------|--------|
| San Diego,  California        |
| March 12, 2007           |

 

50

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders ofStratagene Corporation

We have audited the accompanying consolidatedstatements of income, stockholders’ equity and comprehensive income, and cashflows of Stratagene Corporation and subsidiaries (the “Company”) for the yearended December 31, 2004. Our audit also included the financial statementschedule for 2004 listed in the Index at Item 15(c). These financial statementsand the financial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and the financial statement schedule based on our audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged to perform,an audit of its internal control over financial reporting. Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

In ouropinion, such consolidated financial statements present fairly, in all materialrespects, the results of operations and cash flows of Stratagene Corporationand subsidiaries for the year ended December 31, 2004, in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, such financial statement schedule for 2004, when considered inrelation to the basic 2004 consolidated financial statements taken as a whole,presents fairly in all material respects the information set forth therein.
| /s/ DELOITTE & TOUCHE, LLP |   |   |
|-------------------------------------|--------|--------|
| San Diego,  California              |
| March 30, 2005                 |

 

51

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**STRATAGENE CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                               | ** ** | **December 31,** | ** **  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| ** **                                                                                                                                                               | ** ** | **2006**              | ** **  | **2005** | ** ** |
| **ASSETS**                                                                                                                                                               | ** ** | ** **            | ** **  | ** ** | ** ** |
| Current assets:                                                                                                                                                          |       |                  |        |   |   |
| Cash and cash  equivalents                                                                                                                                               |       | $                     | 9,735,360   |   | $ | 40,508,365 |   |
| Cash—restricted                                                                                                                                                     |       | 33,129,967            |        | 192,388 |   |
| Accounts receivable,  less allowance for doubtful accounts and sales returns of $474,644 and  $580,182 at December 31, 2006 and 2005, respectively                  |       | 12,447,542            |        | 11,530,214 |   |
| Income taxes receivable                                                                                                                                                  |       | —                |        | 1,520,466 |   |
| Inventories                                                                                                                                                              |       | 12,262,819            |        | 13,249,815 |   |
| Deferred income tax  assets                                                                                                                                              |       | 13,446,005            |        | 10,003,948 |   |
| Prepaid expenses and  other current assets                                                                                                                               |       | 3,368,078             |        | 2,134,828 |   |
| Total current assets                                                                                                                                                     |       | 84,389,771            |        | 79,140,024 |   |
| Property and equipment,  net                                                                                                                                             |       | 10,927,339            |        | 11,266,939 |   |
| Other assets                                                                                                                                                             |       | 406,859               |        | 395,453 |   |
| Goodwill                                                                                                                                                                 |       | 27,234,214            |        | 27,234,214 |   |
| Intangible assets                                                                                                                                                        |       | 6,618,018             |        | 6,645,137 |   |
| Total assets                                                                                                                                                             |       | $                     | 129,576,201 |   | $ | 124,681,767 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                           |       |                  |        |   |   |
| Current liabilities:                                                                                                                                                     |       |                  |        |   |   |
| Accounts payable                                                                                                                                                         |       | $                     | 7,418,908   |   | $ | 5,373,865 |   |
| Dividend payable                                                                                                                                                         |       | —                |        | 5,571,321 |   |
| Accrued expenses and  other liabilities                                                                                                                                  |       | 52,642,853            |        | 42,776,252 |   |
| Current portion of  long-term debt                                                                                                                                       |       | 240,000               |        | 5,740,000 |   |
| Income taxes payable                                                                                                                                                     |       | 317,725               |        | — |   |
| Deferred revenue,  current                                                                                                                                               |       | 2,138,232             |        | 736,142 |   |
| Total current  liabilities                                                                                                                                               |       | 62,757,718            |        | 60,197,580 |   |
| Deferred revenue                                                                                                                                                         |       | 540,994               |        | 315,634 |   |
| Long-term debt, less  current portion                                                                                                                                    |       | 3,535,000             |        | 3,775,000 |   |
| Deferred income tax  liabilities                                                                                                                                         |       | 1,383,327             |        | 1,621,040 |   |
| Other liabilities                                                                                                                                                        |       | 242,151               |        | 282,287 |   |
| Total liabilities                                                                                                                                                        |       | 68,459,190            |        | 66,191,541 |   |
| Commitments and contingencies (Note 11)                                                                                                                                  |       |                  |        |   |   |
| Stockholders’ equity:                                                                                                                                               |       |                  |        |   |   |
| Preferred stock, $.0001  par value; 4,000,000 shares authorized; no shares issued and outstanding at  December 31, 2006 and 2005                                    |       | —                |        | — |   |
| Common stock, $.0001 par  value; 50,000,000 shares authorized; 22,452,952 and 22,319,250 shares issued  and outstanding at December 31, 2006 and 2005, respectively |       | 2,245                 |        | 2,232 |   |
| Additional paid-in  capital                                                                                                                                              |       | 56,278,961            |        | 54,398,471 |   |
| Unearned stock-based  compensation                                                                                                                                       |       | (7,969                | )           | (48,294 | ) |
| Retained earnings                                                                                                                                                        |       | 5,790,271             |        | 5,731,260 |   |
| Accumulated other  comprehensive loss                                                                                                                                    |       | (946,497              | )           | (1,593,443 | ) |
| Total stockholders’  equity                                                                                                                                         |       | 61,117,011            |        | 58,490,226 |   |
| Total liabilities and stockholders’ equity                                                                                                                          |       | $                     | 129,576,201 |   | $ | 124,681,767 |   |

 

See accompanying notes to consolidated financial statements.

52

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**STRATAGENE CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME**

| ** **                            | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue:                              |       |                                        |       |   |   |   |   |
| Product sales                         |       | $                                           | 94,228,778 |   | $ | 94,878,594 |   | $ | 84,032,817 |   |
| Royalty revenue                       |       | 1,328,232                                   |       | 35,406,711 |   | 779,786 |   |
| Total revenue                         |       | 95,557,010                                  |       | 130,285,305 |   | 84,812,603 |   |
| Costs and expenses:                   |       |                                        |       |   |   |   |   |
| Cost of revenues                      |       | 34,829,540                                  |       | 45,157,925 |   | 29,324,218 |   |
| Research and development              |       | 12,478,445                                  |       | 12,444,663 |   | 10,754,317 |   |
| Selling and marketing                 |       | 21,270,177                                  |       | 21,267,210 |   | 18,180,822 |   |
| General and administrative            |       | 18,506,408                                  |       | 19,579,800 |   | 16,335,605 |   |
| Litigation charges, net (Note 11)     |       | 9,797,343                                   |       | 20,600,352 |   | — |   |
| Impairment of long-lived assets       |       | 106,901                                     |       | 62,033 |   | 82,446 |   |
| Total costs and expenses              |       | 96,988,814                                  |       | 119,111,983 |   | 74,677,408 |   |
| Income (loss) from operations         |       | (1,431,804                                  | )          | 11,173,322 |   | 10,135,195 |   |
| Other income and  expenses:           |       |                                        |       |   |   |   |   |
| Loss on foreign currency transactions |       | (198,405                                    | )          | (427,041 | ) | (225,586 | ) |
| Equity in income of joint venture     |       | —                                      |       | — |   | 1,787,902 |   |
| Interest expense                      |       | (485,859                                    | )          | (279,190 | ) | (1,641,358 | ) |
| Interest income                       |       | 1,444,638                                   |       | 291,780 |   | 147,041 |   |
| Other income (expense), net           |       | (15,559                                     | )          | 926,899 |   | 495,237 |   |
| Total other income                    |       | 744,815                                     |       | 512,448 |   | 563,236 |   |
| Income (loss)  before income taxes    |       | (686,989                                    | )          | 11,685,770 |   | 10,698,431 |   |
| Income tax  (expense) benefit         |       | 746,000                                     |       | (3,898,000 | ) | (3,260,000 | ) |
| Net income                            |       | $                                           | 59,011     |   | $ | 7,787,770 |   | $ | 7,438,431 |   |
| Earnings per share:                   |       |                                        |       |   |   |   |   |
| Basic                                 |       | $                                           | 0.00       |   | $ | 0.35 |   | $ | 0.39 |   |
| Diluted                               |       | $                                           | 0.00       |   | $ | 0.35 |   | $ | 0.39 |   |
| Weighted average shares:              |       |                                        |       |   |   |   |   |
| Basic                                 |       | 22,389,159                                  |       | 22,112,892 |   | 19,307,564 |   |
| Diluted                               |       | 22,444,102                                  |       | 22,259,057 |   | 19,313,364 |   |

 

See accompanying notes to consolidated financial statements.

53

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**STRATAGENE CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**AND COMPREHENSIVE INCOME

**Years Ended December 31, 2006, 2005 and 2004**
|                                                                                                                                                       | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Unearned  Stock-based** | ** ** | **Retained Earnings  (Accumulated** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**               | ** ** | **Compensation**                         | ** ** | **Deficit)** | ** ** |
| Balance as of  January 1, 2004                                                                                                                   |       | 15,632,668            |       |                    | 1,563      |                      |       | 1,821,202                                |       |   | — |   |   |   | (3,447,340 | ) |   |
| Retirement of  treasury stock                                                                                                                         |       | —                |       |                    | —     |                      |       | (25,344                                  | )          |   | — |   |   |   | — |   |   |
| Fair value of  common shares issued resulting from Hycor merger, plus value attributed to  Hycor options assumed, less registration costs of $105,234 |       | 5,015,453             |       |                    | 502        |                      |       | 43,867,108                               |       |   | — |   |   |   | — |   |   |
| Intrinsic value  assigned to unvested options acquired in the Hycor merger                                                                            |       | —                |       |                    | —     |                      |       | —                                   |       |   | (781,622 | ) |   |   | — |   |   |
| Amortization of  unvested options acquired in the Hycor merger                                                                                        |       | —                |       |                    | —     |                      |       | (28,619                                  | )          |   | 360,945 |   |   |   | — |   |   |
| Common stock  issued from conversion of subordinated debt                                                                                             |       | 1,753,604             |       |                    | 175        |                      |       | 9,179,825                                |       |   | — |   |   |   | — |   |   |
| Common stock  issued to an officer                                                                                                                    |       | 41,250                |       |                    | 4          |                      |       | (4                                       | )          |   | — |   |   |   | — |   |   |
| Common stock  issued for employee stock purchase plan                                                                                                 |       | 25,856                |       |                    | 2          |                      |       | 157,020                                  |       |   | — |   |   |   | — |   |   |
| Common stock  issued upon exercise of stock options                                                                                                   |       | 127,382               |       |                    | 14         |                      |       | 176,283                                  |       |   | — |   |   |   | — |   |   |
| Tax benefit  received from the exercise of stock options                                                                                              |       | —                |       |                    | —     |                      |       | 89,009                                   |       |   | — |   |   |   | — |   |   |
| Redemption of  common stock for outstanding notes receivable from officers                                                                       |       | (524,160              | )          |                    | (53        | )                         |       | (3,404,874                               | )          |   | — |   |   |   | — |   |   |
| Redemption of  common stock for outstanding notes receivable from affiliates                                                                     |       | (42,623               | )          |                    | (4         | )                         |       | (276,874                                 | )          |   | — |   |   |   | — |   |   |
| Compensation  expense from remeasurement of stock options                                                                                             |       | —                |       |                    | —     |                      |       | 101,172                                  |       |   | — |   |   |   | — |   |   |
| Compensation  expense for non-employee stock options                                                                                                  |       | —                |       |                    | —     |                      |       | 357,171                                  |       |   | — |   |   |   | — |   |   |
| Interest accretion  on notes receivable from stockholders of Stratagene                                                                               |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Payment in full of  notes receivable from stockholders of Stratagene                                                                                  |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Distributions paid  to BCH members                                                                                                                    |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | (476,280 | ) |   |
| Deferred tax asset  applicable to asset acquisition of BCH                                                                                            |       | —                |       |                    | —     |                      |       | 874,495                                  |       |   | — |   |   |   | — |   |   |
| Redemption of  interests from BCH members                                                                                                             |       | —                |       |                    | —     |                      |       | (7,378                                   | )          |   | — |   |   |   | — |   |   |
| Net income                                                                                                                                            |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | 7,438,431 |   |   |
| Foreign currency  translation                                                                                                                         |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Unrealized gain on  securities                                                                                                                        |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Comprehensive  income                                                                                                                                 |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Balance as of  December 31, 2004                                                                                                                 |       | 22,029,430            |       |                    | $          | 2,203                     |       |                                     | $          | 52,880,192 |   |   | $ | (420,677 | ) |   |   | $ | 3,514,811 |   |   |
| Adjustment to  deferred tax asset applicable to asset acquisition of BCH                                                                              |       | —                |       |                    | —     |                      |       | (514,403                                 | )          |   | — |   |   |   | — |   |   |
| Amortization of  unvested options acquired in the Hycor merger                                                                                        |       | —                |       |                    | —     |                      |       | —                                   |       |   | 303,030 |   |   |   | — |   |   |
| Adjustment to  stock-based compensation for terminated employees                                                                                      |       | —                |       |                    | —     |                      |       | (69,353                                  | )          |   | 69,353 |   |   |   | — |   |   |
| Common stock issued  for employee stock purchase plan                                                                                                 |       | 51,609                |       |                    | 5          |                      |       | 374,902                                  |       |   | — |   |   |   | — |   |   |
| Common stock  issued upon exercise of stock options                                                                                                   |       | 238,211               |       |                    | 24         |                      |       | 1,124,783                                |       |   | — |   |   |   | — |   |   |
| Tax benefit  received from the exercise of stock options                                                                                              |       | —                |       |                    | —     |                      |       | 415,294                                  |       |   | — |   |   |   | — |   |   |
| Compensation  expense for non-employee stock options                                                                                                  |       | —                |       |                    | —     |                      |       | 187,056                                  |       |   | — |   |   |   | — |   |   |
| Dividend payable  to stockholders                                                                                                                     |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | (5,571,321 | ) |   |
| Net income                                                                                                                                            |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | 7,787,770 |   |   |
| Foreign currency  translation                                                                                                                         |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Unrealized gain on  securities                                                                                                                        |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Comprehensive  income                                                                                                                                 |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Balance as of  December 31, 2005                                                                                                                 |       | 22,319,250            |       |                    | $          | 2,232                     |       |                                     | $          | 54,398,471 |   |   | $ | (48,294 | ) |   |   | $ | 5,731,260 |   |   |
| Amortization of  unvested options acquired in the Hycor merger                                                                                        |       | —                |       |                    | —     |                      |       | —                                   |       |   | 39,256 |   |   |   | — |   |   |
| Adjustment to  stock-based compensation for terminated employees                                                                                      |       | —                |       |                    | —     |                      |       | —                                   |       |   | 1,069 |   |   |   | — |   |   |
| Common stock  issued for employee stock purchase plan                                                                                                 |       | 67,817                |       |                    | 6          |                      |       | 397,867                                  |       |   | — |   |   |   | — |   |   |
| Common stock  issued upon exercise of stock options                                                                                                   |       | 65,885                |       |                    | 7          |                      |       | 474,678                                  |       |   | — |   |   |   | — |   |   |
| Tax benefit  received from the exercise of stock options                                                                                              |       | —                |       |                    | —     |                      |       | 77,104                                   |       |   | — |   |   |   | — |   |   |
| Compensation  expense for non-employee stock options                                                                                                  |       | —                |       |                    | —     |                      |       | (14,492                                  | )          |   | — |   |   |   | — |   |   |
| Stock-based  compensation expense for employee stock options and employee stock purchase  plan                                                        |       | —                |       |                    | —     |                      |       | 945,333                                  |       |   | — |   |   |   | — |   |   |
| Net income                                                                                                                                            |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | 59,011 |   |   |
| Foreign currency  translation                                                                                                                         |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Unrealized gain on  securities                                                                                                                        |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Comprehensive  income                                                                                                                                 |       | —                |       |                    | —     |                      |       | —                                   |       |   | — |   |   |   | — |   |   |
| Balance as of  December 31, 2006                                                                                                                 |       | 22,452,952            |       |                    | $          | 2,245                     |       |                                     | $          | 56,278,961 |   |   | $ | (7,969 | ) |   |   | $ | 5,790,271 |   |   |

 

*(Continued)*

See accompanying notes to consolidated financial statements.

54

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**STRATAGENE CORPORATION AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**AND COMPREHENSIVE INCOME

**Years Ended December 31, 2006, 2005 and 2004**

 
|                                                                                                                                                       | ** ** | **Notes  Receivable  From**                                         | ** ** | **Accumulated  Other  Comprehensive** | ** **      | **Treasury Stock** | ** ** | **Total  Stockholders’** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|---------------------------------------|-----------------|-------------------------|------------|-------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **Stockholders**                                                    | ** ** | **Income (loss)**                | ** **      | **Shares**              | ** ** | **Amount**                    | ** ** | **Equity** | ** ** |
| Balance as of  January 1, 2004                                                                                                                   |       | (3,356,309                                                          | )          |                                  | (940,514        | )                       |       | 7,040                         |       | (25,344 | ) |   | (5,946,742 | ) |   |
| Retirement of  treasury stock                                                                                                                         |       | —                                                              |       |                                  | —          |                    |       | (7,040                        | )          | 25,344 |   |   | — |   |   |
| Fair value of  common shares issued resulting from Hycor merger, plus value attributed to  Hycor options assumed, less registration costs of $105,234 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 43,867,610 |   |   |
| Intrinsic value  assigned to unvested options acquired in the Hycor merger                                                                            |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (781,622 | ) |   |
| Amortization of  unvested options acquired in the Hycor merger                                                                                        |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 332,326 |   |   |
| Common stock  issued from conversion of subordinated debt                                                                                             |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 9,180,000 |   |   |
| Common stock  issued to an officer                                                                                                                    |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | — |   |   |
| Common stock  issued for employee stock purchase plan                                                                                                 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 157,022 |   |   |
| Common stock  issued upon exercise of stock options                                                                                                   |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 176,297 |   |   |
| Tax benefit  received from the exercise of stock options                                                                                              |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 89,009 |   |   |
| Redemption of  common stock for outstanding notes receivable from officers                                                                            |       | 3,289,181                                                           |       |                                  | —          |                    |       | —                        |       | — |   |   | (115,746 | ) |   |
| Redemption of  common stock for outstanding notes receivable from affiliates                                                                          |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (276,878 | ) |   |
| Compensation  expense from remeasurement of stock options                                                                                             |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 101,172 |   |   |
| Compensation  expense for non-employee stock options                                                                                                  |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 357,171 |   |   |
| Interest accretion  on notes receivable from stockholders of Stratagene                                                                               |       | (83,132                                                             | )          |                                  | —          |                    |       | —                        |       | — |   |   | (83,132 | ) |   |
| Payment in full of  notes receivable from stockholders of Stratagene                                                                                  |       | 150,260                                                             |       |                                  | —          |                    |       | —                        |       | — |   |   | 150,260 |   |   |
| Distributions paid  to BCH members                                                                                                                    |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (476,280 | ) |   |
| Deferred tax asset  applicable to asset acquisition of BCH                                                                                            |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 874,495 |   |   |
| Redemption of  interests from BCH members                                                                                                             |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (7,378 | ) |   |
| Net income                                                                                                                                            |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 7,438,431 |   |   |
| Foreign currency  translation                                                                                                                         |       | —                                                              |       |                                  | 124,019         |                    |       | —                        |       | — |   |   | 124,019 |   |   |
| Unrealized gain on  securities                                                                                                                        |       | —                                                              |       |                                  | 150             |                    |       | —                        |       | — |   |   | 150 |   |   |
| Comprehensive  income                                                                                                                                 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 7,562,600 |   |   |
| Balance as of  December 31, 2004                                                                                                                 |       | —                                                              |       |                                  | (816,345        | )                       |       | —                        |       | — |   |   | 55,160,184 |   |   |
| Adjustment to  deferred tax asset applicable to asset acquisition of BCH                                                                              |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (514,403 | ) |   |
| Amortization of  unvested options acquired in the Hycor merger                                                                                        |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 303,030 |   |   |
| Adjustment to  stock-based compensation for terminated employees                                                                                      |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | — |   |   |
| Common stock  issued for employee stock purchase plan                                                                                                 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 374,907 |   |   |
| Common stock  issued upon exercise of stock options                                                                                                   |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 1,124,807 |   |   |
| Tax benefit  received from the exercise of stock options                                                                                              |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 415,294 |   |   |
| Compensation  expense for non-employee stock options                                                                                                  |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 187,056 |   |   |
| Dividend payable  to stockholders                                                                                                                     |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (5,571,321 | ) |   |
| Net income                                                                                                                                            |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 7,787,770 |   |   |
| Foreign currency  translation                                                                                                                         |       | —                                                              |       |                                  | (776,948        | )                       |       | —                        |       | — |   |   | (776,948 | ) |   |
| Unrealized gain on  securities                                                                                                                        |       | —                                                              |       |                                  | (150            | )                       |       | —                        |       | — |   |   | (150 | ) |   |
| Comprehensive  income                                                                                                                                 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 7,010,672 |   |   |
| Balance as of  December 31, 2005                                                                                                                 |       | $                                                                   | —     |                                  |            | $ (1,593,443       | )          |                          | —     |   | $      — |   |   | $ 58,490,226 |   |   |
| Amortization of  unvested options acquired in the Hycor merger                                                                                        |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 39,256 |   |   |
| Adjustment to  stock-based compensation for terminated employees                                                                                      |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 1,069 |   |   |
| Common stock  issued for employee stock purchase plan                                                                                                 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 397,873 |   |   |
| Common stock  issued upon exercise of stock options                                                                                                   |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 474,685 |   |   |
| Tax benefit  received from the exercise of stock options                                                                                              |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 77,104 |   |   |
| Compensation  expense for non-employee stock options                                                                                                  |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | (14,492 | ) |   |
| Stock-based  compensation expense for employee stock options and employee stock purchase  plan                                                        |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 945,333 |   |   |
| Net income                                                                                                                                            |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 59,011 |   |   |
| Foreign currency  translation                                                                                                                         |       | —                                                              |       |                                  | 646,946         |                    |       | —                        |       | — |   |   | 646,946 |   |   |
| Comprehensive  income                                                                                                                                 |       | —                                                              |       |                                  | —          |                    |       | —                        |       | — |   |   | 705,957 |   |   |
| Balance as of  December 31, 2006                                                                                                                 |       | $          — |       |                                  | $ (946,497 | )                       |       | —                        |       | $      — |   |   | $ 61,117,011 |   |   |
|                                                                                                                                                       |            |                                                                     |            |                                       |                 |                         |            |                               |            |  |  |  |  |  |  |  |

 

*(Concluded)*

See accompanying notes to consolidated financial statements.

55

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**STRATAGENE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                         | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Cash flows from operating activities:**                                          |       |                                        |       |   |   |   |   |
| Net income                                                                         |       | $                                           | 59,011     |   | $ | 7,787,770 |   | $ | 7,438,431 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and amortization                                                      |       | 3,662,016                                   |       | 3,576,305 |   | 3,240,721 |   |
| Stock-based compensation                                                           |       | 899,192                                     |       | 453,533 |   | 903,236 |   |
| Equity in (income) of  joint venture                                               |       | —                                      |       | — |   | (1,787,902 | ) |
| Impairment of long-lived  assets                                                   |       | 106,901                                     |       | 62,033 |   | 82,446 |   |
| Bad debt expense                                                                   |       | (10,656                                     | )          | 53,357 |   | (295,809 | ) |
| Excess and obsolete  inventory expense                                             |       | 257,114                                     |       | 746,324 |   | (395,462 | ) |
| Loss on redemption of  partnership interest                                        |       | —                                      |       | — |   | 242,959 |   |
| Loss on disposal of  assets                                                        |       | 131,148                                     |       | 10,053 |   | 13,979 |   |
| Interest accrued on  notes receivable from stockholders                            |       | —                                      |       | — |   | (83,134 | ) |
| Accretion of interest on  long-term debt                                           |       | —                                      |       | — |   | 740,842 |   |
| Deferred income taxes                                                              |       | (3,679,770                                  | )          | (6,169,860 | ) | 476,646 |   |
| Changes in assets and liabilities (net of impact of  merger with Hycor):           |       |                                        |       |   |   |   |   |
| Foreign currency  exchange contracts                                               |       | —                                      |       | — |   | 205,110 |   |
| Accounts receivable                                                                |       | (615,746                                    | )          | (1,033,139 | ) | 937,805 |   |
| Inventories                                                                        |       | 1,043,239                                   |       | (1,335,844 | ) | 8,852 |   |
| Prepaid expenses and  other current assets                                         |       | (1,199,896                                  | )          | (508,478 | ) | 1,464,657 |   |
| Due from related party                                                             |       | —                                      |       | — |   | 96,642 |   |
| Due to related party                                                               |       | —                                      |       | — |   | 451,630 |   |
| Income taxes receivable                                                            |       | 1,520,057                                   |       | (1,250,605 | ) | (4,680 | ) |
| Other assets                                                                       |       | 1,680                                       |       | 137,181 |   | 195,929 |   |
| Accounts payable                                                                   |       | 1,797,878                                   |       | 1,514,647 |   | (1,392,321 | ) |
| Accrued expenses and  other liabilities                                            |       | 9,669,254                                   |       | 33,091,382 |   | 442,296 |   |
| Deferred revenue                                                                   |       | 1,570,971                                   |       | (352,824 | ) | (73,926 | ) |
| Deferred compensation to  employees                                                |       | —                                      |       | — |   | (268,200 | ) |
| Other liabilities                                                                  |       | (40,136                                     | )          | 282,287 |   | — |   |
| Income taxes payable                                                               |       | 320,126                                     |       | (240,745 | ) | (1,727,563 | ) |
| Net cash provided by  operating activities                                         |       | 15,492,383                                  |       | 36,823,377 |   | 10,913,184 |   |
| **Cash flows from investing activities:**                                          |       |                                        |       |   |   |   |   |
| Purchases of property  and equipment                                               |       | (1,867,441                                  | )          | (1,544,746 | ) | (1,796,755 | ) |
| Additions to intangible  assets                                                    |       | (1,448,761                                  | )          | (1,479,724 | ) | (1,309,391 | ) |
| Cash acquired in merger,  net of acquisition costs                                 |       | —                                      |       | — |   | 4,520,153 |   |
| Proceeds from maturities  of marketable debt securities                            |       | —                                      |       | 195,000 |   | 699,847 |   |
| Proceeds from sales of  property and equipment                                     |       | 30                                          |       | 21,592 |   | — |   |
| Redemption of BCH member  interests                                                |       | —                                      |       | — |   | (7,378 | ) |
| Changes in restricted  cash                                                        |       | (32,933,909                                 | )          | 390,607 |   | (28,878 | ) |
| Cash distributions from  joint venture                                             |       | —                                      |       | — |   | 2,012,052 |   |
| Net cash provided by (used in) investing activities                                |       | (36,250,081                                 | )          | (2,417,271 | ) | 4,089,650 |   |
|                                                                                    |            |                                             |            |  |  |  |  |  |  |  |

 

*(Continued)*

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**STRATAGENE CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)**

 

| ** **                                                                                                                                         | ** ** | **Years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                                         | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Cash flows from financing  activities:**                                                                                                         |       |                                        |       |   |   |   |   |
| Principal payments on long-term debt                                                                                                               |       | (240,000                                    | )          | (735,000 | ) | (23,203,760 | ) |
| Issuance of long-term debt                                                                                                                         |       | —                                      |       | — |   | 6,000,000 |   |
| Borrowings under line of credit                                                                                                                    |       | 9,030                                       |       | 5,546,620 |   | 11,977,647 |   |
| Payments under line of credit                                                                                                                      |       | (5,509,030                                  | )          | (5,003,544 | ) | (7,040,724 | ) |
| Distributions to BCH members                                                                                                                       |       | —                                      |       | — |   | (476,280 | ) |
| Distributions to shareholders                                                                                                                      |       | (5,571,321                                  | )          | — |   | — |   |
| Tax benefit from stock option exercises                                                                                                            |       | 77,104                                      |       |   |   |   |   |
| Proceeds from issuance of common stock                                                                                                             |       | 872,558                                     |       | 1,499,715 |   | 176,283 |   |
| Net cash provided by (used in) financing activities                                                                                                |       | (10,361,659                                 | )          | 1,307,791 |   | (12,566,834 | ) |
| Effects of foreign currency exchange rates on cash                                                                                                 |       | 346,352                                     |       | (95,990 | ) | 450,696 |   |
| Net (decrease) increase in cash and cash equivalents                                                                                               |       | (30,773,005                                 | )          | 35,617,907 |   | 2,886,696 |   |
| Cash and cash equivalents at beginning of period                                                                                                   |       | 40,508,365                                  |       | 4,890,458 |   | 2,003,762 |   |
| Cash and cash equivalents at end of period                                                                                                         |       | $                                           | 9,735,360  |   | $ | 40,508,365 |   | $ | 4,890,458 |   |
| **Supplemental disclosure of cash  flow information:**                                                                                             |       |                                        |       |   |   |   |   |
| Cash paid during  the period for:                                                                                                                  |       |                                        |       |   |   |   |   |
| Interest                                                                                                                                           |       | $                                           | 160,724    |   | $ | 168,473 |   | $ | 1,350,652 |   |
| Income taxes                                                                                                                                       |       | $                                           | 1,102,649  |   | $ | 11,369,769 |   | $ | 4,067,514 |   |
| Non-cash  financing and investing activities:                                                                                                      |       |                                        |       |   |   |   |   |
| Shares of common stock issued in exchange for the  outstanding shares of Hycor and fair value of $3,331,223 assigned to the  Hycor options assumed |       | $                                           | —     |   | $ | — |   | $ | 43,972,844 |   |
| Shares of common stock issued with respect to the  conversion of outstanding debt                                                                  |       | $                                           | —     |   | $ | — |   | $ | 9,180,000 |   |
| Redemption of common stock for outstanding notes  receivable from stockholders                                                                     |       | $                                           | —     |   | $ | — |   | $ | (3,681,805 | ) |
| Deferred taxes recorded in connection with BCH asset  purchase                                                                                     |       | $                                           | —     |   | $ | (514,403 | ) | $ | 874,495 |   |
| Dividends  declared but not paid                                                                                                                   |       | $                                           | —     |   | $ | 5,571,321 |   | $ | — |   |

 

*(Concluded)*

See accompanying notes to consolidated financial statements.

57

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**STRATAGENE CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**Years Ended December 31,2006, 2005 and 2004

**1.**                 TheCompany and Its Business

*Description of Business*—Stratagene Corporation (“Stratagene” or “the Company”)develops and manufactures biological products, instruments, and softwaredesigned to improve the speed and accuracy of life sciences research andclinical diagnosis. Stratagene markets its products to researchers andclinicians in clinical laboratories and academic, hospital, and governmentinstitutions, as well as to scientists in pharmaceutical and biotechnologycompanies, in the U.S. and internationally. Scientists and clinicians useStratagene’s products to identify genes and proteins, study how cells areregulated by genes and proteins, determine the molecular mechanisms of healthand disease, search for new drug therapies, and develop diagnostic tests.

Stratagene engages in business activity in twooperating segments: Research Supplies and Clinical Diagnostics. The Company hasmarketed and sold its Research Supplies products for over 20 years, while theClinical Diagnostics products are a new addition to Stratagene’s productportfolio as a result of a merger with Hycor Biomedical Inc. in June 2004.(See Note 3)

*Basis of Presentation*—Thefinancial information of the Company has been presented on a consolidatedbasis, and includes the results of operations of Hycor Biomedical Inc. andsubsidiaries (“Hycor”) since Hycor was acquired by the Company on June 2,2004. The financial information also includes the results of operations ofBioCrest Holdings, L.L.C. (“BCH”), whose assets were acquired by the Company onJune 2, 2004. Prior to the acquisition, BCH was under common control withStratagene, and substantially all of the BCH membership units were held bycertain Stratagene shareholders. The acquisition of the BCH assets has beenpresented as a change in reporting entity. Accordingly, the financialstatements of Stratagene and BCH are presented on a consolidated basis for allperiods. (See Note 3.)  On February 9,2006, the Company dissolved BCH.

**2.**                 Summaryof Significant Accounting Policies

*Principles of Consolidation*—The consolidated financial statements of Stratageneinclude the accounts of Stratagene and all of its wholly owned subsidiaries.Intercompany balances and transactions have been eliminated as appropriate inthe consolidation of Stratagene.

*Use of Estimates*—The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the amountsreported in the consolidated financial statements and disclosures made in theaccompanying notes. Actual results could differ from those estimates.

*Cash and cash equivalents—*Stratagene considers all highly liquid investmentswith original maturities of three months or less to be cash equivalents.

*Restricted Cash*—Restricted cash totaled $33,129,967 and $192,388 at December 31,2006 and 2005, respectively. Total interest earned on restricted cash was$1,050,396, $5,014 and $2,623 for the years ended December 31, 2006, 2005and 2004, respectively.

Restricted cash deposits include a $21.0 million civilsupersedeas bond that Stratagene posted in order to permit the Company toappeal a judgment of the district court related to litigation with Third WaveTechnologies without being subject to collection activities by Third Wave. Thisbond is secured by $21.0 million of cash in an interest-bearing restrictedaccount. The cash collateral required to support the bond 

58

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was provided from theavailable cash resources of the Company. For further detail on this litigation,see Note 11, *Commitments and Contingencies—Legal.*

Restricted cash deposits also include a $11.5 millioncivil supersedeas bond that Stratagene posted in order to permit the company toappeal a judgment of the district court related to litigation with InvitrogenCorporation without being subject to collection activities by Invitrogen. Thisbond is secured by $11.5 million of cash in an interest-bearing restrictedaccount. The cash collateral required to support the bond was provided from theavailable cash resources of the Company. For further detail on this litigation,see Note 11, *Commitments and Contingencies—Legal*.

Also included in restricted cash are amounts relatedto the sinking fund payments required under the reimbursement agreementrelating to the Bastrop County Industrial Revenue Bonds (“IRB”). The Companymakes monthly deposits into an interest-bearing sinking fund account. EachApril, the sinking fund deposits are then used to make the required IRB annualpayment. Annual payments of $240,000 are required through April 2021 withan annual payment of $175,000 in April 2022 when the bonds mature.

*AccountsReceivable*—The Companyperforms ongoing credit evaluations of its customers and adjusts credit limitsbased upon payment history and the customer’s current creditworthiness. TheCompany regularly monitors collections and payments from customers andmaintains a provision for estimated credit losses based upon historicalexperience and any specific customer collection issues that have beenidentified. The Company does not write off individual accounts receivable untilwe have exhausted substantially all avenues of legal recourse to collect theoutstanding amount. The Company’s credit losses have historically been withinexpectations and the provisions established.

*Inventories*—Inventories consist primarily of biological productsand instruments and are stated at the lower of cost or market. Cost isdetermined on a first-in, first-out basis. Stratagene regularly reviewsinventory quantities on hand and records a provision for excess and obsoleteinventory on specifically identified items based primarily on an estimated forecastof product demand and production requirements. Stratagene’s losses fromdisposal of excess and obsolete inventories have historically been withinexpectations and the provisions established.

Netinventories include the following at December 31,

| ** **                  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-----------------------------|------------|-----------|------------|-----------|------------|
| Raw materials and  supplies |       | $         | 6,902,492  |      | $          | 4,955,062 |   |
| Work-in-process             |       | 1,344,175 |       | 3,854,153 |       |
| Finished goods              |       | 4,016,152 |       | 4,440,600 |       |
| Total                       |       | $         | 12,262,819 |      | $          | 13,249,815 |   |

 

*Research and DevelopmentCosts*—Research anddevelopment costs are expensed in the period incurred.

*Property and Equipment*—Property and equipment are stated at cost.Depreciation of furniture and equipment and vehicles is calculated using thestraight-line method based upon an estimated useful life of three to fiveyears. Buildings are depreciated over 25 years using the straight-line method.Leasehold improvements are amortized using the straight-line method over the shorterof the lease term or estimated useful life of the asset, generally five years.

59

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Propertyand equipment are summarized as follows:

| ** **                                      | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|-------------------------------------------------|------------|-------------|------------|-------------|------------|
| Land                                            |       | $           | 607,890    |        | $          | 607,890 |   |
| Building                                        |       | 8,758,974   |       | 8,772,090   |       |
| Furniture and  equipment                        |       | 12,788,703  |       | 14,867,943  |       |
| Leasehold  improvements                         |       | 1,141,836   |       | 1,247,965   |       |
| Vehicles                                        |       | 222,378     |       | 171,717     |       |
| Construction in  process                        |       | 104,186     |       | 19,361      |       |
|                                            |       | 23,623,967  |       | 25,686,966  |       |
| Less accumulated  depreciation and amortization |       | (12,696,628 | )          | (14,420,027 | )          |
| Total                                           |       | $           | 10,927,339 |        | $          | 11,266,939 |   |

 

Depreciation expense totaled approximately $2,293,000,$2,277,000, and $2,304,000 for the twelve months ended December 31, 2006,2005, and 2004, respectively.

*Intangible assets*—Intangible assets include long-lived assetsassociated with the merger with Hycor in June 2004. Intangibles alsoinclude costs incurred in connection with patent applications, consistingprincipally of legal fees. Amortization is calculated using the straight-linemethod over the estimated useful lives of the patents, generally seven years.Amortization expense totaled $1,368,979, $1,272,029, and $875,967 for the yearsended December 31, 2006, 2005 and 2004, respectively.

*Revenue Recognition*—Revenue from biological products and basicinstrumentation products is recognized under the provisions of Staff AccountingBulletin (“SAB”) No. 104, RevenueRecognition, which is generally when products are shipped, titlehas transferred and risk of loss has passed. In accordance with Statement ofPosition (“SOP”) No. 97-2, Software Revenue Recognition, as amendedby SOP No. 98-9, for instrumentation products where software isconsidered more than incidental to the product, revenue is recognized whenpersuasive evidence of an arrangement exists, delivery has occurred, the salesprice is fixed or determinable and collectibility is probable. Generally, thesecriteria are met at the time product is shipped and title has transferred. Whensubstantive contractual acceptance clauses exist, revenue is recognized uponsatisfaction of such clauses. Contract research service revenues are earned andrecognized in accordance with contract provisions. Amounts received in advanceof performance or acceptance are recorded as deferred revenue.

Thefollowing table summarizes the types of deferred revenue and the timing of whenthat revenue is recognized:

| Type of deferred revenue                          | ** ** | ** **                                                                                                                                                                                                                               | ** ** | **When recognized** |
|---------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|
| Extended warranty or  maintenance agreements      |       | Recognized over the term  of the contract, generally 12 months. In most cases, these contracts were  sold at the time of product purchase and the recognition of revenue begins  after the warranty period, which is generally one year. |
| License agreements                                |       | Recognized over  the term of the agreement, generally 12 months.                                                                                                                                                                         |
| Collaboration agreements—milestone  payments |       | Recognized during  the period that the specified services or products are delivered and accepted  by the customer.                                                                                                                       |

 

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Thefollowing table provides the percentage of the ending balance in deferredrevenue that each type of deferred revenue represents as of December 31,2006 and 2005:

| **Type of deferred revenue**               | ** ** | ** ** | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------|------------|
| Extended  warranty, installation or maintenance agreement |       |       | 41         | %                           |       |                        | 59         | % |   |
| License  agreements                                       |       |       | 23         | %                           |       |                        | 41         | % |   |
| Collaboration  agreements—milestone payments         |       |       | 36         | %                           |       |                        | 0          | % |   |
| Total deferred revenue                                    |       |       | 100        | %                           |       |                        | 100        | % |   |

 

Some of the Company’s agreements contain multipleelements. Emerging Issues Task Force (“EITF”) No. 00-21, *Revenue Arrangements with Multiple Deliverables,*provides guidance on accounting for arrangements that involve the delivery orperformance of multiple products, services, or rights to use assets withincontractually binding arrangements. Stratagene recognizes revenue for deliveredelements in accordance with SAB No. 104 and its revenue recognition policyand only when it determines that the earnings process is complete and allevents for recognition of contract revenue have been achieved.

Some of the Company’s agreements also containmilestone payments. Revenue from a milestone achievement is recognized whenearned, as evidenced by acknowledgement from the Company’s collaborator,provided that (i) the milestone event is substantive, (ii) themilestone represents the culmination of an earnings process, (iii) themilestone payment is non-refundable and (iv) there are no furtherperformance obligations on the part of Stratagene. If all of these criteria arenot met, the milestone achievement is recognized over the remaining minimumperiod of our performance obligations under the agreement.

*Warranty**—*The Company warrants certain equipmentagainst defects in workmanship or materials for a period of one year from thedate of purchase. Upon shipment of equipment sold that includes a warranty, theCompany establishes, as part of cost of products sold, a provision for theexpected costs of such warranty.

Accruedwarranty activity for the years ended December 31, 2006 and 2005 is asfollows:

| ** **                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Balance at  beginning of year   |       | $        | 233,299    |     | $          | 333,277 |   |
| Charged to costs  and expenses  |       | 401,714  |       | 444,461  |       |
| Reductions of  accrued warranty |       | (417,002 | )          | (544,439 | )          |
| Balance at end of year          |       | $        | 218,011    |     | $          | 233,299 |   |

 

*Advertising*—Advertisingcosts are expensed as incurred and included in selling and marketing expenses. Advertisingexpenses include external advertising, catalog, newsletter and promotionalliterature. Advertising expenses were approximately $3,129,000, $3,372,000 and$3,098,000 for the years ended December 31, 2006, 2005 and 2004,respectively.

*IncomeTaxes**—*Stratageneand its subsidiaries record income taxes using the asset and liability methodof accounting for income taxes. Under the asset and liability method, deferredtax assets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets and liabilities are measured using enacted tax rates expected to applyto taxable income in the years in which those temporary differences areexpected to be recovered or settled. The effect on deferred tax assets andliabilities of a change in tax rates is recognized in operations in the periodthat includes the enactment date.

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Historically, BCH consisted of limited liabilitycompanies that were treated as partnerships for income tax purposes; therefore,any related income tax liabilities were the responsibility of the members. As aresult, the operations of BCH did not reflect a provision for income taxesuntil these limited liability companies were acquired when Stratagene acquiredthe assets of BCH in June 2004. Since June 2004, income taxes havebeen recorded based on the net income or loss of the limited liabilitycompanies.

*ForeignCurrency Translation/Transaction—*The accounts offoreign subsidiaries and affiliates of the Company are measured using the localcurrency as the functional currency. For these operations, assets andliabilities are translated into U.S. dollars at period-end exchange rates, andincome and expense accounts are translated at average monthly exchange rates.Net translation gains or losses are excluded from net income and reflected inaccumulated other comprehensive loss in the accompanying consolidated balancesheets. Realized gains or losses from foreign currency transactions areincluded in operations as incurred.

*DerivativeFinancial Instruments**—*Aspart of distributing its products, the Company regularly enters intointercompany transactions with its foreign subsidiaries. The Company’s currencyexposures vary, but are primarily concentrated in the Euro, British Pound,Swiss Franc and Japanese Yen. In the past, the Company periodically enteredinto foreign currency exchange futures contracts to mitigate foreign currencyrisk on its European revenues. The Company managed its exposure over a maximumof twelve months. All futures contracts entered into for fiscal year 2004 weresettled by year end, and the Company had no pending futures contractsoutstanding as of December 31, 2004.

In the past, the Company’s derivative instruments havenot qualified for hedge accounting in accordance with Statement of FinancialAccounting Standards (“SFAS”) No. 133, *Accountingfor Derivative**Instruments andHedging Activities,*as amended (“SFAS No. 133”). Accordingly,both unrealized and realized gains or losses resulting from changes in fairvalue are recognized as incurred in gain (loss) on foreign currencytransactions in the current period statement of operations. The Company doesnot enter into derivative instruments for trading or speculative purposes.

*FairValue of Financial Instruments**—*The carrying amounts of cash and cashequivalents, restricted cash, accounts receivable, other current assets,accounts payable, other current liabilities, and line of credit are consideredto be representative of their respective fair values because of the short-termnature of these financial instruments. The carrying amount of the long-termdebt is a reasonable estimate of fair value, as the loans have terms based onmarket rates.

*Impairmentof Long-Lived Assets—*The Company accounts forlong-lived assets in accordance with the provisions of SFAS No. 142, *Goodwill and**Intangibles,*and SFAS No. 144, *Accounting for the Impairment or Disposal of**Long-Lived Assets.*TheseStatements require that long-lived assets and certain identifiable intangibleassets with finite lives be reviewed for impairment whenever events or changesin circumstances indicate that the carrying amount of an asset may not berecoverable. Goodwill and non-amortizable intangible assets are reviewed forimpairment annually or whenever events or changes in circumstances indicatethat the carrying amount of an asset may not be recoverable. Recoverability ofassets to be held and used is measured by a comparison of the carrying amountof the asset to the future net undiscounted cash flows expected to be generatedby the asset. If such assets are considered to be impaired, the impairment tobe recognized is measured by the amount by which the carrying amounts of theassets exceed the fair values of the assets. Assets to be disposed of arereported at the lower of the carrying amount or fair value less costs to sell.

*Accountingfor Stock-Based Compensation**—*In December 2004, the Financial Accounting StandardsBoard (“FASB”) revised SFAS 123(R), *Share-Based Payment*,which establishes accounting for share-based awards exchanged for employeeservices and requires companies to expense the estimated fair value of theseawards over the requisite employee service period. On April 14, 2005, theSEC adopted a new 

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rule amending theeffective dates for SFAS No. 123(R). In accordance with the new rule, theCompany adopted the accounting provisions of SFAS No. 123(R) beginningin the first quarter of 2006.

Under SFAS No. 123(R), share-based compensationcost is measured at the grant date, based on the estimated fair value of theaward, and is recognized as expense over the employee’s requisite serviceperiod. The Company has no awards with market or performance conditions. TheCompany adopted the provisions of SFAS No. 123(R) on January 1,2006, using the modified prospective application. Under the modifiedprospective application, prior periods are not revised for comparative purposes.Prior to January 1, 2006, the Company followed Accounting Principles Board(“APB”) Opinion No. 25, *Accounting forStock Issued to Employees,*(“ABP No. 25”),**asamended, for its stock compensation. The valuation provisions of SFAS No. 123(R) applyto new awards and to awards that are outstanding on the effective date andsubsequently modified or cancelled. The Company has recognize estimatedcompensation expense for awards outstanding at the effective date over the remainingservice period using the compensation cost calculated for pro forma disclosurepurposes under FASB Statement No. 123, *Accounting for Stock-BasedCompensation* (“SFAS No. 123”).

On November 10, 2005,the FASB issued FASB Staff Position No. SFAS 123(R)-3, *Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards*. The Company has elected to adopt thealternative transition method provided in this FASB Staff Position forcalculating the tax effects of share-based compensation pursuant to SFAS No. 123(R).The alternative transition method includes a simplified method to establish thebeginning balance of the additional paid-in capital pool (“APIC pool”) relatedto the tax effects of employee share-based compensation, which is available toabsorb tax deficiencies recognized subsequent to the adoption of SFAS No. 123(R).

**Share-Based CompensationInformation under SFAS No. 123(R)**

The value of Stratagene employee stock options wasestimated at the dates of grant using the minimum value method of SFAS No. 123from the inception date of the applicable stock option plan through June 2,2004, and the fair value method for all option grants made subsequent to thatdate using the Black-Scholes option pricing model. The fair value of the Hycoremployee stock options assumed by Stratagene in the Hycor merger were estimatedat the merger date using the Black-Scholes pricing model for all option grants.For options granted that have multiple cliff vesting periods, the Companyamortizes compensation cost using the graded vesting method prescribed by FASBInterpretation No. 28, *Accounting for StockAppreciation Rights and Other Variable Stock Option and Award Plans*.The Company has elected to follow the graded vesting method and will continue touse the Black-Scholes valuation method under SFAS No. 123(R).

Theweighted-average grant date fair values of employee stock options grantedduring the twelve months ended December 31, 2006 were $3.06. Theweighted-average grant date fair values of employee stock granted underStratagene Corporation’s Employee Stock Purchase Program (“ESPP”) during thetwelve months ended December 31, 2006 were $1.68 using the Black-Scholesmodel with the following weighted-average assumptions (annualized percentages)for the twelve months ended December 31, 2006:

| ** **                   | ** ** | **Twelve Months Ended  December 31, 2006** | ** ** |
|------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                   | ** ** | **Stock  Options**                                             | ** ** | **ESPP** | ** ** |
| Risk free  interest rate     |       | 4.9                                                            | %          | 4.9 | % |
| Dividend yield               |       | 0                                                              | %          | 0 | % |
| Volatility factor            |       | 45                                                             | %          | 45 | % |
| Expected life (in  years)    |       | 4.8 years                                                      |       | 0.25 years |   |
| Pre-vesting forfeiture  rate |       | 7                                                              | %          | — |   |

 

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The risk-free interest rate assumption is based uponobserved interest rates appropriate for the expected terms of the Company’semployee stock options. The Company paid a special $0.25 per share dividend toshareholders on January 6, 2006 as a result of a settlement with CambridgeAntibody Technology, but this dividend was not considered in the dividend yieldof 0.0% as the Company has no intentions of paying cash dividends in theforeseeable future. The volatility factor was calculated based on thehistorical volatility of the Hycor and Stratagene stock prices and theconsideration of trends and future events. The expected life of employee stockoptions represents the weighted-average period the stock options are expectedto remain outstanding and is calculated using the simplified method asdescribed in the SEC’s SAB No. 107, *Share-Based Payment,*(“SABNo. 107”). Using the simplified method, options granted to employees witha four year vesting schedule have an expected life of 6.25 years and optionsgranted to directors with a three year vesting schedule have an expected lifeof 6 years. Due to the fact that options vest ratably over the vesting period,the weighted average expected life is calculated as 4.8 years. The pre-vestingforfeiture rate is based on the Company’s historical option forfeitureinformation and was normalized for significant non-recurring employeeterminations.

Total estimatedshare-based compensation expense, related to all of the Company’s share-basedawards, including those granted under the ESPP, recognized for the twelvemonths ended December 31, 2006 was comprised as follows:

| ** **                                               | ** ** | **Twelve Months  Ended  December 31,  2006** | ** ** |
|----------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Capitalized to  inventory                                |       |                                                   | $          | 70,189 |   |   |
| Cost of product sales                                    |       |                                                   | 89,314     |   |   |
| Research and  development                                |       |                                                   | 192,741    |   |   |
| Selling and  marketing                                   |       |                                                   | 207,879    |   |   |
| General and  administrative                              |       |                                                   | 385,209    |   |   |
| Share-based compensation expense before taxes            |       |                                                   | 875,143    |   |   |
| Related income  tax benefits                             |       |                                                   | (293,173   | ) |   |
| Share-based compensation expense after taxes             |       |                                                   | $          | 581,970 |   |   |
| Net share-based compensation expense, per common  share: |       |                                                   |       |   |   |
| Basic                                                    |       |                                                   | $          | 0.03 |   |   |
| Diluted                                                  |       |                                                   | $          | 0.03 |   |   |

 

**Pro Forma Information under SFASNo.123(R) for Periods Prior to Fiscal 2006**

Prior to adopting the provisions of SFAS No. 123(R),the Company recorded compensation expense for employee stock options based upontheir intrinsic value on the date of grant pursuant to APB No. 25 andprovided the required pro forma disclosures of SFAS No. 123. Because theCompany established the exercise price based on the fair market value of theCompany’s stock at the date of grant, the stock options had no intrinsic valueupon grant, and therefore no expense was recorded prior to adopting SFAS No. 123(R).Each accounting period, the Company reported the potential dilutive impact ofstock options in its diluted EPS using the treasury-stock method.Out-of-the-money stock options (i.e., the average stock price during the periodwas below the strike price of the stock option) were not included in diluted EPSas their effect was anti-dilutive.

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Forpurposes of pro forma disclosures under SFAS No. 123 for the years endedDecember 31, 2005 and 2004, the estimated fair value of the share-basedawards was assumed to be amortized to expense over the their vesting periods.The pro forma effects of recognizing estimated compensation expense under thefair value method on net income and EPS were as follows:

| ** **                                                                                                       | ** ** | **Twelve Months Ended  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                       | ** ** | **2005**                                             | ** ** | **2004** | ** ** |
| Net income as  reported                                                                                          |       | $                                                    | 7,787,770  |   | $ | 7,438,431 |   |
| Stock-based  employee compensation expense included in reported net income, net of related  tax effects          |       | —                                               |       | 64,751 |   |
| Stock-based  compensation expense determined under SFAS No. 123 for all awards, net  of related tax effects |       | (2,331,204                                           | )          | (821,573 | ) |
| Pro forma net  income                                                                                            |       | $                                                    | 5,456,566  |   | $ | 6,681,609 |   |
| Earnings per  common share:                                                                                      |       |                                                 |       |   |   |
| Basic—as reported                                                                                           |       | $                                                    | 0.35       |   | $ | 0.39 |   |
| Basic—pro forma                                                                                             |       | $                                                    | 0.25       |   | $ | 0.35 |   |
| Diluted—as reported                                                                                         |       | $                                                    | 0.35       |   | $ | 0.39 |   |
| Diluted—pro forma                                                                                           |       | $                                                    | 0.25       |   | $ | 0.35 |   |

 

The acceleration of certain outstanding employee stockoptions in the first quarter of 2005 impacted the pro forma stock-basedcompensation expense determined under SFAS No. 123 presented in the tableabove. On March 31, 2005, the Compensation Committee of the Board ofDirectors of the Company accelerated the vesting of certain unvestednon-qualified stock options previously awarded to the Company’s executiveofficers and other employees under the Company’s Amended and Restated Year 2000Stock Option Plan that had an exercise price greater than or equal to $8.05,the closing price of the Company’s common stock on the date preceding theCompensation Committee’s action. Options to purchase approximately 1.2 millionshares of common stock (of which approximately 905,000 shares were subject tooptions held by executive officers) were subject to this acceleration. Optionsheld by non-employee directors and advisory board members and “incentive stockoptions” were not accelerated.

Because these options hadexercise prices at or in excess of the fair market value of the Company’scommon stock at the time they were accelerated, and were not fully achievingtheir original objectives of incentive compensation and employee retention, theCompany believes that the acceleration had a positive effect on employeemorale, retention and perception of option value. The acceleration willeliminate any future compensation expense the Company would otherwise recognizein its income statement with respect to these options with the implementationof SFAS No. 123(R), *Share-Based Payment*,which became effective for the Company’s first quarterly reporting period in2006. At the date of acceleration of the options, management estimated that thefuture expense that would be eliminated beginning in 2006 as a result of theacceleration of the vesting of these options is approximately $1.6 million, orapproximately $1.0 million net of tax, of which approximately $1.2 million, or$775,000 net of tax, is attributable to options held by executive officers. Theoption acceleration did not result in compensation expense in the first quarterof 2005 under APB No. 25 and FASB Interpretation No. 44 because theseoptions had exercise prices at or in excess of the fair market value of theCompany’s common stock at the time they were accelerated.

**Options to Non-Employees**

Charges for options granted to non-employees have beendetermined in accordance with SFAS No. 123 and EITF No. 96-18, *Accounting for Equity Instruments that are Issued to Other ThanEmployees for Acquiring, or in Conjunction with Selling, Goods or Services*,as the estimated fair value of the consideration 

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received or the estimatedfair value of the equity instruments issued, whichever is more reliablymeasured. The fair value for these options is based on the Black-Scholespricing model. The Company recognized ($14,492), $187,056 and $357,171 ofstock-based compensation expense (income) for the years ended December 31,2006, 2005 and 2004, respectively. The expense (income) was recorded inresearch and development expense. The total deferred charges for options grantedto non-employees are re-measured quarterly as the underlying options vest andare included in additional paid-in capital in the financial statements.

*SegmentReporting—*The Company currently operates in twooperating segments: Research Supplies and Clinical Diagnostics.

*RecentAccounting Pronouncements**—*In July 2006, the FASB issued FASB Interpretation No. 48,(“FIN 48”), *Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109*.FIN 48 clarifies the accounting for uncertainty in income taxes recognizedin a company’s financial statements in accordance with SFAS No. 109, *Accounting for Income Taxes,*(“SFAS No. 109”)*.*This interpretation prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. This Interpretation also provides guidance on derecognition,classification, interest and penalties, accounting in interim periods,disclosure, and transition. FIN 48 is effective for fiscal years beginningafter December 15, 2006. The Company has consistently evaluated therequirement for a tax reserve with each fiscal year end and believe that wehave adequate means to support appropriate tax reserves as of December 31,2006. Management is still evaluating the impact of FIN 48 on our financialresults for future periods.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements* (“SFAS No. 157”).SFAS No. 157 establishes a framework for measuring fair value in generallyaccepted accounting principles (“GAAP”), and expands disclosures about fairvalue measurements. This Statement is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, and interim periodswithin those fiscal years. Management has not yet completed its evaluation ofthe impact of adopting SFAS No. 157.

In September 2006,the SEC issued SAB No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current Year FinancialStatements* (“SAB No. 108”). SAB No. 108 establishes asingle quantification framework wherein the significance measurement is basedon the effects of the misstatements on each of the financial statements as wellas the related financial statement disclosures. If a company’s existing methodsfor assessing the materiality of misstatements are not in compliance with theprovisions of SAB No. 108, the initial application of the provisions maybe adopted by restating prior period financial statements under certaincircumstances or otherwise by recording the cumulative effect of initiallyapplying the provisions of SAB No. 108 as adjustments to the carryingvalues of assets and liabilities as of January 1, 2006 with an offsettingadjustment recorded to the opening balance of retained earnings. SAB No. 108is effective for the first annual period ending after November 15, 2006.The adoption of SAB No. 108 has not had a material effect on the Company’sresults of operations or financial position.

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**3.**                 BusinessCombinations

*Hycor Merger*

On June 2,2004, Stratagene acquired all of the outstanding shares of Hycor through amerger of a wholly owned subsidiary of Stratagene and Hycor, with Hycorsurviving as a wholly owned subsidiary of Stratagene. Hycor engages in researching,developing, manufacturing and marketing clinical diagnostic products throughoutthe United States and in many foreign countries. The primary reasons for themerger were the following:

·       thecombination of Stratagene’s molecular diagnostics technology and Hycor’s GoodManufacturing Practice (“GMP”) approved facilities and U.S. Food and DrugAdministration (“FDA”) experience allows the Company to enter the clinicaldiagnostics market;

·       potentialgrowth from increased earnings and revenue;

·       expandedaccess to capital markets; and

·       diversifiedcustomer base and product lines.

As a result of the merger, Hycor’s former shareholdersreceived 0.6158 of a share of Stratagene common stock in exchange for eachshare of Hycor common stock, plus cash for fractional shares. The fair value ofthe consideration exchanged in the merger was calculated based upon the fairvalue of Hycor’s publicly-traded common shares, as their fair value wasdetermined to be more clearly evident than that of Stratagene’s common shares.In accordance with EITF No. 99-12, *Determiningthe Measurement**Date for theMarket Price for an Acquirer of Securities Issued in a Business**Combination,*the market price wasdetermined based on an average of the closing prices of the Hycor stock for thetrading days nearest July 24, 2003, the date on which the merger agreementwas originally signed. Using the 0.6158 exchange ratio, 5,015,453 shares ofStratagene common stock were issued to the former Hycor stockholders inconnection with the merger and 655 fractional shares were redeemed through acash payment by Stratagene.

Stratagene alsoassumed each outstanding option to purchase shares of Hycor common stock issuedunder the stock option plans of Hycor, whether or not then exercisable, onsubstantially the same terms and conditions as were applicable prior to themerger date, except that:

·       theoptions are now exercisable for shares of Stratagene common stock; and

·       thenumber of shares of Stratagene common stock that may be purchased are equal tothe number of shares of Hycor common stock underlying the option multiplied by0.6158, rounded down to the nearest whole number.

The stock optionplans of Hycor included the following:

·       theHycor Biomedical Inc. 2001 Stock Option Plan;

·       theHycor Biomedical Inc. 1992 Incentive Stock Plan; and

·       theHycor Biomedical Inc. Nonqualified Stock Option Plan for Non-EmployeeDirectors, as amended.

The exercise price per share for the Stratagene commonstock issuable under each Hycor option equals the per share exercise price ofthe Hycor common stock purchasable under the Hycor option divided by theexchange ratio of 0.6158, rounded up to the nearest whole cent.

Stratagene has reserved for issuance a number ofshares of Stratagene common stock at least equal to the number of shares ofStratagene common stock that are issuable upon the exercise of options assumed 

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by Stratagene inconnection with the Hycor merger. Stratagene assumed options to purchase anaggregate of 756,822 shares of Stratagene common stock in connection with themerger.

Thetotal purchase consideration for the acquisition of Hycor was $45,714,053,based on the following components:

| **Purchase consideration:**                                                 |   |      |       |
|-----------------------------------------------------------------------------|--------|-----------|------------|
| Fair value of 5,015,453 Stratagene common shares  issued at $8.10 per share |   | $         | 40,641,622 |   |
| Fair value of Hycor fractional shares acquired with  cash                   |   | 6,120     |       |
| Fair value of Hycor common stock options assumed                            |   | 3,331,223 |       |
| Merger related costs                                                        |   | 1,735,088 |       |
| Total purchase  consideration                                               |   | $         | 45,714,053 |   |

 

Thefollowing represents an allocation of the purchase price to the acquired assetsand the assumed liabilities of Hycor. Stratagene considered a number of factorsin determining the allocation of the purchase price, including the results of athird-party valuation. Stratagene completed its final analysis of the purchaseprice allocation related to the Hycor merger in the fourth quarter of 2004 andrecorded an adjustment to increase deferred tax assets by $619,509 based on thecompletion of the tax returns as of the merger date. The offset of $619,509 wasreflected in goodwill. The purchase was a non-taxable transaction andaccordingly, no goodwill was established for tax purposes.

| **Purchase price allocation:**                                        |   |       |       |
|-----------------------------------------------------------------------|--------|------------|------------|
| Current assets                                                        |   | $          | 15,631,593 |   |
| Property and equipment                                                |   | 2,269,676  |       |
| Goodwill                                                              |   | 27,234,214 |       |
| Other non-amortizable intangible assets                               |   | 1,575,000  |       |
| Amortizable intangible assets                                         |   | 1,669,000  |       |
| Unearned stock-based compensation for unvested stock  options assumed |   | 781,622    |       |
| Deferred tax assets, net                                              |   | 1,024,239  |       |
| Total assets acquired                                                 |   | 50,185,344 |       |
| Total liabilities assumed                                             |   | (4,471,291 | )          |
| Net assets  acquired                                                  |   | $          | 45,714,053 |   |

 

Goodwill represents the excess of the purchase priceover the fair value of the tangible and identifiable intangible assets. Theother non-amortizable intangible assets represent $1,575,000 for a trade namewith an indefinite life. The amortizable intangible assets include $480,000 forpatents and trademarks, which will be amortized over 1 to 5 years, and$1,189,000 for contractually based customer relationships, which will be amortizedover 1 to 5 years.

Unearned stock-based compensation for unvested Hycorstock options assumed is the sum of the intrinsic value of each unvested stockoption assumed by Stratagene in the merger with Hycor. The unvested portion ofthe assumed options will be amortized over the remaining vesting period usingthe graded vesting method prescribed under FIN No. 28, *Accounting**for Stock Appreciation Rights and Other Variable Stock Option or AwardPlans*.

In connection withthe merger, the following events occurred on June 2, 2004:

·       Stratageneforgave $390,000 of the shareholder note receivable due to Stratagene by Dr. JosephA. Sorge, Stratagene’s Chief Executive Officer (“Dr. Sorge”), and paid theincome taxes related to the forgiveness, which resulted in a charge toStratagene of $650,000. This forgiveness was applied to reduce Dr. Sorge’snote receivable to the Company, which was $3,351,311 at June 2, 2004,including 

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interest. Dr. Sorgesatisfied the remaining portion of his shareholder note receivable on June 2,2004 by tendering an aggregate of 524,160 shares of common stock to Stratageneat a price of approximately $6.50 per share. The share price was based on Hycor’sstock price of approximately $4.00 at the time Stratagene and Hycor agreed onthe repurchase, adjusted for the exchange ratio.

·       Inaddition, another shareholder paid off the balance of her note, which was$276,877 at June 2, 2004, including interest, by tendering 42,623 sharesof common stock to Stratagene at a price of approximately $6.50 per share. Thisprice was based on Hycor’s stock price of approximately $4.00 at the timeStratagene and Hycor agreed on the repurchase price, adjusted for the exchangeratio.

·       Dr. Sorgereceived a bonus in the amount of approximately $1,670,000, which was evidencedby a promissory note with a 39-month term and an interest rate of 3.89%per annum. This promissory note was paid in full by Stratagene in December 2004.

·       Stratageneentered into a new employment agreement with Dr. Sorge, pursuant to which,among other things, Dr. Sorge’s base annual salary was reduced from $1.1million to $450,000, and Dr. Sorge was granted an option to purchase738,960 shares of Stratagene common stock at an exercise price of $9.34 pershare. The contract provides for Dr. Sorge’s base salary to be reviewed onat least an annual basis by the compensation committee of the board ofdirectors, which may also increase Dr. Sorge’s base salary from time totime in its discretion. Pursuant to the employment agreement, the CEO is entitledto participate in the Company’s bonus program on a basis at least comparable toother senior executives. Dr. Sorge may also receive bonuses at thediscretion of the board of directors upon the recommendation of thecompensation committee. The new employment agreement has an initial term ofthree years and is subject to successive one-year renewals unless either partyprovides a notice of non-renewal at least 30 days prior to the termination ofthe then current term.

·       In accordance with theterms of the instrument governing its then outstanding subordinated notes,Stratagene converted $9.0 million in principal amount of the subordinated notesinto 1,753,604 shares of Stratagene common stock. As a result of theconversion, there are no subordinated notes outstanding subsequent to themerger.

**Pro FormaInformation**

Theresults of operations of Hycor have been included in the accompanyingconsolidated financial statements of Stratagene from the date of acquisition.However, the following unaudited pro forma information assumes that the June 2,2004 Hycor merger occurred on January 1, 2004. These unaudited pro formaresults have been prepared for comparative purposes only and are not indicativeof the results of operations that would have actually resulted had theacquisition been in effect as of the periods indicated above, or of futureresults of operations. The unaudited pro forma results for the year ended December 31,2004 are as follows:

| ** **               | ** ** | **2004**   | ** ** |
|--------------------------|------------|------------|------------|
| Revenues                 |       | $          | 93,779,136 |   |
| Net income               |       | $          | 8,715,988  |   |
| Earnings per share:      |       |       |       |
| Basic                    |       | $          | 0.40       |   |
| Diluted                  |       | $          | 0.40       |   |
| Weighted average shares: |       |       |       |
| Basic                    |       | 21,909,391 |       |
| Diluted                  |       | 21,915,191 |       |

 

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The unaudited proforma information presented above has been adjusted for charges for material,nonrecurring items that include the following:

·       removinginterest income on shareholder loans that were paid off upon the closing of themerger;

·       removinginterest expense on subordinated debt that converted to common stock upon theclosing of the merger;

·       recordingamortization expense on acquired other intangible assets;

·       recordingamortization expense on unearned stock-based compensation for assumed stock options;

·       reducingthe CEO’s salary pursuant to a new employment agreement effective on the mergerdate;

·       removingHycor’s merger related costs incurred in the periods presented; and

·       recording the tax provisionadjustment to the pro forma statement of operations at the statutory rate of36%.

*BCH Acquisition*

Concurrently with the closing of the Hycor merger,Stratagene acquired substantially all of the assets of BCH, including BCH’sinterests in its subsidiaries. In exchange, Stratagene forgave all of theoutstanding intercompany indebtedness owed by BCH and its subsidiaries toStratagene of approximately $5.4 million and assumed all of the otheroutstanding liabilities of BCH and its subsidiaries of approximately $0.8million. Because Stratagene and BCH were under common control, andsubstantially all of the BCH membership units were held by certain Stratageneshareholders, the acquisition of BCH was recorded on a historical cost basis.As such, there was no adjustment of BCH’s assets and liabilities to fair valueand no goodwill resulting from the purchase. As of and for the periods endedDecember 31, 2004, Stratagene’s financial statements are presented on aconsolidated basis, which represents a change in reporting entity under APBOpinion No. 20, *Accounting Changes*.Previously combined statements are now presented on a consolidated basis as aresult of the transaction. There is no change to income for previous periodspresented on a combined basis. For tax purposes, this transaction is taxable.The financial statements in 2004 reflected net deferred tax assets ofapproximately $875,000 for differences between the tax and book basis of assetsand liabilities acquired by Stratagene. With the completion of the initialconsolidated tax returns in 2005, the Company adjusted the deferred tax assetassociated with the acquired assets and liabilities and reflected a $514,000reduction to the net deferred tax asset and additional paid-in capital inaccordance with SFAS No. 109, *Accounting for IncomeTaxes.*

Prior to the acquisition date, Stratagene presentedits financial statements on a combined basis with BCH. BCH consistedsubstantially of limited liability companies that were treated as partnershipsfor income tax purposes; therefore, any related income tax liabilities were theresponsibility of the members of BCH. As a result, the operations of BCH didnot reflect a provision for income taxes in the combined financial statements,including its share of the $1.8 million gain in equity in earnings of a jointventure on June 1, 2004. (See Note 13) Beginning on June 2, 2004, theconsolidated results of Stratagene, which includes the results of BCH, includea provision for income taxes.

As part of the BCH acquisition, Stratagene acquiredBCH’s interests in its subsidiaries, which include Phenogenex, LLC(“Phenogenex”), Iobion Informatics, LLC and subsidiaries (“Iobion”) and aninvestment in a joint venture consisting of a 49% interest in a limitedpartnership that operates a research lab. The investment is accounted for underthe equity method.

As a result of the acquisition, Stratagene owned 100%of Phenogenex and approximately 78% of Iobion. The remaining 22% interest inIobion was represented by membership units held by two individuals, neither ofwhich is now associated with the Company. In October 2004, the Company 

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purchased the remaining22% outstanding membership interests in Iobion owned by these individuals. As aresult of the purchase of these minority interests, Stratagene now owns 100% ofIobion. Total cash consideration of $330,000 and an intangible asset of$330,000 was recorded and is being amortized to expense over 36 months.

During 2005, the Companymerged Iobion and Phenogenex into Stratagene, leaving only the IobionInformatics (Canada), Ltd. subsidiary, and on February 9, 2006, Stratagenedissolved BCH. There was no financial statement impact to this merger ordissolution.

**4.**                 EarningsPer Share (“EPS”)

BasicEPS is based on the weighted-average number of shares outstanding during theperiods, while diluted EPS additionally includes the dilutive effects of theCompany’s outstanding common stock options computed using the treasury stockmethod. The number of shares used in computing EPS is as follows:

| ** **                              | ** ** | **Twelve Months Ended December 31,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average shares:                |       |                                                     |       |   |   |   |   |
| Basic                                   |       | 22,389,159                                               |       | 22,112,892 |   | 19,307,564 |   |
| Effect of dilutive common stock options |       | 54,943                                                   |       | 146,165 |   | 5,800 |   |
| Diluted                                 |       | 22,444,102                                               |       | 22,259,057 |   | 19,313,364 |   |

 

Options outstandingtotaling 2,420,646, 1,950,631 and 2,338,395 for the years endedDecember 31, 2006, 2005 and 2004, respectively, were excluded from thecalculations of earnings per common share, as their effect would have beenantidilutive.

**5.**                 IntangibleAssets and Goodwill

Thefollowing sets forth the Company’s intangible assets by major asset class:

| ** **                                      | ** ** | ** **                    | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------|------------|-------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **Useful Life  (Years)** | ** ** | **Gross**                       | ** ** | **Accumulated  Amortization**   | ** ** | **Net Book  Value** | ** ** | **Gross** | ** ** | **Accumulated  Amortization** | ** ** | **Net Book  Value** | ** ** |
| Intangible assets subject  to amortization:     |       |                          |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Amortizable patents and other                   |       | 2 - 7  years                  |       | $                               | 9,977,035  |                            |       | $ | 5,307,691 |   |   | $ | 4,669,344 |   | $ | 8,696,142 |   |   | $ | 4,284,418 |   |   | $ | 4,411,724 |   |
| Amortizable intangible assets                   |       | 1 - 5  years                  |       | $                               | 1,189,000  |                            |       | $ | 815,326 |   |   | $ | 373,674 |   | $ | 1,189,000 |   |   | $ | 530,587 |   |   | $ | 658,413 |   |
| Intangible assets not  subject to amortization: |       |                          |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-amortizable intangible assets               |       |                          |       | $                               | 1,575,000  |                            |       | $ | — |   |   | $ | 1,575,000 |   | $ | 1,575,000 |   |   | $ | — |   |   | $ | 1,575,000 |   |
| Goodwill                                        |       |                          |       | $                               | 27,234,214 |                            |       | $ | — |   |   | $ | 27,234,214 |   | $ | 27,234,214 |   |   | $ | — |   |   | $ | 27,234,214 |   |
|                                            |       |                          |       | $                               | 39,975,249 |                            |       | $ | 6,123,017 |   |   | $ | 33,852,232 |   | $ | 38,694,356 |   |   | $ | 4,815,005 |   |   | $ | 33,879,351 |   |

 

Amortizable patents and other includes costs incurredin connection with patent applications, which consist principally of legalfees. Amortizable intangible assets, non-amortizable intangible assets andgoodwill were established in connection with the merger with Hycor. Goodwillrepresents the excess of the purchase price over the fair value of the tangibleand identifiable intangible assets. The other non-amortizable intangible assetsrepresent $1,575,000 for a trade name with an indefinite life. The intangibleassets subject to amortization include $480,000 for patents and trademarks,which will be amortized over 2 to 7 years, and $1,189,000 for contractually basedcustomer relationships, which will be amortized over 1 to 5 years.

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Amortizationexpense totaled $1,368,979, $1,272,029 and $875,967 for the years ended December 31,2006, 2005 and 2004, respectively. Amortization expense in each of the nextfive fiscal years is expected to be as follows:

| **Year**   | ** ** | ** ** | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|------------|------------|
| 2007       |       | $          | 1,214,088  |       |
| 2008       |       | 941,671    |       |
| 2009       |       | 801,671    |       |
| 2010       |       | 613,195    |       |
| 2011       |       | 465,714    |       |
| Thereafter |       | 1,006,679  |       |
| Total      |       | $          | 5,043,018  |       |

 

**6.**                 AccruedExpenses and Other Liabilities

Accruedexpenses and other liabilities consist of the following:

| ** **                              | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Accrued  compensation                   |       | $                           | 2,284,497  |                        | $          | 3,406,685 |   |
| Accrued royalties                       |       | 17,811,849                  |       | 17,208,443                  |       |
| Litigation  accruals                    |       | 30,584,401                  |       | 20,600,352                  |       |
| Warranty                                |       | 218,011                     |       | 233,299                     |       |
| Other accrued  expenses and liabilities |       | 1,744,095                   |       | 1,327,473                   |       |
| Total                                   |       | $                           | 52,642,853 |                        | $          | 42,776,252 |   |

 

*See Note11, Commitments and Contingencies, Royalty Payments.*

**7.**                 Long-TermDebt

During 2006, the Company had debt instruments bearinginterest at variable rates, most of which are guaranteed by Stratagene andsecured by substantially all of the assets of Stratagene. The outstanding debtinstruments contained restrictive covenants requiring the Company to maintaincertain financial ratios, including minimum debt service coverage ratios, fixedcharge coverage ratios and tangible net worth. The debt instruments alsorestricted the payments of dividends to the Company’s stockholders. At September 30,2006, the Company was not in compliance with its minimum tangible net worthcovenant as a result of a non-cash litigation charge taken in the third quarterof 2006 of approximately $12.5 million related to the Invitrogen case. (SeeNote 11 for details on this case.)  As aresult, the Company was in default of the terms of the credit agreement and in November 2006,the credit agreement holder terminated the reducing revolving line of creditfacility portion of the credit agreement. The Company had not drawn on therevolving line of credit since December 2005, and there were no amountsoutstanding and the Company was not seeking to borrow against this revolvingline of credit. The Company still has a stand-by letter of credit thatguarantees the industrial revenue bonds. There are no covenants related to thisletter of credit.

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Long-termdebt and line of credit consist of the following:

| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Reducing  revolving line of credit not to exceed $9,000,000, which was terminated on  November 10, 2006, bearing interest at LIBOR plus 2.55% (7.87% and 6.94%  at November 10, 2006 and December 31, 2005, respectively; 7.61% and  5.94% average rate for the periods ended November 10, 2006 and  December 31, 2005, respectively.); debt held by subsidiary of the  Company, guaranteed by the Company and secured by substantially all of its  assets                                                                                                                                    |       |                  | $          | —                |       |   |   | $ | 5,500,000 |   |   |
| Debt held by subsidiary of the Company from bond  indenture agreement with Bastrop County, Texas in the original principal amount  of $9,100,000, at an average interest rate of 3.62% and 2.57% for the years  ended December 31, 2006 and 2005, respectively (4.03% and 3.65% at  December 31, 2006 and 2005, respectively); sinking fund payment of  $240,000 required per year through April 2021, and $175,000 required in  April 2022 when the bonds mature; proceeds are restricted to the  purchase of land, building and equipment. The bonds are secured by a stand-by  letter of credit |       |                  | 3,775,000  |                  |       |   | 4,015,000 |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       |                  | 3,775,000  |                  |       |   | 9,515,000 |   |   |
| Current portion of long-term debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                  | 240,000    |                  |       |   | 5,740,000 |   |   |
| Long-term debt, less  current portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                  | $          | 3,535,000             |       |   |   | $ | 3,775,000 |   |   |

 

The Company received a written consent from the creditfacility holder to pay a special cash dividend of $0.25 per share on theCompany’s common stock to holders of record on December 16, 2005. The specialcash dividend of $5,571,321 was paid on January 6, 2006.

Theaggregate maturities of long-term debt principal payments for each of the fiveyears subsequent to December 31, 2006 are as follows:

| ** **          | ** ** | **Principal  Payment** | ** ** |
|---------------------|------------|------------------------|------------|
| Less than one  year |       | $                      | 240,000    |   |
| One year            |       | 240,000                |       |
| Two years           |       | 240,000                |       |
| Three years         |       | 240,000                |       |
| Four years          |       | 240,000                |       |
| Thereafter          |       | 2,575,000              |       |
| Total               |       | $                      | 3,775,000  |   |

 

**8.**                 RelatedParty Transactions

Activity for related parties during 2006, 2005, and2004 is as follows:

The Company had a promissory note in the amount of$240,000 due from two stockholders, one of which is an officer and director ofthe Company. The note was secured by a second deed of trust on certain realproperty located in San Diego County, California and bore interest at 8%,compounded annually. Principal and interest were due August 12, 2002. Uponfailure to pay the note at maturity in 2002, the note provided for the interestrate to become 10%, compounded annually, on the entire remaining principalbalance. The note was paid in full in June 2004 (see Note 3) in the amountof $276,877, including interest. 

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Total interest income forthis note was $11,240 for the year ended December 31, 2004. A secondpromissory note in the amount of $250,000 with the same parties was alsooutstanding. This note was secured by a second mortgage on certain realproperty located in Wyoming and bore interest at 8%, compounded annually.Principal and interest was due upon the earlier of the sale of the relatedproperty or July 9, 2005. The second mortgage provided that the Companymay, at its option, release the indebtedness, extend the due date, alter theterms of payment of the note, or alter, substitute or release property securingthe indebtedness. The note was paid in full in December 2004 in the amountof $302,422, including interest. Total interest income for the year ended December 31,2004 was $21,686.

In June 2004, theCompany entered into a promissory note payable to an officer of the Company inthe principal amount of approximately $1,670,000. The promissory note had a 39-monthterm and an interest rate of 3.89% per annum. In December 2004, the Boardof Directors approved the pre-payment in full of the outstanding principal andinterest under the promissory note. Total interest paid for the year ended December 31,2004 totaled $33,898.

**9.**                 Stockholders’Equity

*Stratagene’sCommon Stock**—*Eachshare of common stock is entitled to one vote. The holders of common stock arealso entitled to receive dividends out of legally available funds when declaredby the board of directors, subject to the rights of any preferred stock.

In July 2003, the Board of Directors approved a 1for 2 reverse stock split of Stratagene’s common stock. Financial and sharedata appropriately reflect this reverse stock split.

*RegistrationRights Agreement**—*Inrelation to the merger with Hycor in June 2004, Stratagene entered into aregistration rights agreement with Dr. Sorge, pursuant to which Dr. Sorgewas granted the right, subject to certain conditions, to require the registrationof 2,000,000 shares of Stratagene common stock controlled by Dr. Sorge orone of his affiliates and customary piggyback registration rights toparticipate in other registrations.

*2000Stock Option Plan, as amended and restated**—*In 2000, Stratagene adopted a stockoption plan (the “2000 Plan”), which provides for the grant of options toemployees of Stratagene or a subsidiary of Stratagene and BCH or a subsidiaryof BCH to purchase up to 2,000,000 shares of common stock at exercise prices ofnot less than the fair value of the common stock. Options under the 2000 Planvest over a period determined by Stratagene’s board of directors, but notlonger than five years. The options generally expire seven years after thegrant date. BCH was dissolved on February 9, 2006.

In 2000, the Board of Directors approved the Plan, aform of Non-Qualified Stock Option Agreement (“Option Agreement”) to be usedwith the Plan, and the granting of options, effective December 31, 2000,to purchase an aggregate of 1,272,543 shares of common stock subject to theexecution of the Option Agreements. For the years ended December 31, 2006,2005 and 2004, options to purchase additional shares of common stock totaling0, 50,000, and 0, respectively, were granted, subject to execution of theOption Agreements, in employment offer letters or by special grant of the PlanAdministrator pursuant to the Plan.

In 2004, prior to the completion of the merger withHycor, Stratagene amended and restated the 2000 Plan. As amended and restated,the stock option plan permits the issuance of options to purchase an aggregateof 3,000,000 shares of common stock. Options under the amended and restated2000 Plan vest over a period determined by Stratagene’s board of directors, butnot longer than five years. The options generally expire ten years after thegrant date.

*2004Independent Directors Option Plan**—*In June 2004, the Company adopted adirector’s stock option plan for its independent directors. Approximately300,000 shares of the Company’s common stock have been reserved for issuanceunder this plan. The independent directors each received an automatic award of 

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an option to purchase20,000 shares of common stock under the director’s stock option plan uponinitial appointment or election to the Company’s board of directors and,thereafter, will receive an automatic award of an option to purchase up to10,000 shares of common stock at each annual meeting occurring during theirterm as a member of Stratagene’s board of directors. The options vest in threeequal annual installments on the anniversary date of such grant and expire tenyears after the grant date. The price per share of these options equals 100% ofthe fair market value of a share of common stock on the date the option wasgranted.

*StratageneCorporation 2006 Equity Incentive Award Plan (the “2006 Plan”)**—*On June 1, 2006, the Company’s shareholders approvedthe 2006 Plan. Under this plan, employees, consultants and directors mayreceive grants of stock options, stock appreciation rights, restricted stockawards, restricted stock units and dividend equivalents in any combination,separately or in tandem. Approval of the 2006 Plan was necessitated in part bythe Company’s desire to expand the types of equity awards that the board ofdirectors may grant to its employees, consultants and directors. Additionally,the number of shares remaining available for issuance under the existing 2000Stock Option Plan was not sufficient to meet the Company’s anticipated needs.

As a result of theadoption of the 2006 Plan, no new awards will be made under the 2000 Plan. Initially,the number of shares of Stratagene common stock that may be issued pursuant toawards granted under the 2006 Plan shall not exceed, in the aggregate, 500,000shares. The number of shares of common stock initially reserved for issuanceunder the 2006 Plan shall be subject to increase pursuant to the terms of the2006 Plan. In addition, the number ofshares reserved for issuance pursuant to awards under the 2006 Plan will beautomatically increased on each January 1 during the term of the 2006Plan, commencing on January 1, 2007 and continuing until, and including, January 1,2016. The annual increase in the number of shares shall be equal to the leastof:

·       5%of the Company’s outstanding capital stock on such January 1;

·       750,000shares; or

·       anamount determined by the Company’s board of directors.

The number of shares of our common stock that may beissued pursuant to awards granted under the 2006 Plan shall not exceed, in theaggregate, 11,000,000 shares during the term of the Plan.

Any shares that are represented by awards under the2006 Plan that are forfeited, expire, or are canceled, or that are forfeitedback to Stratagene or reacquired by Stratagene after delivery for any reason,or that are tendered to Stratagene or withheld to pay the exercise price orrelated tax withholding obligations in connection with any award under the 2006Plan, will again be available for awards under the 2006 Plan. Only sharesactually issued under the 2006 Plan will reduce the share reserve.

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Thefollowing table summarizes option activity for all plans: 

| ** **                               | ** ** | **Options** | ** ** | **Weighted-  average  Exercise  Price** | ** ** |
|------------------------------------------|------------|-------------|------------|-----------------------------------------|------------|
| Outstanding,  January 1, 2004       |       | 1,449,022   |       |                                    | $          | 10.34 |   |   |
| Options assumed from Hycor in the merger |       | 756,822     |       |                                    | 5.34       |   |   |
| Granted                                  |       | 1,514,960   |       |                                    | 8.75       |   |   |
| Exercised                                |       | (184,829    | )          |                                    | 3.34       |   |   |
| Forfeited                                |       | (540,566    | )          |                                    | 10.05      |   |   |
| Outstanding,  December 31, 2004     |       | 2,995,409   |       |                                    | $          | 8.76 |   |   |
| Granted                                  |       | 364,750     |       |                                    | 8.61       |   |   |
| Exercised                                |       | (300,186    | )          |                                    | 5.81       |   |   |
| Forfeited                                |       | (389,375    | )          |                                    | 9.35       |   |   |
| Outstanding,  December 31, 2005     |       | 2,670,598   |       |                                    | $          | 8.98 |   |   |
| Granted                                  |       | 562,750     |       |                                    | 6.86       |   |   |
| Exercised                                |       | (71,878     | )          |                                    | 7.47       |   |   |
| Forfeited                                |       | (348,531    | )          |                                    | 8.30       |   |   |
| Outstanding,  December 31, 2006     |       | 2,812,939   |       |                                    | $          | 8.68 |   |   |

 

The weighted average remaining contractual term ofoutstanding options at December 31, 2006 is 6.36 years. The aggregateintrinsic value of such options is $699,963. The weighted average remainingcontractual term of exercisable options at December 31, 2006 is 5.35 years.The aggregate intrinsic value of such options is $333,794. Intrinsic valuerepresents the difference between the option price at grant date and the marketprice of Stratagene’s common stock, which was $7.44 at December 31, 2006.

The total intrinsic value of options exercised duringthe year ended December 31, 2006 is $181,664.

As of December 31, 2006, there was $1,331,031 oftotal unrecognized compensation costs related to non-vested share-basedcompensation arrangements under the various option plans. This cost is expectedto be recognized over a weighted average period of 2.1 years.

The total compensation expense recognized under SFAS No. 123(R) forthe year ended December 31, 2006 was approximately $875,000.

Thefollowing table summarizes information about Stratagene stock optionsoutstanding as of December 31, 2006:

| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                     | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | ** **                   | ** ** | **Number  Outstanding  as of  December 31, 2006** | ** ** | **Weighted-average  Remaining  Contractual  Life (in Years)** | ** ** | **Weighted-average  Exercise Price** | ** ** | **Number  Exercisable  as of  December 31, 2006** | ** ** | **Weighted-average  Exercise Price** | ** ** |
| $1.73 - $8.00                               |       |                         | 774,359    |                                                             |       |   | 7.52 |   |   |   | $ | 6.58 |   |   |   | 201,017 |   |   |   | $ | 5.99 |   |   |
| $8.01 - $8.11                               |       |                         | 426,400    |                                                             |       |   | 6.35 |   |   |   | 8.11 |   |   |   | 384,400 |   |   |   | 8.11 |   |   |
| $8.47 - $9.20                               |       |                         | 309,375    |                                                             |       |   | 7.79 |   |   |   | 8.65 |   |   |   | 107,441 |   |   |   | 8.67 |   |   |
| $9.34                                       |       |                         | 798,960    |                                                             |       |   | 7.42 |   |   |   | 9.34 |   |   |   | 778,962 |   |   |   | 9.34 |   |   |
| $9.60 - $11.18                              |       |                         | 156,141    |                                                             |       |   | 4.35 |   |   |   | 9.98 |   |   |   | 119,579 |   |   |   | 9.80 |   |   |
| $12.00                                      |       |                         | 347,704    |                                                             |       |   | 0.98 |   |   |   | 12.00 |   |   |   | 347,704 |   |   |   | 12.00 |   |   |
|                                        |       |                         | 2,812,939  |                                                             |       |   | 6.36 |   |   |   | $ | 8.68 |   |   |   | 1,939,103 |   |   |   | $ | 9.22 |   |   |
|                                             |            |                              |            |                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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In April 2004, 41,250 shares were delivered to anofficer on a deferred basis pursuant to an option exercised in 2001. During2004, the Company recognized $101,172 of general and administrative expenseassociated with this transaction.

*Employee Stock PurchasePlan**—*In June 2004,the Company adopted the Stratagene Corporation Employee Stock Purchase Plan (“ESPP”)that provides for the issuance of up to 1,000,000 shares of the Company’scommon stock. The ESPP is intended to qualify under Section 423 of the InternalRevenue Code and is for the benefit of qualifying employees as designated bythe board of directors. Under the terms of the ESPP, purchases are madequarterly. Participating employees may elect to have a maximum of 15% of theircompensation, up to a maximum of $25,000 of the fair market value of the commonstock per calendar year, withheld through payroll deductions to purchase sharesof common stock under the ESPP. The price of the common stock purchased underthe ESPP will be equal to 85% of the fair market value of the common stock onthe offering or purchase date, whichever is lower. During fiscal years 2006,2005 and 2004, 67,817, 51,609 and 25,856 shares of common stock were issuedunder the ESPP from proceeds of $397,867, $374,902 and $157,022, respectively.During the years ended December 31, 2006, 2005 and 2004, the Companyexpensed $113,750, $0 and $0 of share-based compensation related to the ESPP,respectively.

**10.**          IncomeTaxes

Componentsof income tax expense of the Company are as follows:

| ** **                    | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Current:                      |       |       |       |       |       |       |       |
| Federal                       |       | $          | 2,860,475  |       | $          | 10,144,673 |       | $ | 2,617,912 |   |
| State                         |       | 97,785     |       | 110,860    |       | 174,550    |       |
| Foreign                       |       | (24,500    | )          | 69,809     |       | 38,906     |       |
|                          |       | 2,933,760  |       | 10,325,342 |       | 2,831,368  |       |
| Deferred:                     |       |       |       |       |       |       |       |
| Federal                       |       | (3,257,345 | )          | (6,654,205 | )          | 450,792    |       |
| State                         |       | (422,415   | )          | 156,533    |       | (22,160    | )          |
| Foreign                       |       | —     |       | 70,330     |       | —     |       |
|                          |       | (3,679,760 | )          | (6,427,342 | )          | 428,632    |       |
| Income tax (benefit)  expense |       | $          | (746,000   | )          | $          | 3,898,000  |       | $ | 3,260,000 |   |

 

Theactual income taxes differ from the expected income taxes (computed by applyingthe federal income tax rate of 34% to the Company’s earnings before incometaxes) as follows:

| ** **                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|--------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Computed expected  federal income taxes of the Company |       | $        | (230,352   | )        | $          | 3,984,994 |       | $ | 3,637,467 |   |
| Foreign  operations, net of tax                        |       | (138,673 | )          | 183,804  |       | 253,118   |       |
| State income  taxes, net of federal benefit            |       | (214,256 | )          | 176,479  |       | 93,727    |       |
| General business  credits                              |       | (176,827 | )          | (172,311 | )          | (185,191  | )          |
| BCH (income) not  included in corporate group          |       | —   |       | —   |       | (570,689  | )          |
| Section 199  and foreign income deductions        |       | (229,919 | )          | (471,755 | )          | (170,000  | )          |
| Non-deductible  expenses and other, net                |       | 244,027  |       | 196,789  |       | 201,568   |       |
| Income tax (benefit)  expense                          |       | $        | (746,000   | )        | $          | 3,898,000 |       | $ | 3,260,000 |   |

 

The Company estimates a provision for income taxes forall tax jurisdictions in which it operates. During 2004, Stratagene merged withHycor and filed combined tax returns that included the results of operations ofHycor since the merger date. In connection with the allocation of purchaseprice to the net 

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assets of Hycor,Stratagene recorded the fair value of the Hycor deferred tax assets as of themerger date. The net deferred tax assets of Hycor were approximately $2.5million and primarily related to net operating loss (“NOL”) carryforwards,research and other credits and temporary differences between the book and taxbasis of the Hycor net assets recorded at the merger date. These net operatinglosses and credits are subject to an annual limitation by Section 382 ofthe Internal Revenue Code and have a 20 year life. Stratagene realized all ofHycor’s NOL’s as of December 31, 2005, and it believes that the othercredits recorded under purchase accounting will be realized within thecarryforward periods.

Deferredincome taxes result from temporary differences between the tax basis of anasset or a liability and its reported amount in the accompanying consolidatedbalance sheets. The components of deferred tax assets and liabilities at December 31,2006 and 2005 are as follows:

| ** **                             | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
| Deferred tax assets:                   |       |       |       |       |       |
| Accounts receivable                    |       | $          | 166,772    |       | $          | 230,253 |   |
| Inventories                            |       | 1,645,988  |       | 1,722,039  |       |
| Accrued expenses and other liabilities |       | 12,870,781 |       | 9,205,164  |       |
| Long-term debt, net                    |       | 34,728     |       | 44,240     |       |
| General business credits               |       | 203,378    |       | 434,331    |       |
| Net operating losses                   |       | 1,526,224  |       | 1,727,959  |       |
| Deferred tax assets                    |       | 16,447,871 |       | 13,363,986 |       |
| Deferred tax  liabilities:             |       |       |       |       |       |
| State taxes                            |       | (447,815   | )          | (433,087   | )          |
| Patents                                |       | (1,548,177 | )          | (1,313,770 | )          |
| Property and equipment                 |       | (87,757    | )          | (495,354   | )          |
| Acquired intangibles and other         |       | (733,779   | )          | (941,557   | )          |
|                                   |       | (2,817,528 | )          | (3,183,768 | )          |
| Valuation  allowance                   |       | (1,567,665 | )          | (1,797,310 | )          |
| Net deferred tax assets                |       | $          | 12,062,678 |       | $          | 8,382,908 |   |

 

At December 31, 2006 the Company utilized all ofits federal research credits and had approximately $203,000 of state researchcredits. The Company recognizes state research credits when they are generated.Excess credits are recognized and will be used to offset future taxable income,as management believes it is more likely than not that the credits will be utilized.The state research credits have an indefinite carryforward period.

At December 31, 2006 the Company had approximately$4,246,000 of foreign NOL carryforwards. These foreign NOL’s have an indefinitecarryforward period. The Company has established a valuation allowance for thefull amount of the foreign NOL’s based on an evaluation of the history ofoperating profitability of each operation and the projection of the futuretaxable income for each entity. Approximately $1.2 million of the valuationallowance relates to acquired NOL’s which to the extent recognized in thefuture will result in a reduction of goodwill.

Concurrent with theclosing of the Hycor merger, the Company acquired the assets of BCH, whichconsists of substantially limited liability companies that are treated aspartnerships for income tax purposes. Through the acquisition date, any relatedincome tax liabilities were the responsibility of the members of BCH, and theCompany did not reflect a provision for income taxes. Beginning on June 2,2004, Stratagene has provided a provision for income taxes in the consolidatedstatements for the results of operations of BCH.

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**11.**          Commitmentsand Contingencies

*Operating LeaseCommitments**—*TheCompany leases certain facilities and equipment under noncancelable operatingleases, with facility leases for the Company’s headquarters in La Jolla and itsother offices expiring on various dates between July 4, 2007 and September 30,2011. Total rental expense under all operating leases was $2,065,400,$2,064,014 and $1,686,494 in 2006, 2005 and 2004, respectively. Future minimumlease payments under noncancelable operating leases are as follows:

| ** ** | ** ** | **Future Minimum  Payment** | ** ** |
|------------|------------|----------------------------------|------------|
| 2007       |       |                             | $          | 2,076,585 |   |   |
| 2008       |       |                             | 1,036,779  |   |   |
| 2009       |       |                             | 172,295    |   |   |
| 2010       |       |                             | 145,198    |   |   |
| 2011       |       |                             | 108,899    |   |   |
| Thereafter |       |                             | —     |   |   |
| Total      |       |                             | $          | 3,539,756 |   |   |

 

*License Agreements**—*In connection with its research anddevelopment efforts, Stratagene has entered into various license agreementswith unrelated third parties which provide Stratagene with rights to develop,produce and market products using certain technologies and patent rightsmaintained by the third parties. The terms of the various agreements requireStratagene to pay royalties ranging generally from 1% to 10% of biological andinstrumentation sales and 50% of sales on software products that have beenproduced using the technologies. Such agreements generally provide for termsthat commence upon execution and continue until expiration of the last patentrelative to the technology. During 2006, 2005 and 2004, royalty expensesrelated to product sales were approximately $3,713,000, $3,840,000 and$4,281,000, respectively, and were included in cost of products sold in theaccompanying consolidated statements of operations.

*Royalty Payments**—*TheCompany accrues and pays royalties in accordance with the applicable royaltycontracts to which it is a party. Accrued expenses and other liabilitiesat each of December 31, 2006 and December 31, 2005 include $5.2million of accrued royalties due to an unrelated third party license holder forestimated royalties due from the second quarter of 2003 through the thirdquarter of 2005. The Company accrued royalties under this patent licenseagreement based on an estimate of the amounts payable in accordance with theterms of the patent license agreement. The Company’s calculations of royaltypayments are subject to review by the license holder. Beginning in the secondhalf of 2003 through late 2005, such royalty payments were withheld by theCompany while the Company evaluated a possible overpayment of royalties paid inprior periods. However, no assurances can be made that the Company will recoverany of the overpayments. Stratagene’s financial position, results of operationsand cash flows could be materially affected if the parties subsequentlydetermine that the royalties differ significantly from the amounts recorded byStratagene. The patent underlying this royalty obligation expired in the UnitedStates in March 2005. The corresponding foreign patents expire in 2006 and2007. Following the expiration of these process patents, Stratagene will nolonger be required to pay royalties on future product sales related to suchpatents. The expiration of the United States patent in March 2005 resultedin an approximately $250,000 per quarter reduction in royalty expense beginningin the second quarter of 2005. In addition, upon the expiration of thecorresponding foreign patents, Stratagene achieved an additional $125,000reduction in royalty expense since March 2006. The Company believes thatthis decrease in royalty expense has been partially offset by decreases in theaverage unit selling price of products using the patented technology followingthe expiration of the patents.

*Corporate Collaborations**—*Stratagene entered into a strategicpartnership with Strand Life Sciences in December 2005 to develop a suiteof next generation software solution products for sale. Under the terms of theagreement, Strand and Stratagene will collaborate on the design and developmentof innovative 

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software productsto address the increasingly complex demands of biological data analysis forlife scientists. Stratagene will exclusively market and sell the jointlydeveloped products. Under the agreements, Stratagene was required to makeaggregate milestone payments of $0.9 million to Strand upon acceptance ofcertain deliverables. Research and development expense of $0.2 million and $0.6million was recorded in the years ended December 31, 2006 and  2005 respectively. The additional $0.1million will be expensed in 2007. Also, Stratagene is required to make $1.5million in minimum annual payments to Strand in the first twelve months afterthe first commercial sale or 60 days after final acceptance of the product. Thefirst minimum annual payment period began on April 1, 2006. The minimumannual payments will be offset by $0.5 million of the milestone payments in thefirst twelve months of the contract term. Stratagene has accrued and paid threefourths of the first-year minimum payments, less credits for milestonepayments, due under agreements through December 31, 2006. Stratagene willalso be required to make $1.7 million in minimum annual payments to Strand inthe second twelve months of the contract term, which begins on April 1,2007.

Stratagene entered into anagreement with the Diagnostics Division of Bayer HealthCare LLC, or Bayer, in December 2005,pursuant to which Bayer will purchase a customized version of Stratagene’sMx3005P instrument system for use in a new platform Bayer is developing forperforming molecular diagnostics tests worldwide. Under the terms of theagreement, Stratagene is developing customized software and system features forBayer’s use. The agreement also calls for Stratagene to implement QualitySystem Regulations (“QSR”) and procedures under which Stratagene willmanufacture the customized Mx3005P instrument system for Bayer. Stratagenereceives milestone payments based upon completion of software-basedcustomization and regulatory activities needed to meet Bayer’s clinicalrequirements.

EITF No. 00-21,*Revenue Arrangements with MultipleDeliverables,* provides guidance on accounting for arrangements, suchas the Bayer agreement, that involve the delivery or performance of multipleproducts, services, or rights to use assets within contractually bindingarrangements. The Company recognizes revenue for delivered elements inaccordance with SAB No. 104 and our revenue recognition policy and onlywhen it is determined that the earnings process is complete and all elementsfor recognition of contract revenue have been achieved.

The Bayer agreementincludes milestone payments during the development phase of the contract. Forinstrumentation products where software is considered more than incidental tothe product, the Company recognizes revenue when persuasive evidence of anarrangement exists, delivery has occurred, the sales price is fixed anddeterminable and collectibility is probable. During the development phase ofthis contract, the Company will perform engineering services and deliverdevelopment units to Bayer. Revenue is recognized when the Company’s revenuerecognition criteria is met, which is generally upon the delivery andacceptance of the development units by Bayer. The Company records deferredrevenue for amounts received in advance of acceptance as deferred revenue.Costs incurred under the Bayer agreement are classified as work-in-processunder Prepaid Expenses and Other Current Assets, and will be recognized in thesame manner as revenue.

Stratagene also enteredinto a License, Manufacturing and Supply Agreement with Focus Diagnostics, Inc.,or Focus in October 2005, to address the growing molecular diagnosticsmarket for infectious diseases. Focus, which was recently acquired by QuestDiagnostics, a publicly-traded company, is a specialty diagnostics company thatdevelops innovative infectious disease products and is a leading referencelaboratory for infectious and immunological diseases. Under the agreement,Stratagene has granted Focus a non-exclusive license to its proprietaryFullVelocity technology, and Stratagene will provide expertise and knowledgethat Focus will use to develop selected molecular diagnostics testing kits andproducts. In exchange, Focus will pay Stratagene a royalty fee based on Focus’sales of finished products. Stratagene will also manufacture the diagnosticproducts which Focus intends to commercialize globally. Additionally,Stratagene will manufacture and sell reagents to Focus for laboratory-developedtests to be used in Focus’ national reference laboratory.

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Stratagene also entered into a Joint Development andLicense Agreement with Rosetta Inpharmatics LLC (“Rosetta”) in July 2006,whereby the Company and Rosetta will work together to develop an RNA extractionproduct. The product consists of a machine, a consumable cartridge, and areagent pack that fits in the machine. The cartridge contains the sample to beprocessed and the machine moves fluids from the reagent pack through the cardin order to purify RNA. The product will be used to get RNA profiles fromclinical trial patients.  Rosetta willpay us for milestones achieved during the development period. In the case of asuccessful product, Rosetta will also pay the Company a royalty on our sales offinished products to Merck (Rosetta’s parent) and other third parties.

*Legal**—*Stratagene is a party to litigation inthe ordinary course of business. Due to the uncertainties inherent inlitigation, no assurances can be given as to the outcome of these proceedings.If any of these matters were resolved in a manner unfavorable to the company,Stratagene’s business, financial condition, results of operations, and cashflows could be materially harmed. Additionally, favorable outcomes or gaincontingencies that may result from these matters, if any, are not recognizeduntil they are realized. Information on the most significant of these mattersfollows.

***Invitrogen Corporation***

In June 2000, Stratagene was sued by InvitrogenCorporation (formerly Life Technologies, Inc.) in the United StatesDistrict Court for the District of Maryland. The complaint alleges thatStratagene willfully infringed United States patent no. 6,063,608 (and UnitedStates patent nos. 5,244,797 and 5,405,776) for making, using and selling productsderived from, using or containing RNase H minus reverse transcriptase enzymes.Invitrogen’s motion for a preliminary injunction was denied and the case wasstayed pending a trial in a related action involving Invitrogen and a thirdparty regarding the same patents. Invitrogen appealed the denial of aninjunction and the stay to the Federal Circuit Court of Appeals. InFebruary 2002, the Federal Circuit Court of Appeals affirmed the districtcourt’s decision. The case against Stratagene remains administratively stayed.

In March 2001, Stratagene was sued by InvitrogenCorporation in the United States District Court for the Western District ofTexas (Austin). The complaint alleged (1) that Stratagene willfullyinfringed United States patent no. 4,981,797 for making, using and sellingcompetent *E. coli*cell productsand (2) for lost profits and/or reasonable royalty damages of up toapproximately $22.0 million. In November 2001, the district court grantedStratagene’s motion for summary judgment, finding that it did not infringe the‘797 patent. Invitrogen appealed the judgment to the Federal Circuit Court ofAppeals which, in May 2003, reversed the district court’s decision in partand remanded the case for further proceedings. In January 2004, on remandfrom the Federal Circuit Court, the district court determined on Invitrogen’smotion for partial summary judgment that Stratagene infringed the ‘797 patentbased on its then existing manufacturing process and further held on partialsummary judgment, that while the ‘797 patent was not invalid forindefiniteness, the ‘797 patent was invalid because of public use under 35U.S.C. § 102(b). Invitrogen appealed the district court’s ruling of invalidity,and oral arguments were heard before the Federal Circuit Court of Appeals inMay 2005. In October 2005, the Federal Circuit Court reversed thedistrict court’s summary judgment of invalidity due to public use, affirmed thedistrict court’s partial summary judgment of infringement, affirmed thedistrict court’s denial of summary judgment of invalidity due toindefiniteness, and remanded the case for further proceedings. Invitrogenadmitted that Stratagene’s current manufacturing processes do not infringe the‘797 patent and that there is no claim for an injunction. The case went totrial on July 17, 2006 , and on July 25, 2006, the jury returned averdict that the ‘797 patent was valid and that our infringement of the patentwas willful. The jury denied Invitrogen’s request for lost profits damages inthe amount of $32 million dollars but returned a verdict for a reasonableroyalty of approximately $7.9 million, based on a 15% royalty rate. The courtrequested briefing from the parties regarding whether judgment can be enteredon the jury’s verdict based on a 15% royalty rate.

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On October 31, 2006, the district court awardedInvitrogen $16.2 million plus attorneys’ fees and costs in an amount to bedetermined by the district court and pre-judgment interest. The district courtfirst adjusted a portion of the $7.9 million jury award and then trebled aportion of the award that was related to Stratagene’s sales of the allegedlyinfringing products made prior to November 2, 2001. Stratagene believesthat the jury’s verdict and the damages awarded by the district court were notsupported by the facts of the case or the law and as a result, Stratagene hasappealed the decision. In appealing the jury’s verdict and the court’ssubsequent post trial rulings, Stratagene will be challenging the finding ofvalidity of the patent, the appropriateness of the damages determined by thejury, the trebling of a portion of the amount by the court and the award ofattorney’s fees. Stratagene had previously modified its process formanufacturing competent E. coli cell products and, as a result, Invitrogen hasagreed that our products sold in recent years and currently offered for salewill not be affected by the jury verdict. The jury found that Invitrogen wasnot entitled to lost profits because Stratagene has had a non-infringingmanufacturing process for competent cells.

In November of 2006, Stratagene filed asupersedeas bond in the amount of $11.5 million in order to permit the Companyto appeal the judgment of the district court without being subject tocollection activities by Invitrogen. On January 10, 2007, the districtcourt issued an order establishing the attorney’s fees and costs at $2.1million and fixed the supersedeas bond amount at $12.2 million. In January 2007,Stratagene amended the bond to that approved amount for the term of the appeal.The bond is secured by $12.2 million of cash in an interest-bearing restrictedaccount.  The $12.2 million amount forthe supersedeas bond is comprised of the $7.5 million compensatory portion ofthe amended jury verdict, plus estimated attorneys fees and costs of $2.1million, plus pre-judgment interest of $1.5 million and post-judgment interestof $1.1 million.

In considering whether to record a loss contingencyand, if so, an amount, the Company considered the guidance provided by SFAS No. 5,*Accounting for Contingencies,*andFASB Interpretation No. 14 (As Amended), *ReasonableEstimation of the Amount of a Loss, an Interpretation of FASB Statement No. 5*.SFAS No. 5 requires an accrual to be made when a loss is probable andestimatable. The Company has now accrued an aggregate of $19.6 million inexpense for the judgment awarded in this matter. The Company accrued $7.9million for this matter in the second quarter of 2006 based on the jury verdictand accrued $12.5 million in the third quarter of 2006 based upon the courtjudgment and then the accrual was reduced by $0.8 million for the fourthquarter of 2006 based upon the adjustment to estimated legal fees by the court.The $19.6 million accrual includes total damages of $16.2 million, attorneys’fees and costs of $2.1 million, and pre-judgment interest of $1.3 million. Although Stratagene has appealed the districtcourt judgment to the Federal Circuit Court of Appeals, the Company has accrued$19.6 million, as it believes that it has met the conditions for accrual asstated in SFAS No. 5. Post-judgment interest at the rate of approximately5.05% compounded annually will be applied to the compensatory portion of thedamages and will be accrued against our earnings until the matter is resolved.

In November 2001,Stratagene filed a complaint in the United States District Court for theDistrict of Maryland charging Invitrogen Corporation with willful infringementand inducing others to infringe United States patent no. 5,556,772 for making,using, selling and offering for sale certain polymerase blend products.Stratagene seeks a permanent injunction against continued infringement as wellas monetary damages (compensatory and enhanced) and recovery of its attorneys’fees and costs. Given the nature of patent litigation, at the present time theCompany is unable to quantify the amount of remuneration it will ultimatelyseek in this proceeding or the likelihood of recovering any portion of suchremuneration once quantified. Pursuant to a stipulation of the parties, thecase is presently administratively stayed and no trial date is currently setfor this case. Stratagene has been advised by the United States Patent Officeof its Notice of Intent to Issue Reexamination Certificate. The parties haveagreed to a schedule to complete discovery and for trial to begin once thereexamination certificate issues.

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***Takara Bio***

In November 2002,Stratagene filed a complaint in the United States District Court for theDistrict of Maryland charging Takara Bio with willful infringement of andinducing others to infringe United States patent no. 5,556,772 for making,using, selling and offering for sale certain polymerase blend products.Stratagene and Takara Bio have now reached a mutually beneficial settlementresolving the district court litigation and a patent interference proceeding inthe U.S. Patent & Trademark Office. Stratagene believes the principalfinancial effect of the settlement will be the avoidance of the costs and risksof continued litigation. Further, potential disputes in the future will beavoided through cross-licenses of the parties’ respective patent rightsrelating to enzyme blends.

***Third Wave Technologies***

In September 2004, Stratagene was sued by ThirdWave Technologies, Inc. (“Third Wave”) in the United States District Courtfor the Western District of Wisconsin. The complaint alleged that Stratageneinfringed United States patent nos. 6,348,314 and 6,090,543, and have inducedor contributed to infringement of the patents-in-suit, by making, using, importing,offering for sale and/or selling assays employing cleavage of nucleic acids,including at least our FullVelocity products. Third Wave sought a preliminaryand permanent injunction, monetary damages (compensatory and enhanced), andrecovery of its attorneys’ fees and costs. In October 2004, Stratagenefiled its answer to the complaint responding that it did not infringe a validor enforceable claim of either patent. Stratagene also asserted affirmativedefenses, including invalidity and unenforceability, and counterclaims ofinvalidity and non-infringement. Stratagene sought an award of its fees andcosts incurred in defending itself in this action. A jury trial commenced on August 22,2005. The jury returned a verdict that the patents-in-suit were valid andinfringed by Stratagene. Additionally, the jury returned a verdict for monetarydamages in the amount of $5.3 million and that Stratagene’s infringement waswillful. Based on the jury’s verdict, the district court permanently enjoinedStratagene from making, advertising, promoting the use of, selling, offering tosell, using, permitting to be used, contributing to the use, sale or offeringfor sale of, or inducing the use, sale or offering for sale the FullVelocityQPCR and FullVelocity QRT-PCR products, or any other product used in a methodthat meets all of the limitations of any of the asserted claims. On December 19,2005, the district court awarded Third Wave treble damages of $15.9 million,attorneys’ fees and costs in an amount to be determined by the district courtand pre-judgment interest. In January 2006, Stratagene posted a $21.0million civil supersedeas bond to stay payment of the judgment of the districtcourt, and filed an appeal to the Federal Circuit Court of Appeals. As of December 2005,  Stratagene accrued $20.6 million in expensefor the judgment awarded in this matter. This amount included total damages of$15.9 million, attorneys’ fees and costs of $4.2 million, and pre-judgmentinterest of $0.5 million. In March 2006, Third Wave was awarded anadditional $0.1 million for other court costs, bringing the total award to$20.7 million. The district court’s award was appealed to the Federal CircuitCourt of Appeals and the arguments were heard on December 7, 2006.

In January 2007, Stratagene reached anout-of-court settlement with Third Wave for the Wisconsin case for $10.75million. Stratagene agreed to pay Third Wave $10.75 million in cash as fullsatisfaction for the judgment. The companies also have agreed to stay anyfurther litigation for nine months. Stratagene and Third Wave have also agreedto a process to resolve that case or any other disputes through an agreementthat enables either company to elect to arbitrate a patent dispute or toresolve it through a royalty-bearing license. As a result of the settlement,Stratagene adjusted its accrual from $20.7 million to $10.75 million at December 31,2006. The settlement payment was made with funds from the $21.0 million appealbond in February 2007.

In May 2005,Stratagene filed a complaint in the United States District Court for theDistrict of Delaware charging Third Wave Technologies with willful infringementof and inducing others to infringe United States patent nos. 6,528,254 and6,548,250 for making, using, selling and offering for sale certain of 

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itsInvader® Plus products. Stratagene was seeking apermanent injunction against continued infringement as well as monetary damages(compensatory and enhanced) and recovery of its attorneys’ fees and costs. Inconnection with the settlement of the Third Wave vs. Stratagene matters in January 2007,Stratagene also dismissed without prejudice Stratagene’s lawsuit against ThirdWave in the U.S. Court in Delaware.

***Applera Corporation***

In November 2004, Stratagene received notice of apatent infringement suit filed by Applera Corporation against the Company andother parties in the United States District Court for the District ofConnecticut for alleged infringement of U.S. patent no. 6,814,934. TheStratagene products alleged to infringe are the Mx4000 and Mx3000P instrumentsand certain related reagents. In December 2004, Stratagene filed ouranswer to the complaint responding that it does not infringe, directly orindirectly, any valid and enforceable claim of the ‘934 patent and asserting relatedcounterclaims of invalidity and non-infringement. In April 2006, the courtheld a Markman hearing and issued its claim construction. Thereafter, theparties entered into an agreement to stay further discovery and motionspractice pending the outcome of settlement negotiations between the parties. Thisagreement has now expired and discovery is again proceeding while the partiescontinue their negotiations. An estimate of the possible loss or range of losscannot be made at this time and the Company is unable to determine whether theoutcome of the litigation could have a material impact on its results ofoperations, financial condition, or cash flows in any future period.

In June 2005,Stratagene received notice that Applera had filed an infringement action againstthe Company in the Dusseldorf District Court in Germany relating to EPpatent 0 872 562, the European counterpart of the ‘934 patent. By decisionof the Opposition Division of the European Patent Office dated January 7,2005, the ‘562 patent was revoked. Based upon that revocation, Stratagene movedto stay the district court proceedings in July 2005. That motion wasgranted. On July 7, 2006, an appellate panel of the European Patent Officereversed the revocation decision of the Opposition Division and remanded thecase back to the Opposition Division for further consideration of additionalinvalidity grounds. Applera moved to lift the stay in the Dusseldorf DistrictCourt. The court granted the motion and the proceedings have resumed. On November 10,2006, Stratagene filed its response to the complaint. The Dusseldorf DistrictCourt is currently scheduled to conduct a trial of this action in May 2007.The outcome of the trial is uncertain but if the Court were to find that weinfringe the patent, the Court could enjoin us from further sales of ourinstruments in Germany. An estimate of the possible loss or range of losscannot be made at this time and the Company is unable to determine whether theoutcome of the litigation could have a material impact on its results ofoperations, financial condition, or cash flows in any future period.

***Ariadne Genomics***

In March 2005,Stratagene filed a demand for arbitration with the American ArbitrationAssociation (“AAA”) against Ariadne Genomics, Inc. (“Ariadne”) fordeclaratory relief and damages relating to the Exclusive Marketing andDistribution Agreement (the “Agreement”) executed in December 2002 betweenthe parties. Ariadne filed counterclaims in the AAA, which Stratagene denied. Theparties have now reached an amicable settlement of this matter. In October 2005,Stratagene and Ariadne executed a Binding Settlement Agreement Term Sheet (the “TermSheet”) to resolve all of the disputes, and the parties are in the process ofcompleting a comprehensive Settlement Agreement. In brief, the settlementmemorialized in the Term Sheet provides that Stratagene’s exclusive right tomarket, sell and distribute the software products covered by the Agreementbetween the parties has been confirmed, and that the term of that Agreement hasbeen extended through December 31, 2005. In addition, Ariadne agreed topay Stratagene a sum of $300,000 by December 31, 2005, which was paid. Allproceedings between the parties will be dismissed with prejudice, and alldisputes in the United States Patent & Trademark Office will bedismissed by agreement. After executing the Term Sheet, Stratagene and Ariadneentered into 

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negotiationsfor a comprehensive settlement agreement, but have been unable to resolvecertain remaining issues. Pursuant to the Term Sheet, any remaining disputesregarding the settlement or the parties’ claims against each other are to besubmitted to binding arbitration before a single neutral arbitrator in SanDiego County. That arbitration occurred on February 27, 2006. Thearbitration decision was rendered on March 20, 2006, which affirmed andinterpreted the parties’ Term Sheet and required certain actions on the part ofboth parties, none of which involved the payment of any amounts to the otherparty. Ariadne then filed a request that the arbitration award be revised oramended. The arbitrator declined to do so in a ruling on April 19, 2006,declaring that the previous arbitration award was final and would not bechanged.

***Bio-Rad Laboratories, Inc.***

On November 20, 2006,Stratagene filed a complaint in the United States District Court for theSouthern District of California for patent infringement against Bio-RadLaboratories, Inc., MJ GeneWorks, and MJ Research, Inc. (bothsubsidiaries of Bio-Rad) for willful infringement of United States Patent Nos.6,054,263, 5,779,981, 5,288,647, and 5,395,591, which are owned by Stratagene. Stratageneseeks monetary damages (compensatory and enhanced), attorneys’ fees and costsand an injunction. Stratagene is presently exploring settlement with Bio-Radand has agreed not to formally serve the complaint pending these discussions.

***Other Legal Matters***

Pursuant to the terms of a 2002 litigation settlement,Stratagene was entitled to receive 35,290 shares of a European company. TheCompany received 11,763 shares in August 2004, 11,764 shares in September 2004and the final 11,763 shares in March 2005. These shares were sold andconverted into cash upon receipt, resulting in a gain in other income ofapproximately $530,000 during the quarter ended March 31, 2005 and$664,000 during the quarter ended September 30, 2004.

In October, 2005 Stratagene realized pre-tax income ofapproximately $34.1 million from a settlement with Cambridge AntibodyTechnology related to certain patent rights. This $34.1 million was offset by a$10.7 million royalty obligation related to this settlement due to a thirdparty. The amount due related to the third party has not been settled andremains accrued as of December 31, 2006.

During 2005, Stratagene paid $2.9 million in legalfees to an outside law firm that represented the Company in a litigation matterthat was tried before a jury. Subsequent to year end, Stratagene ended ourattorney/client relationship with this firm. Subsequent to year end, Stratageneindicated that it may pursue claims for damages against the outside law firmand the outside law firm indicated that it may adjust billing creditspreviously applied to payments made through the third quarter of 2005 in theamount of $1.1 million. Stratagene believes that it has fairly stated its legalexpenses in 2005 and 2006 after considering these unresolved issues. As of December 31,2006, accrued but unpaid legal fees amounted to $1.0 million.

*401(k) SavingsPlan**—*TheCompany has a qualified 401(k) Employee Savings Plan (the “Savings Plan”)available to substantially all full-time employees over the age of 21.

The Company matches 25% of the contributions ofemployees with one to three years of service up to a maximum of $1,000, 25% ofthe contributions of employees with three to six years of service up to amaximum of $1,750, and 30% of the contributions of employees with six or moreyears of service up to a maximum of $2,500. The contributions vest immediately.For employees of Hycor, the Company matches 50% of the first 2% of salarycontributed. The Company then makes a secondary matching contribution of 100%of the next 1% of salary contributed to the Savings Plan. The secondary matchis funded in the first quarter following the plan year end. The Companymatching expense for the years ended December 31, 2006, 2005 and 2004 was$419,458, $308,013, and $242,669, respectively.

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*EmploymentAgreements**—*Stratagenehas entered into employment agreements with certain of its officers with salaryranges from $260,000 to $500,0000. Such agreements are typically short induration but are subject to successive automatic one year renewals unless oneparty gives proper notice of its intention not to renew the employmentagreement. These agreements generally provide for severance benefits if theCompany terminates the officer other than for cause, as defined in theemployment agreements.

*OtherPurchase Commitments**—*Inthe normal course of operations, the Company enters into purchase commitmentswith vendors and suppliers of key raw materials and other goods and servicesthrough purchase orders or other documentation. Such obligations are generallyoutstanding for periods of less than one year and are settled by cash paymentsupon delivery of goods and services. At December 31, 2006, aggregatepurchase commitments related to various key raw materials and other goods andservices was approximately $3.1 million.

*Manufacturingmove to Texas**—*InJune 2004, the Company made the decision to move the remainingmanufacturing operations it conducts in San Diego, California to its primarymanufacturing facility near Austin, Texas. As a result of the move, the Companyincurred relocation and severance costs for employees affected by thetransition. In accordance with SFAS No. 146, *Accounting for Costs Associated**with Exit or Disposal Activities*, the Company estimated theemployee severance costs associated with the move and charged those costs toexpense ratably over the future service period. Approximately $29,000 and$73,000 of the expense was recorded in 2005 and 2004, respectively. The entireobligation was paid by the Company by the end of the second quarter of 2005.

*Europe Consolidation*—InFebruary 2007, the Company decided to move operations it conducts inKassel, Germany to its facility in Amsterdam, the Netherlands. As a result ofthis move, the Company will incur relocation and severance costs for employeesaffected by the transition. In accordance with SFAS No. 146, the Companyhas estimated the severance costs associated with the move and will chargethose costs ratably over the future service period. Total estimated expensesfor this move are approximately $400,000. This amount is expected to berecognized during 2007 and 2008.

**12.**          SegmentInformation

TheCompany operates in two business segments: research supplies and clinicaldiagnostics. The segment information provided for the years ended December 31,2006, 2005 and 2004 includes only seven months of clinical diagnostics segmentinformation in 2004, due to the establishment of separate reporting segments bythe Company in connection with the Hycor merger on June 2, 2004.

| ** **                            | ** ** | **Twelve Months Ended  December 31, 2006** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                            | ** ** | **Research  Supplies**                                         | ** ** | **Clinical  Diagnostics** | ** ** | **Total** | ** ** |
| Total revenue                         |       | $                                                              | 70,958,208 |   | $ | 24,598,802 |   | $ | 95,557,010 |   |
| Income (loss) before  income taxes(1) |       | $                                                              | (7,967,579 | ) | $ | 7,280,590 |   | $ | (686,989 | ) |

 

| ** **                     | ** ** | **Twelve Months Ended  December 31, 2005** | ** **  |
|--------------------------------|------------|----------------------------------------------------------------|-------------|
| ** **                     | ** ** | **Research  Supplies**                                         | ** **  | **Clinical  Diagnostics** | ** ** | **Total** | ** ** |
| Total revenue                  |       | $                                                              | 106,986,369 |   | $ | 23,298,936 |   | $ | 130,285,305 |   |
| Income before income  taxes(1) |       | $                                                              | 5,414,643   |   | $ | 6,271,127 |   | $ | 11,685,770 |   |

 

86

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| ** **                        | ** ** | **Twelve Months Ended  December 31, 2004** | ** ** |
|-----------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                        | ** ** | **Research  Supplies**                                         | ** ** | **Clinical  Diagnostics** | ** ** | **Total** | ** ** |
| Total revenue                     |       | $                                                              | 71,460,980 |   | $ | 13,351,623 |   | $ | 84,812,603 |   |
| Income before income  taxes(1)(2) |       | $                                                              | 7,188,899  |   | $ | 3,509,532 |   | $ | 10,698,431 |   |

----

(1)          Income before incometaxes related to the Research Supplies segment includes litigation chargesrecorded in 2006 and 2005 and impairment charges on long-lived assets.

(2)          In 2004, income beforeincome before income taxes related to the Research Supplies segment alsoinclude the equity in income (loss) of joint venture.

At December 31,2006 and 2005, total assets for each business segment were as follows:

| ** **      | ** ** | **2006**               | ** ** | **2005**                  | ** ** |
|-----------------|------------|------------------------|------------|---------------------------|------------|
| ** **      | ** ** | **Research  Supplies** | ** ** | **Clinical  Diagnostics** | ** ** | **Total** | ** ** | **Research  Supplies** | ** ** | **Clinical  Diagnostics** | ** ** | **Total** | ** ** |
| Total assets(1) |       | $                      | 88,149,644 |                      | $          | 41,426,557 |   | $ | 129,576,201 |   | $ | 82,611,880 |   | $ | 42,069,887 |   | $ | 124,681,767 |   |
|                 |            |                        |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Goodwill of $27,234,214is associated with the Clinical Diagnostics segment.

Informationabout the Company’s revenue by market category and operations by geographiclocation for the years ended December 31, 2006, 2005 and 2004 is shownbelow:

| **Market Category Information:** | ** ** | ** ** | ** ** | **2006** | ** ** | **%**      | ** ** | **2005**    | ** ** | **%**      | ** ** | **2004** | ** ** | **%**  | ** ** |
|--------------------------------------------|------------|------------|------------|----------|------------|------------|------------|-------------|------------|------------|------------|----------|------------|--------|------------|
| Total revenue by market  categories:       |       |       |       |     |       |       |       |        |       |       |       |     |       |
| Genetic analysis                           |       | $          | 26,919,266 |     | 28.2       | %          | $          | 29,757,332  |       | 22.9       | %          | $        | 32,281,949 |   | 38.1       | % |
| QPCR systems                               |       | 21,929,371 |       | 22.9     | %          | 20,899,677 |       | 16.0        | %          | 17,272,091 |       | 20.4     | %          |
| Protein analysis and cell biology          |       | 16,004,345 |       | 16.7     | %          | 16,863,936 |       | 12.9        | %          | 17,006,666 |       | 20.0     | %          |
| Allergy                                    |       | 11,327,993 |       | 11.9     | %          | 10,318,800 |       | 7.9         | %          | 5,811,118  |       | 6.8      | %          |
| Urinalysis                                 |       | 10,888,197 |       | 11.4     | %          | 10,932,718 |       | 8.4         | %          | 6,265,786  |       | 7.4      | %          |
| Autoimmune                                 |       | 2,018,654  |       | 2.1      | %          | 1,630,050  |       | 1.3         | %          | 985,103    |       | 1.2      | %          |
| Other(a)                                   |       | 6,469,184  |       | 6.8      | %          | 39,882,792 |       | 30.6        | %          | 5,189,890  |       | 6.1      | %          |
|                                       |       | $          | 95,557,010 |     | 100.0      | %          | $          | 130,285,305 |       | 100.0      | %          | $        | 84,812,603 |   | 100.0      | % |

 

| **Geographic Information:**        | ** ** | ** ** | ** ** | **2006** | ** ** | **%**      | ** ** | **2005**    | ** ** | **%**      | ** ** | **2004** | ** ** | **%**  | ** ** |
|-----------------------------------------|------------|------------|------------|----------|------------|------------|------------|-------------|------------|------------|------------|----------|------------|--------|------------|
| Total revenue by  geographic region(b): |       |       |       |     |       |       |       |        |       |       |       |     |       |
| U.S.(a).                                |       | $          | 63,973,820 |     | 66.9       | %          | $          | 101,174,782 |       | 77.7       | %          | $        | 61,335,195 |   | 72.3       | % |
| Netherlands                             |       | 19,640,762 |       | 20.5     | %          | 17,837,175 |       | 13.7        | %          | 19,048,552 |       | 22.5     | %          |
| Japan                                   |       | 5,219,535  |       | 5.5      | %          | 5,589,276  |       | 4.3         | %          | 1,187,017  |       | 1.4      | %          |
| Germany                                 |       | 4,653,270  |       | 4.9      | %          | 3,835,508  |       | 2.9         | %          | 2,112,852  |       | 2.5      | %          |
| Scotland                                |       | 2,069,623  |       | 2.2      | %          | 1,848,564  |       | 1.4         | %          | 1,128,987  |       | 1.3      | %          |
|                                    |       | $          | 95,557,010 |     | 100        | %          | $          | 130,285,305 |       | 100        | %          | $        | 84,812,603 |   | 100        | % |

----

(a)           2005 includesapproximately $34.1 million of royalties related to a settlement with CambridgeAntibody Technology.

(b)          Total revenue bygeographic region is presented based on the shipping point of the product.

87

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Long-livedassets by geographic region at December 31, 2006 and 2005 are as follows:

| ** **  | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------|------------|----------|------------|----------|------------|
| U.S.        |       | $        | 44,353,336 |     | $          | 44,785,322 |   |
| Netherlands |       | 294,187  |       | 193,859  |       |
| Japan       |       | 118,383  |       | 142,112  |       |
| Germany     |       | 211,696  |       | 236,287  |       |
| Scotland    |       | 208,828  |       | 184,163  |       |
|        |       | $        | 45,186,430 |     | $          | 45,541,743 |   |

 

**13.**          Transactionsin Joint Venture

Until December of 2004, the Company had a 49%minority interest in a limited partnership (“LP”) that operated a research lab.This investment was accounted for using the equity method of accounting. On June 1,2004, prior to the BCH asset acquisition by the Company (Note 3), the LP soldthe assets related to its clinical diagnostics business to a third party forapproximately $4.5 million. The consolidated financial statements reflect a$1.8 million gain in equity in earnings of joint venture for BCH’s share of therealized gain on the sale of these assets. The taxes attributable to the gainare the responsibility of the members of BCH and accordingly, the consolidatedfinancial statements do not include a provision for income taxes on this $1.8million gain. The LP made a partial distribution of the cash proceeds to BCH onJune 1, 2004. In turn, BCH made a distribution to its members to pay forthe taxes related to the sale in the amount of $476,280.

On December 23, 2004,the Company’s rights and interests in the LP were redeemed by the LP. Inreturn, the Company received cash consideration of approximately $1.0 millionand recorded a non-operating loss of approximately $0.2 million for thedifference between the carrying basis in the entity on December 23, 2004and the consideration received. As a result of the redemption transaction, theCompany has rights to additional amounts realized by the LP from future royaltystreams and future clinical trial revenues. These amounts are recorded by theCompany as other non-operating income when the amounts are known and thecollection is assured.

**14.   SelectedQuarterly Data (unaudited)**

Quarterlyfinancial data for the year ended December 31, 2006 is as follows:

| ** **                           | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|--------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| Total revenue                        |       | $                  | 24,255,494 |                | $          | 23,403,551         |       | $                   | 23,199,916 |   | $ | 24,698,049 |   |
| Gross profit                         |       | 15,792,074         |       | 15,117,175          |       | 14,617,438         |       | 15,200,783          |       |
| Net income (loss)                    |       | 1,103,029          |       | (3,745,111          | )          | (6,305,813         | )          | 9,006,906           |       |
| Basic net income  (loss) per share   |       | $                  | 0.05       |                | $          | (0.17              | )          | $                   | (0.28      | ) | $ | 0.40 |   |
| Diluted net income  (loss) per share |       | $                  | 0.05       |                | $          | (0.17              | )          | $                   | (0.28      | ) | $ | 0.40 |   |

 

Quarterlyfinancial data for the year ended December 31, 2005 is as follows:

| ** **                    | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|-------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| Total revenue                 |       | $                  | 24,600,040 |                | $          | 24,891,395         |       | $                   | 23,695,883 |   | $ | 57,097,987 |   |
| Gross profit                  |       | 16,134,012         |       | 16,198,154          |       | 15,248,943         |       | 37,546,271          |       |
| Net income                    |       | 2,935,292          |       | 2,137,444           |       | 688,428            |       | 2,026,606           |       |
| Basic net income  per share   |       | $                  | 0.13       |                | $          | 0.10               |       | $                   | 0.03       |   | $ | 0.09 |   |
| Diluted net income per  share |       | $                  | 0.13       |                | $          | 0.10               |       | $                   | 0.03       |   | $ | 0.09 |   |

 

88

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**Item 9.   Changes in and Disagreements withAccountants on Accounting and Financial Disclosure**

None.

**Item 9A.   Controls and Procedures**

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in the reportswe file pursuant to the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the rules and forms of the Securities and Exchange Commission, and thatsuch information is accumulated and communicated to management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, and inreaching a reasonable level of assurance, management necessarily was requiredto apply its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.

We carried out anevaluation, under the supervision and with the participation of management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this annual report. Based onthe foregoing, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective at thereasonable assurance level.

*Changes in InternalControl*

There have been no changesin our internal control over financial reporting during our fourth fiscalquarter that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

**Item 9B.   OtherInformation**

None.

89

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**PART III.**

**Item 10.   Directors, Executive Officers andCorporate Governance**

The information requiredby this item will be contained in our definitive proxy statement to be filedwith the Securities and Exchange Commission in connection with the AnnualMeeting of our Stockholders (the “Proxy Statement”), which is expected to befiled not later than 120 days after the end of the fiscal year ended December 31,2006, and which is incorporated in this report by reference.

**Item 11.   ExecutiveCompensation**

The information requiredby this item will be set forth in the Proxy Statement and is incorporated inthis report by reference; provided, however, that the Compensation CommitteeReport on Executive Compensation (1) shall not be deemed incorporated byreference in this Annual Report on Form 10-K and (2) shall nototherwise be deemed “filed” as part of this Annual Report on Form 10-K.

**Item 12.   Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters**

The information requiredby this item will be set forth in the Proxy Statement and is incorporated inthis report by reference.

**Item 13.   Certain Relationships and RelatedTransactions, and Director Independence**

The information requiredby this item will be set forth in the Proxy Statement and is incorporated inthis report by reference.

**Item 14.   Principal Accountant Fees and Services**

The information requiredby this item will be set forth in the Proxy Statement and is incorporated inthis report by reference.

90

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**PART IV**

**Item 15.   Exhibits and Financial StatementSchedules**

*(a)**         Listthe following documents filed as a part of this report:*

1.                 Financialstatements.

The ConsolidatedFinancial Statements required by this Item are included in Part II, Item 8of this Annual Report on Form 10-K.

2.                 List of financialstatement schedules.

The financialstatement schedules listed under Item 15(c) hereof are filed as part ofthis Annual Report on Form 10-K.

3.                 List of exhibits.

The exhibits listedunder Item 15(b) hereof are filed as part of this Annual Report on Form 10-K.

*(b)**         Exhibits.*

The following exhibits are filed with this AnnualReport on Form 10-K:

|           | **Exhibit   Number** | ** **                                                                                                                                                                                                                                                                                                                 | ** ** | **Description** |
|-----------|----------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| 2.1(1)    |                 | Agreement and Plan of  Reorganization dated as of July 24, 2003 by and among the registrant, SHC  Acquisition Sub, Inc. and Hycor Biomedical Inc.                                                                                                                                                                          |
| 2.2(1)    |                 | Amendment No. 1 to  Agreement and Plan of Reorganization dated as of December 29, 2003 by and  among the registrant, SHC Acquisition Sub, Inc. and Hycor Biomedical Inc.                                                                                                                                                   |
| 2.3(1)    |                 | Amendment No. 2 to  Agreement and Plan of Reorganization dated as of February 25, 2004 by and  among the registrant, SHC Acquisition Sub, Inc. and Hycor Biomedical Inc.                                                                                                                                                   |
| 3.1(2)    |                 | Second Amended and  Restated Certificate of Incorporation of the registrant                                                                                                                                                                                                                                                |
| 3.2(2)    |                 | Amended and Restated  Bylaws of the registrant                                                                                                                                                                                                                                                                             |
| 4.1(1)    |                 | Specimen common stock  certificate of the registrant                                                                                                                                                                                                                                                                       |
| 4.2(2)    |                 | Registration Rights  Agreement dated as of June 2, 2004 by and among the registrant and Dr. Joseph  A. Sorge, the J. A. Sorge Trust I, the J. A. Sorge Trust II, the J. A. Sorge  Trust III, the J. A. Sorge Trust IV, Biosense Partners, L.P. and the Joseph  A. Sorge Charitable Remainder Trust dated December 26, 2002 |
| 10.1(3) # |                 | The Year 2000 Stock  Option Plan of the registrant, as amended and restated                                                                                                                                                                                                                                                |
| 10.2(3) # |                 | The 2004 Independent  Directors Option Plan of the registrant                                                                                                                                                                                                                                                              |
| 10.3(3) # |                 | Employee Stock Purchase  Plan of the registrant                                                                                                                                                                                                                                                                            |
| 10.4(3) # |                 | Hycor Biomedical Inc.  2001 Stock Option Plan                                                                                                                                                                                                                                                                              |
| 10.5(3) # |                 | Hycor Biomedical Inc.  1992 Incentive Stock Plan                                                                                                                                                                                                                                                                           |
| 10.6(2) # |                 | Amended and Restated  Employment Agreement dated as of June 2, 2004 by and between the registrant  and Dr. Joseph A. Sorge                                                                                                                                                                                                 |
| 10.7(1)   |                 | Loan Agreement dated as  of April 1, 1997 by and between Bastrop County Industrial Development Corporation  and BioCrest Manufacturing, L.P., a wholly owned subsidiary of the registrant                                                                                                                                  |

91

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| 10.11(1)† |   | Thermal Cycler Supplier  Authorization Agreement dated as of January 1, 1995 by and between The  Perkin-Elmer Corporation and Stratagene California (formerly known as  Stratagene), a wholly owned subsidiary of the registrant |
|----------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.12(1)† |   | Patent License Agreement  dated as of July 26, 1994 by and between Roche Molecular Systems, P.  Hoffmann-La Roche Ltd. and Stratagene California (formerly known as  Stratagene), a wholly owned subsidiary of the registrant    |
| 10.13(1)       |   | Lease Agreement by and  between Slough TPSP LLC and Stratagene California (formerly known as  Stratagene), a wholly owned subsidiary of the registrant, for 11011 North  Torrey Pines Road, La Jolla, California                 |
| 10.14(1)       |   | Credit Agreement dated  as of January 21, 2004 by and among Merrill Lynch Business Financial Services  Inc., the registrant, BioCrest Holdings, L.L.C. and BioCrest Manufacturing,  L.P.                                         |
| 10.15(5)       |   | Amendment No. 1 to  Credit Agreement dated as of May 26, 2004 by and among Merrill Lynch Business  Financial Services Inc., the registrant, BioCrest Holdings, L.L.C. and  BioCrest Manufacturing, L.P.                          |
| 10.16(5)       |   | Amendment No. 2 to  Credit Agreement dated as of September 28, 2004 by and among Merrill Lynch  Business Financial Services Inc., the registrant, BioCrest Holdings, L.L.C.  and BioCrest Manufacturing, L.P.                    |
| 10.17(6)       |   | Amendment No. 3 to  Credit Agreement dated as of February 24, 2005 by and among Merrill Lynch  Business Financial Services Inc., the registrant, BioCrest Holdings, L.L.C.  and BioCrest Manufacturing, L.P.                     |
| 10.18 (7)      |   | Amendment No. 4 to  Credit Agreement dated as of January 24, 2006 by and among Merrill Lynch  Business Financial Services Inc., the registrant, BioCrest Holdings, L.L.C.  and BioCrest Manufacturing, L.P.                      |
| 10.19 (8)#     |   | Form of Employment  Agreement dated March 10, 2006, with Steve R. Martin, David W. Weber and John  R. Pouk.                                                                                                                      |
| 10.20(8)       |   | Employment Separation  Agreement and Mutual General Release of all Claims, dated October 6,  2006, between Stratagene Corporation and Ms. Ronni L. Sherman                                                        |
| 10.21(9)       |   | Consulting Agreement  effective October 13, 2006, between Stratagene Corporation and  Mr. Ronni L. Sherman.                                                                                                            |
| 10.22(10)      |   | Stratagene Corporation  2006 Equity Incentive Award Plan                                                                                                                                                                         |
| 21.1           |   | List of subsidiaries of  the registrant                                                                                                                                                                                          |
| 23.1           |   | Consent of Mayer Hoffman  McCann P.C., Independent Registered Public Accounting Firm                                                                                                                                             |
| 23.2           |   | Consent of Deloitte  & Touche LLP, Independent Registered Public Accounting Firm                                                                                                                                             |
| 31.1           |   | Certification of Chief  Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the  Securities Exchange Act of 1934                                                                                             |
| 31.2           |   | Certification of Chief  Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the  Securities Exchange Act of 1934                                                                                             |

92

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| 32.1* |   | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350, as created by Section  906 of the Sarbanes-Oxley Act of 2002 |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|
| 32.2* |   | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350, as created by Section  906 of the Sarbanes-Oxley Act of 2002 |

----

       (1) Incorporated by reference to the Registration Statement on Form S-4(No. 333-109420) filed on October 2, 2003, as amended.

       (2) Incorporated by reference to the Quarterly Report on Form 10-Q forthe period ended June 30, 2004.

       (3) Incorporated by reference to the Registration Statement on Form S-8(No. 333-116544) filed on June 16, 2004.

       (4) Incorporated by reference to the Current Report on Form 8-K filed onFebruary 1, 2005. 

       (5) Incorporated by reference to the Quarterly Report on Form 10-Q for theperiod ended September 30, 2004.

       (6) Incorporated by reference to the Annual Report on Form 10-K for theyear ended December 31, 2004.

       (7) Incorporated by reference to the Annual Report on Form 10-K for theyear ended December 31, 2005.

       (8) Incorporated by reference to the Current Report on Form 8-K filed onMarch 15, 2006

       (9) Incorporated by reference to the Quarterly Report on Form 10-Q forthe period ended September 30, 2006.

(10) Incorporated by reference to the Registration Statement on Form S-8(No. 333-135720) filed on July 12, 2006.

#                 Indicates amanagement contract or compensatory plan or arrangement. 

†                    Certainconfidential portions of this exhibit were omitted by means of redacting aportion of the text. An unredacted version of this exhibit was filed separatelywith the Secretary of the Commission pursuant to the registrant’s ApplicationRequesting Confidential Treatment pursuant to Rule 406 under the SecuritiesAct.

*                    Thesecertifications are being furnished solely to accompany this annual reportpursuant to 18 U.S.C. Section 1350, and are not being filed for purposes ofSection 18 of the Exchange Act and are not to be incorporated by reference intoany filing of Stratagene Corporation, whether made before or after the datehereof, regardless of any general incorporation language in such filing.

*(c)**          FinancialStatement Schedules.*

Thefollowing financial statement schedule is filed as part of this Annual Reporton Form 10-K:

| Schedule Number | ** ** | ** **                        | ** ** | **Description** | ** ** | **Page** |
|-----------------|------------|-----------------------------------|------------|-----------------|------------|----------|
| II              |       | Valuation and Qualifying Accounts |       | 95              |

 

93

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

| Date: March 13, 2007 |   | STRATAGENE CORPORATION |
|---------------------------|--------|------------------------|
|                      |   | By:                    | /s/ JOSEPH A. SORGE |
|                      |   |                   | Joseph A. Sorge, M.D. |
|                      |   |                   | Chairman of the Board, Chief Executive Officer and  President |
|                      |   | By:                    | /s/ STEVE R. MARTIN |
|                      |   |                   | Steve R. Martin |
|                      |   |                   | Vice President and Chief Financial Officer |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

|                        | **Signature** | ** **                                                      | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|------------------------|---------------|-----------------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ JOSEPH  A. SORGE   |          | Chairman of the  Board, Chief Executive Officer and             |       | March 13,  2007 |
| Joseph  A, Sorge, M.D. |          | President (Principal  Executive Officer)                        |       |                 |
| /s/ STEVE R.  MARTIN   |          | Vice President  and Chief Financial Officer                     |       | March 13,  2007 |
| Steve  R. Martin       |          | (Principal Financial  Officer and Principal Accounting Officer) |       |                 |
| /s/ CARLTON  J. EIBL   |          | Director                                                        |       | March 13,  2007 |
| Carlton  J. Eibl       |          |                                                            |       |                 |
| /s/ ROBERT  C. MANION  |          | Director                                                        |       | March 13,  2007 |
| Robert  C. Manion      |          |                                                            |       |                 |
| /s/ PETER  ELLMAN      |          | Director                                                        |       | March 13,  2007 |
| Peter  Ellman          |          |                                                            |       |                 |
| /s/ JOHN  C. REED      |          | Director                                                        |       | March 13,  2007 |
| John C. Reed           |          |                                                            |       |                 |

 

94

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Schedule II

**STRATAGENECORPORATION AND SUBSIDIARIESVALUATION AND QUALIFYING ACCOUNTSFOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004**

| ** **                                                      | ** ** | **Balance at  Beginning  of Year** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions** | ** ** | **Balance at  End of Year** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------|------------|----------------|------------|--------------------------------------------|------------|
| **Allowance for doubtful accounts  receivable**                 |       |                                         |       |                                          |       |           |       |                                       |       |   |   |
| 2004                                                            |       | 990,849                                      |       | (220,734                                      | )          | 3,343          |       |                                       | 766,772    |   |   |
| 2005                                                            |       | 766,772                                      |       | 53,357                                        |       | 239,947        |       |                                       | 580,182    |   |   |
| 2006                                                            |       | 580,182                                      |       | (10,656                                       | )          | 94,882         |       |                                       | 474,644    |   |   |
| **Allowance  for excess, obsolete and short-dated inventories** |       |                                         |       |                                          |       |           |       |                                       |       |   |   |
| 2004                                                            |       | 1,814,287                                    |       | 1,730,830                                     |       | 216,117        |       |                                       | 3,329,000  |   |   |
| 2005                                                            |       | 3,329,000                                    |       | 1,708,848                                     |       | 962,524        |       |                                       | 4,075,324  |   |   |
| 2006                                                            |       | 4,075,324                                    |       | 1,363,321                                     |       | 1,303,173      |       |                                       | 4,135,472  |   |   |

 

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