UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission File Number: 0-11647

HYCOR BIOMEDICAL INC.

7272 Chapman Avenue, Garden Grove, California 92841

Registrant’s telephone number, including area code (714) 933-3000

No Change

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

     Indicate by check mark whether the registrant is an accelerated filer (as identified in Rule 12b-2 of the Exchange Act). Yes   [   ]   No   [X]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Hycor Biomedical Inc.
Index

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PART I. FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

HYCOR BIOMEDICAL INC. AND SUBSIDIARIES

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HYCOR BIOMEDICAL INC. AND SUBSIDIARIES

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HYCOR BIOMEDICAL INC. AND SUBSIDIARIES

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HYCOR BIOMEDICAL INC. AND SUBSIDIARIES

1. Basis of Presentation

     The accompanying unaudited consolidated financial statements include all adjustments necessary to present fairly the financial position of the Company as of March 31, 2004 and December 31, 2003, the results of its operations and its cash flows for the three-month periods ended March 31, 2004 and 2003. These statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission and do not include all the information and note disclosures required by accounting principles generally accepted in the United States of America for complete financial statements but reflect all adjustments (consisting only of normal recurring accruals) necessary for the fair presentation of the financial position, results of operations and cash flows for the periods and dates presented. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2003 annual report on Form 10-K as filed with the Securities and Exchange Commission. Certain items in the 2003 consolidated financial statements have been reclassified to conform to the 2004 presentation.

     The results of operations for any interim period are not necessarily indicative of results to be expected for the full year.

     Basic earnings per share is computed by dividing net income by the weighted-average number of shares outstanding, while diluted EPS additionally includes the dilutive effect of the Company’s outstanding options computed using the treasury stock method.

2. Accounting for Stock-Based Compensation

     The Company accounts for its employee stock-based awards using the intrinsic value method in accordance with APB Opinion No. 25, and its related interpretations.

     Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” requires the disclosure of pro forma net income and net income per share had the Company adopted the fair value method. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. If the computed fair values of the 2004 and 2003 stock awards had been amortized to expense over the vesting period of the awards, pro forma net income would have been as follows:

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3. Inventories

     Inventories are valued at the lower of cost (first-in, first-out method) or market. Cost includes material, direct labor, and manufacturing overhead. Inventories at March 31, 2004 and December 31, 2003 consist of:

4. Long Term Debt

     The Company has available a $2,000,000 line of credit with a maturity date of July 1, 2004. Advances under the line of credit are collateralized by the Company’s accounts receivable, inventories, and property and equipment and bear interest at the prime rate or at LIBOR plus 2% (3.11% as of March 31, 2004).

     The line of credit contains restrictive covenants, the most significant of which relate to the maintenance of minimum tangible net worth, debt-to-tangible net worth requirements, and liquid assets plus accounts receivable-to-current liabilities requirements. At March 31, 2004, the Company was in compliance with such covenants, did not have any amounts outstanding and does not expect to renew the line of credit.

5. Other Commitments and Contingencies

     The Company has entered into employment contracts with each of the Company’s five officers. These contracts generally provide for severance benefits if the officer is terminated by the Company for convenience or by the officer for substantial cause. In addition, in order to

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assure that the officers would continue to provide independent leadership consistent with the Company’s best interests in the event of an actual or threatened change in control of the Company, the contracts also generally provide four of the officers with certain protections in the event of such a change in control. Two of the contracts provide certain benefits in the event of a change of control only and two of the contracts provide certain benefits in the event of a change of control and the occurrence of other specified events. In the event the proposed transaction with Stratagene Holding Corporation is completed, the Company will incur severance obligations of approximately $1.5 million that are included in the expected merger related costs disclosed above under the heading “Execution of Agreement”.

     There are no material pending legal proceedings. However, on occasion there may exist immaterial routine litigation that is incidental to the normal operations of the business to which the Company is a party or to which the Company’s property is subject.

6. New Accounting Pronouncements

     In December 2003, the Securities and Exchange Commission released Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition, which supersedes SAB No. 101, Revenue Recognition in Financial Statements. SAB No. 104 clarifies existing guidance regarding revenues for contracts which contain multiple deliverables to make it consistent with Emerging Issues Task Force (“EITF”) No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. The adoption of SAB No. 104 did not have a material impact on the Company’s revenue recognition policies, nor its financial position or results of operations.

     In January 2003, the FASB issued Interpretation (FIN) No. 46, Consolidation of Variable Interest Entities and in December 2003, issued Interpretation No. 46 (revised December 2003) Consolidation of Variable Interest Entities — An Interpretation of APB No. 51. In general, a variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights, or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. FIN No. 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN No. 46 (R) clarifies the application of Accounting Research Bulletin (“ARB”) No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without subordinated financial support from other parties. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. FIN No. 46 (R) applies immediately to variable interest entities created after December 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies no later than the first reporting period ending after December 15, 2004, to variable interest entities in which an enterprise holds a variable interest (other than special purpose) that it acquired before January 1, 2004. FIN No. 46 (R) applies to public enterprises as of the beginning of the applicable interim or annual period. The Company believes that the adoption of FIN No. 46 and FIN No. 46 (R) will not have a material impact on its financial position or results of operations because the Company

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has no variable interest entities.

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope, which may have previously been reported as equity, as a liability (or an asset in some circumstances). This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003 for public companies. In October 2003, the FASB indefinitely deferred implementation of paragraphs 9 and 10 of SFAS No. 150 regarding parent company treatment of minority interest for certain limited life entities. The adoption of SFAS No.150 did not have a significant impact on the Company’s consolidated financial statements.

7. Merger Agreement

     On July 24, 2003, the Company announced the execution of an Agreement and Plan of Reorganization (the “Merger Agreement”) by and among Stratagene, a Delaware corporation, SHC Acquisition Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Stratagene, and the Company. Pursuant to the Merger Agreement, Stratagene would acquire all of the outstanding shares of the Company through a merger between SHC Acquisition Sub and the Company. The Company will survive the merger as a wholly owned subsidiary of Stratagene. Pursuant to the Merger Agreement, the Company’s stockholders would receive a fixed exchange ratio of 0.6158 Stratagene shares in exchange for each share of the Company, plus cash for any fractional shares. The closing of the transaction is subject to closing conditions, including, but not limited to, the parties obtaining the necessary regulatory and shareholder approvals. The Company expects that the proposed transaction will be recognized as a tax-free reorganization.

     Stratagene has filed a registration statement on Form S-4 (No. 333-109420) related to the proposed transaction. The SEC declared the Form S-4 effective on May 29, 2004 and it has been mailed along with the proxy, to the shareholders of Hycor.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

     This section and this entire report contains forward-looking statements and include assumptions concerning the Company’s operations, future results and prospects. These forward-looking statements are based on current expectations and are subject to a number of risks, uncertainties, and other factors. In connection with the Private Securities Litigation Reform Act of 1995, the Company provides the following cautionary statements identifying important factors which, among other things, could cause the actual results and events to differ materially from those set forth in or implied by the forward-looking statements and related assumptions contained in this Section and in this entire Report. The Company intends that all forward-looking statements be subject to the “safe-harbor” provisions contained in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

     Such factors include, but are not limited to, product demand and market acceptance risks; the effect of economic conditions; the impact of competitive products and pricing; product development; commercialization and technological difficulties; capacity and supply constraints or difficulties;

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difficulties competing against larger companies which have substantially greater financial resources; failure to receive and maintain regulatory approvals for our products; rapid technological change and new products developed by others which are more effective or less costly than our current or future products or which render our technologies and products obsolete or non-competitive; availability of capital resources; general business and economic conditions, including currency risks based on the relative strength or weakness of the U.S. dollar, euro conversions, and changes in government laws and regulations, including taxes; and the other risks and uncertainties described in the Company’s filings with the Securities and Exchange Commission. The historical results achieved by the Company are not necessarily indicative of its future prospects. The Company undertakes no obligation to publicly update or revise any forward looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Execution of Agreement

     On July 24, 2003, the Company announced the execution of an Agreement and Plan of Reorganization (the “Merger Agreement”) by and among Stratagene, a Delaware corporation, SHC Acquisition Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Stratagene, and the Company. Pursuant to the Merger Agreement, Stratagene would acquire all of the outstanding shares of the Company through a merger between SHC Acquisition Sub and the Company. Pursuant to the Merger Agreement, the Company’s stockholders would receive a fixed exchange ratio of 0.6158 Stratagene shares in exchange for each share of the Company, plus cash for any fractional shares. The closing of the transaction is subject to closing conditions, including, but not limited to, the parties obtaining the necessary regulatory and shareholder approvals. The Company expects that the proposed transaction will be recognized as a tax-free reorganization.

     Stratagene has filed a registration statement on Form S-4 (No. 333-109420) related to the proposed transaction. The SEC declared the Form S-4 effective on May 29, 2004 and it has been mailed along with the proxy to the shareholders of Hycor.

     If the proposed transaction is completed, the combined company would offer diagnostic products and life sciences research tool product lines to the global academic, pharmaceutical, and clinical and government laboratory markets. The Company is expected to be impacted by merger-related costs of approximately $3.7 million, consisting of severance payments, investment banking fees, professional fees and other miscellaneous expenses, of which the Company has incurred approximately $837,000 as of March 31, 2004 and the balance is expected to be recognized in the second quarter of 2004.

Significant Accounting Policies

     The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and management is required to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which the Company believes are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition

     Revenues from product sales are recognized at the time of shipment and passage of title. Revenues from customers under distributorship agreements are also recognized at the time of shipment and passage of title. The Company offers customers the right to return products only if the products are shipped in error, are damaged or in the event of product failure. While such returns have

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historically not been significant, the Company cannot guarantee that it will continue to experience the same return rates that it has in the past. Any significant increase in product failure rates and the resulting credit returns could have a material adverse impact on the Company’s operating results for the period or periods in which such returns materialize.

Accounts Receivable

     The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current creditworthiness. The Company continuously monitors collections and payments from customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. The Company’s credit losses have historically been within expectations and the provisions established. However, the inability of any one of the Company’s significant customers to pay amounts owed could have a material adverse impact on the Company’s operating results.

Inventories

     Inventories are valued at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. The Company regularly reviews inventory quantities on hand and records a provision for excess and obsolete inventory on specifically identified items based primarily on an estimated forecast of product demand and production requirements. The Company’s losses from disposal of excessive and obsolete inventories have historically been within expectations and the provisions established. However, the Company’s estimates of future product demand may prove to be inaccurate, in which case the Company may have understated or overstated the provision required for excess and obsolete inventory. In addition, rapid technological change or new product development could result in an increase in the amount of obsolete inventory quantities on hand. In the future, if the Company’s inventory is determined to be overvalued, it would be required to recognize such costs in its cost of goods sold at the time of such determination. Likewise, if the Company’s inventory is determined to be undervalued, it may have over-reported its costs of goods sold in previous periods and would be required to recognize such additional operating income at the time of sale.

     Additionally, the Company’s manufacturing costs and inventory carrying costs are dependent on management’s accurate estimates of customer demand for the Company’s products. A significant increase in the demand for the Company’s products could result in a short-term increase in the cost of inventory purchases, while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand and increase the expense of storing and maintaining the inventory until it is sold. Therefore, although management makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of the Company’s inventory and its reported operating results.

Deferred Taxes

     The Company’s deferred taxes relate primarily to prior operating losses and R&D tax credits that are available to offset future income taxes. Deferred taxes are also recognized for differences between the financial statement carrying amounts and the tax bases of assets and liabilities. The Company evaluates a variety of factors in determining the amount of deferred income assets to be recognized pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes. During 2003, the Company reversed the valuation allowance on a portion of its deferred assets. To the extent that it becomes more likely than not that the deferred assets, which

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continue to have a valuation allowance, would be realized, the Company would be required to reverse all or a portion of the remaining valuation allowance. Reducing the amount of the valuation allowance would have the affect of reducing the Company’s effective tax rate and have a positive impact on net income in the period of change. To the extent it becomes more likely than not that the net deferred tax asset recorded by the Company will not be realized, the Company would be required to increase its valuation allowance by recording an additional income tax provision.

Warranties

     All products are guaranteed to perform pursuant to Company policy for each product type when stored and used as directed. Warranty is limited to replacement of defective product returned at no cost to the customer. While the Company’s warranty costs have historically not been significant, the Company cannot guarantee that it will continue to experience the same warranty return rates that it has in the past. A significant increase in product return rates could have a material adverse impact on operating results for the period or periods in which such returns materialize.

New Accounting Pronouncements

     Information regarding recent accounting pronouncements is contained in Note 6 to the Consolidated Financial Statements for the period ended March 31, 2004, which note is incorporated herein by this reference and is included as part of “Item 1. Financial Statements,” to this Form 10-Q.

Financial Condition and Liquidity

     As of March 31, 2004, the Company’s working capital increased approximately $635,000 compared to December 31, 2003. This increase was primarily as a result of profitable operations.

     During the three-month periods ended March 31, 2004 and 2003, total capital expenditures were approximately $37,000 and $96,000, respectively. Capital spending during the three-month periods ended March 31, 2004 and 2003 included approximately $22,000 and $65,000 for tooling and test equipment utilized in the Company’s manufacturing and research and development areas, respectively. For fiscal 2004, the Company currently anticipates capital spending on property and equipment to be in the range of $500,000 to $600,000.

     The Company’s principle capital commitments are for lease payments under non-cancelable operating leases. Additionally, the HY•TEC business requires the purchase of instruments, which in many cases are placed in use in laboratories of the Company’s direct customers and paid for over an agreed contract period through the purchase of test reagents. This “reagent rental” sales program, common to the diagnostic market, creates negative cash flows in the initial years.

     The Company has a line of credit that provides for borrowings of up to $2,000,000 and expires on July 1, 2004. The line of credit is collateralized by the Company’s accounts receivable, inventories, and property and equipment. At March 31, 2004, the Company had no outstanding advances under the line of credit and does not expect to renew it. Advances under the line of credit bear interest at the prime rate or at LIBOR plus 2% (3.11% as of March 31, 2004), payable monthly, with the principal due at maturity. The line of credit contains restrictive covenants, the most significant of which relate to the maintenance of minimum tangible net worth, debt-to-tangible net worth requirements and liquid assets plus accounts receivable-to-current liabilities requirements. At March 31, 2004, the Company was in compliance with such covenants.

     In addition, in the normal course of operations, the Company enters into purchase obligations with various vendors and suppliers of various key raw materials and other goods and services through

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purchase orders or other documentation. Such obligations are generally outstanding for periods less than a year and are settled by cash payments upon delivery of goods and services. The purchase commitments covered by these various key raw materials and other goods and services aggregate approximately $642,000 for 2004.

     The following table summarizes the approximate future minimum payments under the above contractual obligations for the twelve-month periods as from March 31, 2004:

     In the past, the Company has generally funded our capital expenditures and working capital requirements with cash flows from operations and funds available under the line of credit. The Company expects to fund future capital expenditures and working capital needs with cash flows from operations.

     In October 2002, the Board of Directors authorized the repurchase of up to an aggregate of 1,000,000 shares of the Company’s outstanding common stock. As of March 31, 2004, 11,500 shares of the Company’s common stock had been purchased at an average cost of $1.77 per share for a total of $20,404. The Company did not repurchase any stock during the first quarter ended March 31, 2004.

Other Commitments and Contingencies

     The Company has entered into employment contracts with each of the Company’s five officers. These contracts generally provide for severance benefits if the officer is terminated by the Company for convenience or by the officer for substantial cause. In addition, in order to assure that the officers would continue to provide independent leadership consistent with the Company’s best interests in the event of an actual or threatened change in control of the Company, the contracts also generally provide four of the officers with certain protections in the event of such a change in control. Two of the contracts provide certain benefits in the event of a change of control only and two of the contracts provide certain benefits in the event of a change of control and the occurrence of other specified contingencies. Such obligations are not included in the table of contractual obligations set forth above. In the event the proposed transaction with Stratagene Holding Corporation is completed, the Company will incur severance obligations of approximately $1.5 million that are included in the expected merger related costs disclosed above under the heading “Execution of Agreement”.

Results of Operations

     During the three-month period ended March 31, 2004, sales increased approximately $591,000 or 12.1%, compared to the same period last year. Sales in the Urinalysis product line increased by approximately $245,000 for the three-month period ended March 31, 2004, compared to the same period last year. This increase was primarily the result of increased sales due to increased volumes with pre-existing accounts. Sales in the clinical immunology product line increased during the three-month period ended March 31, 2004, approximately $297,000, compared to the corresponding period

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last year. This increase was primarily the result of increased sales in the Allergy product line due to increased volumes with pre-existing accounts of approximately $35,000 and increasing activity from new accounts of approximately $173,000 for the three-month period ended March 31, 2004, when compared to the same period last year.

     Gross profit as a percentage of product sales increased for the three-month period ended March 31, 2004 from approximately 52.2% to 60.0% for the same period last year. This increase was due primarily to increases in revenues of the Company’s higher gross margin Urinalysis products and the receipt of $118,000 for a final royalty payment from the sale of the Company’s Hematology product line in 2000.

     Selling, general and administrative expenses increased for the three-month period ended March 31, 2004, approximately $274,000 or 16.0% (36.2% of net sales in 2004 versus 35.0% of net sales in 2003), when compared to the prior year period. This increase was due primarily to expenses related to the merger negotiations of approximately $145,000. In addition, during the first quarter 2004, an unfavorable foreign exchange impact caused an increase in reported expenses of approximately $70,000.

     Research and development costs decreased for the three-month period ended March 31, 2004, approximately $22,000 or 4.0% (9.5% of net sales in 2004 versus 11.1% of net sales in 2003), when compared to the same period in 2003. This decrease was primarily due to costs of approximately $60,000 included in 2003 related to the recruitment of a senior member of management, offset by ongoing development projects with the Company’s allergy product line and expenses associated with the Company’s agreement with Bayer Diagnostics.

     Interest income decreased $23,000 or 50.0% in 2004 over the same period last year, primarily as a result of the sale and transfer in 2003 of approximately $2,255,000 in long-term bonds to money market accounts with lower interest rates. Interest expense decreased approximately $3,000 or 98.6% in 2004 from the same period last year due to the payment of all debt balances in the first quarter 2003.

     During the three-month period ended March 31, 2004, gains from foreign currency transactions decreased approximately $25,000 or 67.2%, primarily due to foreign currency transactions at the Company’s German subsidiary that resulted in a negative foreign currency transaction impact.

     The tax provision for the three months ended March 31, 2004 reflects the provision for federal, state, and foreign liabilities. In the fourth quarter of 2003 the reversal of the valuation allowance resulted in an income tax benefit of approximately $1,329,000 compared to income tax expense of approximately $193,000 in 2002. This reversal was recognized in the fourth quarter of 2003 because first, while the Company was profitable in 2002, management believed the level of profitability was not sufficient to establish at that time that it was more likely than not that the Company would be able to realize its deferred tax asset. Second, during 2003 the Company made significant progress towards the generation of future revenues under two significant research and development (“R&D”)

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arrangements. Accordingly, during the fourth quarter of 2003, management determined that it was now more likely than not that the Company would be able to realize a portion of its deferred tax asset based on (i) the increased profitability during 2003, and (ii) the Company’s progress on the two R&D projects with the anticipation of these projects beginning to generate revenues in the fourth quarter of 2004. Without the benefit of the valuation allowance reversal the Company’s effective tax rate would have been approximately 6.4% in 2003 compared to 13.3% in 2002. Due to the reversal of the valuation allowance in the fourth quarter of 2003, the effective tax rate for the three months ended March 31, 2004 was approximately 35.2% compared to 11.6% for the prior year period.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     The Company’s financial instruments include cash and cash equivalents and investments. At March 31, 2004, the carrying values of our financial instruments approximated their fair values based on current market prices and rates.

     The Company is exposed to a number of market risks in the ordinary course of business. These risks, which include foreign currency exchange risk and interest rate risk, arise in the normal course of business rather than from trading. Aside from the operations of our subsidiaries in Germany and Scotland, we do not transact business in foreign currencies. At the present time, we do not have any hedging programs in place and we are not trading in any financial or derivative instruments.

Foreign Currency

     The Company’s international sales expose it to foreign currency risk in the ordinary course of its business. For the three-month periods ended March 31, 2004 and 2003, the percentage of the Company’s net sales generated by the Company’s foreign subsidiaries (“Foreign Subs”) were approximately 24.5% and 22.8%, respectively. The financial position and results of operations of the Foreign Subs are measured using the local currency as the functional currency. The Foreign Subs sell product in various European currencies that are collected at future dates and purchase raw materials and finished goods in both U.S. Dollars and other European currencies. Accordingly, the Company is exposed to transaction gains and losses that could result from changes in foreign currency exchange rates. Realized gains and losses from foreign currency transactions are included in operations as incurred.

     For financial reporting purposes, the Foreign Subs’ statements of operations are translated from the local currency into U.S. Dollars at the exchange rates in effect during the reporting period. When the local currency strengthens compared to the U.S. Dollar, there is a positive effect on the Foreign Subs’ sales and a negative effect on operating expenses as reported in the Company’s Consolidated Financial Statements. Conversely, when the U.S. Dollar strengthens, there is a negative effect on sales and a positive effect on operating expenses. For the three-month period ended March 31, 2004, the net impact to the Company’s reported sales from the effect of exchange rate fluctuations was an increase of approximately $181,000 or 3.3%, when compared to the comparable period in 2003. The net impact to the Company’s reported operating expenses from the effect of exchange rate fluctuations was an increase of approximately $86,000 or 3.4%, when compared to the comparable period in 2003.

     Assets and liabilities of the subsidiaries are translated at the exchange rate in effect at each period-end. Translation adjustments arising from differences in exchange rates from period to period are included in the accumulated other comprehensive loss account in stockholders’ equity. At March

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31, 2004 the accumulated other comprehensive loss was approximately $443,000, which included the cumulative effect of foreign currency translation adjustments of approximately $450,000.

Interest Rates

     Advances under the Company’s line of credit bear interest at the prime rate or at LIBOR plus 2% (3.11% as of March 31, 2004). At March 31, 2004, the Company had no outstanding advances under the line of credit.

     The Company’s cash and equivalents are generally invested in money market accounts and short-term debt instruments of highly rated credit issuers. The Company limits the amount of credit exposure to any one issuer and seeks to improve the safety and likelihood of preservation of its invested funds by limiting default risk and market risk. Based on the Company’s short-term investment portfolio at March 31, 2004, the Company believes that a 10% rise or fall in interest rates would have had no material impact on its financial statements.

     The Company’s interest income on longer-term investments is dependent on the interest rate attributable primarily to the debt securities purchased by the Company. Since the Company generally holds these securities to maturity, changes in interest rates are not expected to have a material impact on the value of the Company’s portfolio.

Item 4. Controls and Procedures

     Based on the evaluation of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended), the Company’s principal executive officer and principal financial officer have concluded that such controls and procedures were effective as of the end of the period covered by this report. In connection with such evaluation, no change in the Company’s internal control over financial reporting occurred during the last fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

*

Pursuant to Commission Release No. 33-8238, this certification will be treated as “accompanying” this Quarterly Report on Form 10-Q and not “filed” as part of such report for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of Section 18 of the Securities Exchange Act of 1934, as amended, and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the registrant specifically incorporates it by reference.

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SIGNATURE

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

*

Pursuant to Commission Release No. 33-8238, this certification will be treated as “accompanying” this Quarterly Report on Form 10-Q and not “filed” as part of such report for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liability of Section 18 of the Securities Exchange Act of 1934, as amended, and this certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent that the registrant specifically incorporates it by reference.

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